Untitled Quiz

Business Credit Essentials - Chapter 2

• The module authors are Jasman Tuyon, PhD; Rapheedah Musneh, PhD; Siti Julea Supar; and Nurziya Muzzawer, from the Faculty of Business and Management, Universiti Teknologi MARA, Sabah Branch, Kota Kinabalu Campus.
• The course is FIN367, Business Credit Essentials.

Chapter's Outline

• Principles of Lending (9 Principles): Includes details on the 5Cs Model and CAMPARI Model.
• Credit Evaluation Framework: Explores the 5Cs Model (Character, Capacity, Capital, Conditions, Collateral). and CAMPARI Model (Character, Ability to repay, Margin of finance, Purpose, Amount, Repayment terms, Insurance).
• Credit Information and Verification: Covers company documents (credit information), third-party records/opinions (verification), and warning signals.
• Loan and Securities Documentation: Includes Loan Agreement, Property Security, Other Security, Guarantee and Indemnity.

Principles of Lending (cont.)

• Principle of Risk Taking: Effective risk management is crucial, identifying and mitigating risks, using credit covenants, terms, and conditions. The bank must adopt a credit culture that guides the Bank's Management.
• Principle of Prioritizing the Quality of Credit: Loan quality is paramount for sustainability and profitability. Loan impairment can significantly impact financial health. The lender requires 50 to 100 times new credit to offset losses.
• Principle of Proportionate Stake: Lenders assess the financial and capital commitment of borrowers to understand their risk tolerance. A poor financial commitment increases risk of default during economic hardship.
• Principle of Pari-Passu: Creditors must have equal rights in the event of foreclosure. This avoids junior creditor positions and maintains equitable treatment for all lenders.
• Principle of Protection: Collateral and credit supports are crucial risk mitigation strategies. The loan should be protected by sufficient collateral (stable, marketable, easily transferred). Unsecured loans should have viable business cash flow and sufficient unencumbered assets.
• Principle of Control: The lender must manage the loan usage and repayment source. Proper structure, lending covenants, and effective monitoring system are necessary.
• Principle of Risk Diversification: Lender diversification is crucial. Over-concentration in a single industry or borrower group can increase risk.
• Principle of Appropriate Tenure of Financing: The loan term must align with the borrower's needs, avoiding mismatch and abuse of the facility. A longer term entails a higher risk of default.
• Principle of Purposeful and Productive Lending: Loans must serve a clear purpose, supporting productive business operations (income generation for repayment).

Credit Evaluation Framework (cont.)

• The 5Cs Model: Character, Capacity, Capital, Conditions, and Collateral are used to assess borrower creditworthiness.
• Character: Focuses on borrower integrity, responsibility, honesty, diligence, prudence, and reputation, requiring past track record review, personal interviews, and market research.
• Capacity: Assesses the borrower's ability to generate cash flow for repayment. Financial ratios (TIE, DSR), management competency, and professional qualifications are key.
• Capital: Evaluates borrower financial commitment by evaluating ratios (Debt to Equity Ratio), paid-up capital, and retained earnings, ensuring the commitment is sufficient and stable.
• Conditions: Macroeconomic factors influence borrower's ability and stability, considered in terms of global issues, exchange rates, and industry trends.
• Collateral: Measures the security against the loan, assessing its value, marketability, title clarity, and depreciating, fluctuating, or stable value.
• CAMPARI Model: An expansion of the 5Cs Model, adding ability to repay, margin of finance, purpose of the loan, amount borrowed, repayment terms, and insurance coverage.

Credit Information & Verification

• This covers various aspects of verifying borrower creditworthiness, including company documents (registration, financial statements), third-party reports, and 'warning signals' (audit issues, frequent change of offices or auditors, legal disputes, and incomplete regulatory filings).
• The importance of credit bureaus (e.g. CTOS, CCRIS) is emphasized and how they use various sources to generate credit reports.

Loan Securities & Documentation

• Introduction: Security is a fallback mechanism in case of default but doesn't eliminate the risk entirely. Good collateral should include strong marketability and liquidity/measurability, ownership clarity, ease of transfer, and stable value.
• Loan Agreement: This spells out the contract terms, conditions, parties involved, execution/execution dates, and other loan-securing provisions.
• Loan Facilities: Includes details of loan types, amounts, interest rates, repayment schedules, security requirements
• Conditions Precedent: (e.g., directors' resolution approving the loan) and detailed conditions to meet loan approval.
• Conditions of Drawdowns: (e.g., bank approval/verification) - steps to access loan funds.
• Continuing Conditions / Covenants: Measures (e.g., financial covenants, working capital maintenance, sinking fund requirements, borrowing and debt restrictions, dividend payment restrictions) to manage the loan duration and prevent risks.
• General Covenants: Details additional conditions, such as ensuring valid licenses and agreements, adequate insurance policies, prohibited disposal of assets

Key Collateral Categories

• Depreciating: Collateral values that decrease over time, such as vehicles, plant, and machinery.
• Fluctuating: Assets such as stocks, bonds, commodities.
• Stable: Assets such as fixed deposits, which maintain constant value.
• Potentially Appreciating: Assets such as land, which can increase in value.

Guaranteed/Indemnity

• Lenders may require additional credit support or recourse in the event of loan default.
• Guarantors are secondarily liable for debts (sole proprietors, partners cannot provide guarantee for company debts).
• Corporate Guarantees are used by parent/subsidiary companies.
• Important factors for guaranteeing credit (e.g., debt servicing ratio exceeding guidelines, loan terms and asset lifespan).
• Procedures for achieving a guarantee perfection. Procedures for enforcement, such as legal actions (attachment, garnishment, bankruptcy).

Other Security Types

• This covers additional security options beyond property (e.g., fixed deposits, stocks/shares, unit trusts, insurance policies, hire purchase financing, and debentures.

Additional Notes

• Different types of legal charges (e.g., first, second, third-party charges). These are explained, with emphasis on procedures for registering the charge via legal documents with proper authorities.
• Important procedures for property that's not fully developed (under construction, in the process of being sold).