SAIB - Day 3 PRINT - Introduction to corporate banking PDF

Corporate Banking Day 3 © 2024 CHC Financial Training Limited Agenda What? Introduction to corporate banking Corporate credit risk Working capital finance Long-term lending...

Corporate Banking Day 3 © 2024 CHC Financial Training Limited Agenda What? Introduction to corporate banking Corporate credit risk Working capital finance Long-term lending Why?… Capital markets- bonds and equity How?… 2 © 2024 CHC Financial Training Limited Corporate Banking © 2024 CHC Financial Training Limited Business structure Sole trader - is a self-employed individual who Limited company - is a separate legal entity owns and runs their own business. The general formed through incorporation that business doesn’t have any legal identity limits the amount of liability undertaken by the separate to its owner company’s equity or shareholders Partnership - A partnership is a formal arrangement by two or more parties to manage and operate a business, all partners share liabilities and profits equally, while in others, partners may have limited liability 4 © 2024 CHC Financial Training Limited Question In your teams discuss, what is equity? Go to www.menti.com And use code shown on the screen 5 © 2024 CHC Financial Training Limited Question In your teams discuss, why a corporate will come to a bank? Go to www.menti.com And use code shown on the screen 6 © 2024 CHC Financial Training Limited Corporate Banking Financing services Trade Finance services Cash management services Treasury solutions Interest rate derivatives Foreign exchange derivatives Commodity derivatives Structured deposits 7 © 2024 CHC Financial Training Limited Question In your teams discuss, what are the stages in the corporate life cycle? Go to www.menti.com And use code shown on the screen 8 © 2024 CHC Financial Training Limited SAIB’s strategy 9 © 2024 CHC Financial Training Limited Corporate relationship The bank hopes that customer relationships are dynamic and can be developed to become both deeper and more profitable Below are the four stages of development of the customer relationship 10 © 2024 CHC Financial Training Limited Financial controllers Controllers/Treasurers Day-to-day transactional banking Manage working capital Working capital facilities Payments and collections Make sure the questions they ask are relevant to Liquidity management your role and address Reduce banking cost your concerns Optimize banking relationships Trade finance funding Transaction hedging products 11 © 2024 CHC Financial Training Limited Finance director Finance director Financial efficiency Real-time information Rating stability and credit metrics Make sure the questions Risk management strategy they ask are relevant to Long-term funding needs your role and address Capital structure your concerns Investor relations Access Recruitment 12 © 2024 CHC Financial Training Limited Cash management (T) Collections and payments – physical or electronic Cash is a critical for the health of a company and needs to be managed (C) Interacting with accounts, efficiently to support growth and financial tracking and managing activity strength Investment in automation by banks assists (LM) Optimising funds after paid in companies in managing their cash and cash and before paid out cycle Banks look at cash management as: – transactions (T) – channels (C) – liquidity management (LM) 13 © 2024 CHC Financial Training Limited Adding value Efficient processing: automation of payments How can the bank add-value to the and collections domestically/internationally, corporate treasury department? without human intervention. Bank systems globally to be integrated, so process operate as one seamless network with real-time reporting Active management: ability to provide services for the active management of cash positions. Leading to more accurate forecasting of positions and of working capital requirements Strategic support: supporting the corporate through cash management solutions that minimise the cost of funding and reduce idle cash within the corporate structure 14 © 2024 CHC Financial Training Limited Motives for holding cash 15 © 2024 CHC Financial Training Limited Question In your team, list what you think are the objectives of cash management? 16 © 2024 CHC Financial Training Limited Working capital management Objectives Financing If cash is not available Treasurers have clear when needed, the Key questions for the treasurer objectives for wanting corporate must borrow have short- How do I manage my Are there funds to to manage working term facilities supply chain process my capital provided by the bank payments? When will I receive my incoming funds? Can I reduce my short- term debt? What is my cash position? How much cash is needed today? How much cash is needed D+1? Collecting cash from Improving cash flow, customers means cash speedier collection of No 1: How do I increase the efficiency of my business? is available to pay receivables, slowing suppliers and payments to suppliers No 2: How do I reduce my banking costs? employees. Growing or paying suppliers sales does not mean more rapidly in return more cash unless cash for discounts increases is collected the profit margin Cash position Bank value added 17 © 2024 CHC Financial Training Limited Corporate Credit Risk © 2024 CHC Financial Training Limited Corporate risks explained Business risks: Credit risk: Associated with business Default risk on credit strategy, development and instruments held by the firm: marketing strategy: Accounts receivable Consumer tastes Default on investments in Competition other companies Changing technology Concentration risk Operational risk: Market risks: Associated with breakdown Associated with changes in in internal controls: the economic environment: Supply chain/inventory Quality Commodity/energy prices Product delivery FX and Interest rates Internal fraud/theft Equity prices 19 © 2024 CHC Financial Training Limited Total credit risk Credit risk is no longer seen from the Systematic risk is also referred to as perspective of looking at a borrower in ‘undiversifiable’ or macroeconomic risk isolation Banks cannot avoid such risk because Credit risk is based on a total risk model it affects all enterprises, that operate looking at two categories of risks: within a particular jurisdiction Systematic; and unsystematic Unsystematic risk is sometimes referred to as ‘unique risk’ to a particular business This risk can be avoided or reduced if the management of a business is able to diversify the company’s activities 20 © 2024 CHC Financial Training Limited Lots of Cs in credit Borrower application Approval/rejection Credit analysis Credit administration Credit management Customer Capital usage Credit policy Character Compliance Credit structuring Capacity to repay Concentration Credit sanctioning Capacity to contract Collection Credit limit Contribution Provision for default Credit pricing Collateral Charge-off Cross-sell Conditions and covenants Capital requirements 21 © 2024 CHC Financial Training Limited Credit risk Credit risk is the risk of loss through a failure What do we of an issuer to meet obligations in accordance mean by with agreed terms financial strength? Credit risk arises when an investor commits or extends funds to an issuer or agrees a Corporate Sovereign Retail transaction with a counterparty Financial strength, use Historical behavior Historical of internal and Capacity to pay behavior external ratings Willingness to pay Capacity to Limited use of pay collateral Collateral Covenant package availability Analytical data Historical data and modelling 22 © 2024 CHC Financial Training Limited Credit questions for the bank Historically banks asked three questions: Can we and do we want to lend? For a corporate borrower this is likely to How much can or should we lend to this mean an increased margin and or loan customer? fee, shorter maturities for loans and How long can or should we lend for? more robust covenants Since Basel III, additional questions must be raised: Is the deal attractive in comparison to other transactions with similar risk? What are the capital and funding requirements for the transaction? What is the risk adjusted return on the transaction? 23 © 2024 CHC Financial Training Limited Expected loss PD is the likelihood of the borrower EL Expected loss failing to meet their commitments under the credit agreement, failure to pay interest and/or principal on time = PD Probability of default LGD is the amount the bank is likely to X lose if the customer defaults on commitments within the credit LGD Loss given default agreement (1 – RR) X EAD is an estimation of the extent to EAD Exposure at default which a bank may be exposed to a counterparty at the time of default 24 © 2024 CHC Financial Training Limited Drill down on risk Country risk Industry risk Corporate risk Documentation risk 25 © 2024 CHC Financial Training Limited Industry risk Stable or cyclical? Subject to high or low regulation? Are the products stable or discretionary purchases? Industry barriers to entry? Is the industry profitable and growing? Profit margins compared to all industries Levels of competition Opportunities - geographical or customer base 26 © 2024 CHC Financial Training Limited Company risk Management Depth, breadth, experience, integrity and track Strategy for acquisitions and disposals record Dealing with underperforming units Strategy and policies - realistic? Succession planning Management vs the investor’s view Environmental, social and governance record Over-optimistic projections: Poor internal planning Relationship with regulators Reputation within the industry ESG 27 © 2024 CHC Financial Training Limited The rating agencies There are three major global credit rating agencies – Moody’s, S&P, and Fitch Each use symbol-based ratings that is an Issuer credit ratings assessment of a bond’s risk of default Address an obligor’s overall creditworthiness - its ability and Ratings are based on analysis by rating professionals who evaluate public willingness to make timely payments of information to form an opinion as to the interest and principal on its debt risk of default Unlike some opinions, credit rating are not Issue ratings intended to be a recommendation Refer to specific financial obligations of Rating agencies provide outlooks on their an issuer and take into consideration such respective ratings – positive, stable, or factors as ranking in the capital structure negative Introduction to Excel 28 © 2024 CHC Financial Training Limited Credit ratings Introduction to Excel 29 © 2024 CHC Financial Training Limited Customer analysis Size of business Products Large multi-national company Multiple product lines all brand leaders Small domestic company Single product line and a discretionary purchase Customer base Diversified, repeat or long-term contract Supply chain and renewable Well established, long-term Concentrated and one off contracts relationships, and well-funded Limited suppliers with limited flexibility Market position Market leader with a strong brand or Risk management brands Clear recognition of business risks and Market follower and unbranded use of hedging Unclear policy to risk management 30 © 2024 CHC Financial Training Limited Moody’s rating Fundamental analysis Ratio based analysis Source: Moody’s 31 © 2024 CHC Financial Training Limited SWOT analysis 1 CONVERT INTERNAL STRENGHTS WEAKNESSES REMEDY MATCH EXTERNAL OPPORTUNITIES THREATS CONVERT 32 © 2024 CHC Financial Training Limited SWOT analysis 2 Strength - A useful internal resource or competency that allows a company the ? possibility to leverage revenue growth or achieve cost cutting measures Weakness - An internal inefficiency Questions relating to SAIB that prevents a company from earning Strengths and opportunities: Can the additional revenues or cutting costs bank leverage its advantage? Weaknesses and threats: Can the bank Opportunity – An external factor that address its problems? provides a possibility to produce Strengths and treats: Can the bank revenues or reduce costs address its vulnerability? Threat – An external factor that may Weaknesses and opportunities: Can cause the possibility of falling the bank overcome its limitations? revenues or increased costs 33 © 2024 CHC Financial Training Limited Question In your team, list the warning signs to suggest a corporate may have credit or other issues 34 © 2024 CHC Financial Training Limited Working Capital Finance © 2024 CHC Financial Training Limited Operating cycle Operating Cycle – is the time it takes a company to buy goods, sell them and receive cash from the sale of goods Accounts Receivables (AR)/ Cash at Bank Inputs Accounts Payable (AP)/ Purchase to Order to pay pay Days sales outstanding (DSO) Days payables outstanding (DPO) ▪ Margin ▪ Raw materials ▪ Payment terms ▪ Labour Banking solutions Banking solutions ▪ Returns ▪ Utilities ▪ Payment services ▪ Collection services ▪ Supply chain finance ▪ Invoice discounting Working ▪ Trade finance ▪ Liquidity management Capital ▪ Trade finance Sales Processing ▪ Manufacturing Inventory/supply chain ▪ Refining Days inventory outstanding (DIO) ▪ Fabricating 36 © 2024 CHC Financial Training Limited Working capital vs operating working capital 37 © 2024 CHC Financial Training Limited Working capital calculation Current assets Current liabilities Inventory 700,000 Payables 850,000 Receivables 1,200,000 - Short-term-loans 250,000 Cash 300,000 Taxes payable 220,000 Investments 150,000 Dividends 150,000 2,350,000 1,470,000 = Working capital 880,000 = Operating working capital 1,050,000 38 © 2024 CHC Financial Training Limited Metric calculations DIO DSO DPO CCC Days inventory outstanding: How much cash is Days sales outstanding: Level of credit tied up in the production and distribution? given to customers Inventories Trade receivables  365  365 COGS Revenues Days payables outstanding: Level of trade credit from suppliers? COGS to avoid margin changes Trade payables  365 39 © 2024 CHC Financial Training Limited COGS Financing working capital Overdraft Revolving facility credit facility (RCF) Confidential Invoice Supply chain discounting finance /factoring 40 © 2024 CHC Financial Training Limited Corporate RCF Dec 31 Mar 31 Jun 30 Sep 30 Dec 31 Zero RCF limit 41 © 2024 CHC Financial Training Limited Invoice discounting Short-term facility to corporate (1b) Seller electronically submits the invoice to their bank and is advised customers designed to unlock working Seller the financing amount for that invoice Seller’s bank capital held in accounts receivables (order to cash) Corporate controls relationship, sales ledger and collections (2) If acceptable to seller, their bank will remit the loan amount to the seller Buyer not aware that its invoices are (4) Bank repays being discounted and paid by the bank the loan amount to the seller (1a) Sales contract plus collects Facility is flexible and can grow as & invoice raised interest and sales (receivables) grow 3 returns net balance to the Available in different currencies for seller export receivables (3) Buyer remits the full invoice amount on the due date. This payment is often to a separate account in the seller’s name but controlled by their bank Buyer 42 © 2024 CHC Financial Training Limited Supply chain financing (SCF) Facility initiated by the buyer of goods and services that permits its suppliers to sell their invoices to the buyer’s bank at a discount Suppliers can accelerate collection of receivables to reduce its DSO The buyer can now pay the bank later, or potentially receive a discount on the purchase price from the supplier, this impacts their DPO Discount based on credit of buyer SCF can reduce financing costs throughout the supply chain 43 © 2024 CHC Financial Training Limited Long-term lending © 2024 CHC Financial Training Limited Loan structures Bilateral loans Syndicated loans One borrower and one lending bank Under a syndicated loan the borrower executes one loan agreement to cover a loan funded potentially by a large group of relationship and Club loans non-relationship banks Small group of relationship banks Bridging loans Identical terms set by the borrower Short-term financing designed to ‘bridge’ an asset sale, bond issue, stock offering or Restrictions on transfer divestiture Asset based or Cash flow based? 45 © 2024 CHC Financial Training Limited Loan types Asset based Cash flow based Used for acquisition, project finance, and Flexible and relatively quick to put in place equipment financing Confidentiality financing No/lower prepayment penalties Less expensive due to collateral package Amortization can drain cash from the Amortization structure can drain cash from the borrower borrower Managed to very strong covenant package Strong emphasis on historical and future cash Senior secured take priority over all other debt flow financings Collateral – none FIXED CHARGE over physical assets FLOATING CHARGE (debenture) over unspecified assets – inventory, receivables and cash 46 © 2024 CHC Financial Training Limited Repayment structure Equal annual Bullet repayment amortization Amount 1 2 3 4 Years 1 2 3 4 5 Years Grace Equal annual amortization period 0 1 2 3 4 5 6 Years 47 © 2024 CHC Financial Training Limited Question In your teams, list the sources of repayment for a bank loan 48 © 2024 CHC Financial Training Limited Capital Markets – Bonds and Equity Issuance © 2024 CHC Financial Training Limited Financing structure Optimum capital structure Investment needs Why choose debt % Define Cash flow volatility Financial flexibility 91% debt Rating target capacity Maintain credit rating 73% Asset maturity profile Minimize WACC 70% Projected debt repayment capacity Tax benefit 58% Debt Currency exposures structure Acceptable market and liquidity risk Cash flow volatility 50% Existence of natural investor base Selected Credit ratings market Funding cost objectives Investor diversification 50 © 2024 CHC Financial Training Limited What is a bond? What? A fixed income or bonds are: Fixed income, investors are debtholders Debtholders receive the promise of a known cash flow at specific dates Debt can be risk-free, investment grade or speculative grade a medium/long-term debt obligation issued in the capital markets Why?… interest is paid as fixed coupon, other structures do exist principal (borrowed amount) is repaid in one payment at maturity (bullet payment) bonds are negotiable instruments so investors can buy and sell without the How?… Investors, “what can go wrong?” issuer’s approval Equity Investors? 51 © 2024 CHC Financial Training Limited Format for issuance Domestic bonds Bonds issued into issuer’s International/eurobonds home country, in home currency A bond issued in a Euro-currency US domestic market highly currency that is held outside of developed – historical single the country – euro-dollars, euro- currency, single legal system sterling, euro-yen (SEC) Eurobonds not SEC registered cannot be sold in US Foreign bonds Market developed for tax reasons Issued into a domestic market Eurobond coupons always paid by a foreign borrower without any withholding tax Either in the domestic Call provision if changes are currency, e.g., Samurai, made to tax regulations Yankee, Bulldog, Lions, Dim Sum, Panda, and Kimchi 52 © 2024 CHC Financial Training Limited Governments 1 Large amount outstanding, therefore high liquidity Risk-free rate with little or no credit risk associated with government bonds (G14) ‘Benchmark’ yield curve Component in pricing: Corporate bonds, and derivative products Normally, launched via an auction Sold on a yield or price basis Regular and familiar auction process Safe haven 53 © 2024 CHC Financial Training Limited Governments 2 Government Bond Structures US Treasuries - Issued by the U.S. Department of the Treasury – Bills