Credit Investigation

Credit Investigation Overview

• Conducted to quickly determine an applicant's creditworthiness
• Designed to detect and prevent credit extensions to those with unfavorable records
• Includes in-house credit file and field verification

Purpose of Credit Investigation

• Validate data about a loan applicant/borrower
• Can be done on third parties seeking business relationships with the bank
• Gather and analyze relevant borrower information for sound credit decisions

In-House File Verification

• Checks all credit applications not initially rejected against existing records

Consists of:

• Reviewing credit files to find past or present transactions with the company

Court Case Verification

• Involves checking names against compilations of collection cases filed by creditors

In-House Verification Details

• Conducted using the borrower's name, aliases, and trade/business names

Includes checking:

• Spouses: For married individuals, check both spouses for credit transactions
• Co-makers, co-buyers, or guarantors
• Self-employed borrowers under personal and trade/business names
• Individual applicants in family firms, also verify the company
• Corporate accounts: Verify both the entity and owners/stockholders
• Verify that the gathered name matches the applicant's identity on the application

Action if the applicant has a court case

• If the credit investigator knows the applicant is a defendant, investigate to determine if it is the same case

Field Verification

• Consists of:

Residence/Neighborhood Verification

• Inspects the applicant's residence and checks with neighbors and store owners

Purpose:

• Gather background and reputation information
• Verify applicant and spouse's names, aliases, ages, citizenship, and children

Field Verification: Residence Details

• Verify provincial addresses if applicable
• Describe the house and lot/floor areas
• Confirm the client's residence and length of stay
• Determine ownership of vehicles and appliances

Field Verification: Character Assessment

• Assess the client's reputation in the neighborhood
• Determine the living conditions and neighborhood type
• Gather personal data/background
• Determine if the house is rented or owned, and number/age of children

Field Verification: Income

• Determine the applicant's and spouse's income bracket

Business Verification

• Verifies information about the applicant and related business interests.
• Confirms the nature, legitimacy, profitability, address, and position of the business.
• Determines the organization type and registration status.

Business Verification: History

• Checks the history, including the start date, years of operation, employees, major products/services, and clients

Business Verification: Finances

• Examines suppliers, bank accounts, neighborhood character, and building administration
• Compares accountant records and checks business premises
• Assesses branches, assets, financials, sales, receivables, inventory, capital, and income

Employment Verification

• Gathers details related to the applicant's job and employment status

Includes:

• Employment status, length of stay, position, compensation, and client's address

Trade and Bank Verification

• Determines client character and payment habits

Checks:

• Bank accounts, dates opened, average balance (ADB), present balance
• Account status (active or dormant), and bank's experience

Elements of Credit Investigation: Individuals

Identity of the Borrower

• Establish the borrower's identity to ensure enforceability
• Further checking proceeds after identity confirmation

Borrower Information

• Obtain data on age, health, character, reputation, family life, and residence
• These factors affect the ability to repay

Applicant Age

• Young applicants should be established and display financial competence
• Determine remaining productive years of senior applicants

Borrower Health

• Investigate health to assess ability to work and generate income

Borrower Reputation

• Establish reputation through residence and employment checks
• Cover habits, morals, dependability, and attitude toward obligations

Applicant Marital Status

• Indicates applicant's stability
• Creditors avoid lending to unstable families

Borrower Dependents

• Investigate personal circumstances and status of dependents to determine demands on the borrower’s income

Purpose and Motivation of the Loan

• Determine the intended use of the loan
• Unproductive purposes may reduce repayment sources
• BSP regulations require the purpose be in loan transactions

Loan Misuse

• Using the loan for unintended purposes can lead to immediate repayment demands

Source of Income

• Establish amount, regularity, and expected continuity of income
• Gather information on the borrower, employer, or business firm for self-employed individuals

Income Demands

• Calculate living expenses and obligations to check if the borrower can take on additional debt

Financial Condition

• Evaluate net worth to reveal assets available as reserves

Borrower Thriftiness

• Determine the propensity to accumulate savings and credit patterns

Credit History and Paying Habits

• The borrower's payment record is an important predictor
• Obtain information on court cases, litigation, bankruptcies, and repossessions

Corporate Borrowers

• Consider type of corporate borrowers

Corporate Borrowers: Small vs. Large

• Small/Family Held - Include CI on the owners similar to the CI for self-employed individuals.
• Big Corporations with Diversified Ownership - center CI on the amount of debt, credit history, cash flow and capability of the applicant firm.

Corporate Borrowers: Subsiduaries/Affiliates

• Corporation with Subsidiaries/Affiliates - Apart from the borrower-firm, CI shall also include the subsidiaries and affiliates if a big portion of the parent company's income comes from a subsidiary

Identity and Motivation of the Corporate Borrower

• Establish if the corporate applicant is registered with the Securities and Exchange Commission
• Unregistered corporations lack legal identity and the capacity to enter into contracts

Corporate Articles

• Review corporate papers, being familiar with the powers of the corporation under its Articles of Incorporation and the powers of its officers/directors under the By-Laws
• There could be certain restrictions on the powers of the Corporation and its officers/directors that may affect their transactions

Loan Repayment

• Review the purpose of the loan against the corporate powers and should redound to their benefit

Company Profile

• Review profile of people behind the corporation – incorporators, stockholders and principal officers as a gauge of management strength

Corporate Source of Income

• Obtain data about the present operations of the applicant, major product lines, suppliers, clients, market area and competitors
• First-hand information should also be obtained about the corporations’ major facilities and assets

Evaluating Financial Condition

• Evaluate the present and past financial condition of the firm and the structure of the assets, liability and capital

Operational Stability

• Establish the stability of ongoing operations and the probability of continuance on a long-term basis and establish data about financial performance

Evaluation Checklist:

• Comparison of performance versus competitors
• Projection of financial condition and financial performance, as well as cash flow projections, and future prospects of ongoing businesses
• Feasibility study and analysis of project to be finance

Corporate Credit History and Habits

• The corporation's dealings with other creditors and suppliers will serve as predictor of future credit behavior
• Court cases particularly those involving sum-of-money cases against the corporation point toward poor paying habits

Sources of Credit Information: Dual Types

• There are internal and external sources of information

Internal Assessment

• Internal sources of information are those generally provided by the applicant in Loan Application and Personal Interview and must be cross checked before the assessment

Borrower's Bias

• Borrowers tend to withhold certain information that would result in a rejection of his loan application
• This may also apply to other sources who may have an interest in the loan being applied for

Loan Refinancing

• In cases where refinancing is involved, the present lender of the applicant may state positive data even if what they say is not true, they may want the loan transferred to the Bank thereby relieving the first lender of his collection problem

References

• Applicants prefer references that give favorable replies, so consider these with a grain of salt

Overcoming Predictable Bias

• The predictable bias from these sources should impel the skillful investigator to develop evidence from informants not supplied by the Borrower

Asking the Right Questions

• Questions must be specific so that informants are induced to reply factually, rather than being vague by giving loosely stated opinion and judgments or by not mentioning unfavorable points

External Sources of Information: Definition and Importance

• External sources of information are independent data obtained from parties or sources not related to or within the control of the subject-applicant

Sources to Consult

• Negative Data Files, Bank Checking
• These data are however not readily available and proper contacts must be developed for this purpose

Internal Source: Loan Application

• General applicant information is gathered
• Data supplied is treated as unverified

Personal Interview

• Obtain supplementary information
• Determine leads for credit investigation

Financial Statements

• Minimum of three years should be analyzed

Financial Statements: Categories

• Liquidity position- ability to meet day to day current obligations
• Solvency– determines dependence on financial support from creditors
• Managerial efficiency – ability of the firm to operate profitably and successfully for a long time

Key Watchouts: Accounting Information

• Signs of window-dressing or the misstatement of accounting information to reflect a better financial condition than what it is actually
• Non-existent or bloated asset accounts, understated or undeclared obligations

True of Unaudited Financials

• Be aware of unaudited or in-house financial statements

Negative Files

• Blacklisted accounts are blacklisted

Identifying Negative Credit Data

• The Bank relies on the following external sources of negative credit data:
• Bankers Association of the Philippines (BAP) provides the following:

BAP:

• Current accounts closed by member banks due to mishandling

CMap

• actions thru the Credit Management of the Philippines (CMAP)

Bank Details

• Data about:
  • Cancelled credit cards
  • Credit dealings with member banks

External Source: Credit Information Bureau

• This provides information on credit history of applicant with banks and other financial institution, negative data and complete CIR works

Goverment Institutions

• Government agencies such as the Securities and Exchange Commission (SEC) and Department of Trade and Industry are sources of information about applicants doing businesses

SEC Filings

• Articles of Incorporation, By-Laws, Minutes of the Board Meetings and Audited Financial Statements are required to be filed with the SEC.

Employer Information

• This provides information about type of work done, amount/trend of wages, status of employment and chances for advancement, behavior in the office and relationship with co employees.

Obligations with the Company: The Value of Context

• Existing obligations with the company should also be inquired on

Contacting Former Employers

• Similar information may also be obtained from former employers including the reason for subject's departure from the company

Income Tax Returns

• Useful for source validation

Includes data on:

- Sources and trend of income once validated as correct by the BIR or the filing agent
- Confirms the marital status and the number of dependents of the applicant

Applicants with Deductions: Knowing Interest Expenses

• For applicants availing of the itemized deduction scheme, data on interest expense can provide leads as to the present debts of the applicant

Financial Institutions

• Useful for getting the correct data on loan details

Includes information on:

• The applicant's
  • Debts
    • Debt status
    • Payment History
    • Financial condition

Trade References

• The amount of business to be done
  • Gives an indication of the reasonableness of income figures
  • Status of business operations of the applicant
• The credit history with suppliers
  • Will also indicate if the applicant is a good payer

Plant Visit

• Gives an insight on how the business is ran

Includes

- Business processes prospect
- Operating issues can be learned from discussions with officers and employees on the site

• Useful for confirming
  • Confirm financial figures presented in the financial statements and loan application

The Sensitive Information

• Confidential nature of credit information must be safeguarded at all times

What to avoid

• Revealing data to the subject may be a violation of the law

Appraisal of Collateral

• Collateral refers to the property/ies that the borrower puts up to repay a loan in cases of default, or any undertaking from other credit worthy entities to guarantee the borrower's obligation

Evaluating Collateral

• The borrower's capacity to pay shall always be the primary consideration in the extension of credit
• However, endeavor to have a fallback or a secondary source of repayment in the form of value adequate and legally enforceable collateral/security

Key Qualities

The strength of the collateral should be measured and represented by the following: - The quality of the assets the lender holds - The completeness and enforceability of all supporting legal documents

Appraisal Recording

• All collateral/security accepted shall be properly documented and registered/notarized in favor of the lender

Appraisal Defintion

• Appraisal is an estimate or opinion of value usually transmitted in writing of adequately described property as of a specified date supported by presentation of analysis of factual and relevant data
• Used to affix value on a property to secure a loan

Value

• The estimated worth of an asset

Assumed Market Value

• Market value may be defined as the highest price estimated in terms of money that a property will bring when exposed for sale on the open market, allowing a reasonable time to find a purchaser who buys with knowledge of all the uses to which it is adapted and for which it is capable of being used

Factors:

• A willing seller will sell and a willing buyer will buy, neither being under abnormal pressure

General Considerations: Collateral Choice

Key areas to consider:

- Stability of value
- General purpose use
- Liquidity
- Ease of documentation
- Control over collateral

Appraisal Concerns

Areas of concern during evaluation: - Identification of the property - Authenticity of the titles/documents - Correct market values - Overall quality - Confidentiality

Requirements for Collateral: Real Estate Mortgage

• Photocopy of the Transfer Certificate of Title (TCT)/Original Certificate of Title (OCT)/Condominium Certificate of Title (CCT)
• Declaration of Real Property/Tax Declaration
• Tax Clearance or latest copy of Real Estate Tax Receipt
• Location Plan and Vicinity Map signed by Geodetic Engineer
• Insurance
• If* – corporation – a copy of the board resolution duly executed and acknowledged indicating the names and positions of authorized signatories to the mortgage

Chattel Mortgage: Motor Vehicle

Documents Required: - Proof of ownership - Chattel Mortgage contract duly registered with the Register of Deeds - LTO Certificate of Registration and Official Receipt (current) of motor vehicle - Stencil of Motor and Body Number of Motor Vehicle

Info to include

• Property listing including detailed description, location and purchase cost

Assessing Title

Evaluate documents carefully

Evaluating Collateral

Purpose and Importance of Title Verification To ascertain that the borrower is the true and legal owner of the property To determine any restriction/encumbrance registered and annotated on the tile To determine authenticity of the title being offered as collateral

Collateral Types

Primary Collateral: Real Estate Mortgage

• REM is the conveyance of real estate as security with the condition of becoming void after loan payment
• Mortgagor must be the absolute owner

REM Unacceptable:

Properties with the following attributes make it not accepted:

• In underdeveloped subdivisions
• In depressed area
  • Occupied by squatters
  • For government appropriations
  • No right of way
  • Churches

CM v REM

• (CM) – similar to the REM, is not accepted

Chatell Evaluation

• Chattel Mortgage: Merchandise Inventory

1. Evaluation

• Ownership
• copy of Power of Attorney
• Registration
• Insurace

Permissible Collateral

• Hold-Out on Deposits – is the transfer or settling over of deposit or of rights or interest therein from one person to another, or the act by which one person transfers to another, or causes to vest in another, his right over said deposit
  • Transfer details for loan

When Borrowers are third party

Other type:

To secure payment by a third person:

• Details
  • Property owner approval
• Negative Pledge – an undertaking on the part as long is in good standing with financial institution
• Trust and good will of borrower

Assignment and Endorsement

• Evaluate the quality of assignment of debt

Types:

Primary Agreement

What to get copies of:

• Joint and Several Signature (JSS):
  • Evaluate as you would evaluate surety bond

When it is Used:

• For a sole proprietorship, if the husband is the principal borrower, the wife would be the other half of jss and vice versa
• If not a business look for a guantor
• If a borrower has all the above be on top of it
• Be diligent to prevent losses

Analyzing Credit

Credit Evaluation

• The process where the account officer evaluates all credit information about the borrower

Pre-Analysis Requirements

• The account officer must generate all the relevant documents from the prospective client
• Credit evaluation is made against the credit fundamentals and specific risk asset acceptance criteria
• The account officer must always be mindful of the various risks associated with the account

The Key

• Keep personal and professional life separate
• All should be reviewed

Core Elements

The following major factors should be considered in credit evaluation:

• Quality of ownership
• Management capability
• Financial capability
• Quality of collateral
• Conditions.

Things to avoid

Avoid superficial analysis

What To Ask

During credit evaliation ask:

• What it is
• If its a problem or possible issue
• Can you work in the system or not

Avoiding Bias

• Maintain separation between business analysis and any inclination

What to note

• "house name" is not a reason to abandon common sense and sound practice during credit evaluation when assessing

Information

To find:

• Call customer

Important Questions

• Is the partner up to code
• Is he not in any political system

Evalutating Capital

• Are the owners other sources of income
• Any other cash flow avenues

Review Financials

• Review the whole situation

Review Business History

• Does reputation of business affect customers
• Could the borrowers other risky side-business effect the finances of main business

Comittment

What type of loans are needed for business: - Fresh - Improve Assess if management positions have been up to par and review the level of educcation to all personal

• Always review personal loans prior to loans as if you may need their expertise”

Quality Checks!

If applicable review: - Involvement of fraud - Are they involved in anomalies

Is the Turnover is Turnover

• Assess management and determine is this is good or bad for the business

Hiring: Ethical v Policy?

• Assure fair hiring processes by looking at:

  • Training Policy
  • Review the data that is shown is correct

Other Factors

• Ask internal
• Evaluate the whole picture

All things to explore

• What is needed to review*

Financials Checks

• Look with precision

V Analysis

A careful analysis of everything; - Assure all aspects and details of financials are complete - This is why submitting financial is important