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In general terms, banking involves the business activity of accepting customer’s deposits at a small cost to the bank and then lending those funds to customers at a cost high enough for the bank to earn a profit. The business of lending is very risky, therefore lenders are encouraged to apply the principles of good lending or canons of lending. Though the canons of lending do not prevent the risks associated with lending it does mitigate risks involved.
To address the credit request of the Shepherds, the CAMPARI lending principles will be used since they have proven to credit set of guidelines used for making credit decisions.
• The Shepherds currently has no relationship with the bank, they are customers of another bank.
• The pair is married and wishes to form a partnership to purchase a hotel.
• The couple has no relevant experience in management or the hotel business.
• Mrs. Shepherd has some experience in the restaurant trade. Adam is a freelance illustrator and has some experience in sales.
• Good long-standing customers of their bank in the south of England.
• Financial growth experienced under the existing sole trader owner
• No evidence to suggest the Shepherds are experienced enough to run a hotel.
• New venture will not be priority to Mr. Shepherd (Still wants to freelance)
• Margin will reflect the risks involved.
• The customer’s limited knowledge and experience shapes this request as very risky one.
• The purpose facility is to finance the purchase of the Highland Country House Hotel in Scotland.
• Currently a £280,000 mortgage with their bank, which is valued at £530,000 and up for sale. Equity from sale and £100,000 to be used towards injection.
• Hotel on sale is valued for £590,000 but the Shepherds agree to pay £630,000.
• The customers are asking for £420,000; however a Bridging loan of £530,000 will be required.
• According to the information supplied by the vender it appears that repayment is possible.
• According to the information provided there is no detail on what will be offered as security.
Information to be Considered
• Risks associated with taking new business from another bank
• Little to no experience in the hotel / restaurant management
• From the information available it also appears as if the customers are going to require a Bridging Loan. This raises a lot of questions relating to timing, amount and the question of certainty.
• What will the security be? Will hotel be assigned as security? Will insurance be increased and assigned as security?
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Additional Information Needed
To better assess this request we will need to evaluate their creditworthiness, frequency of lodgements and saving habits and history. Therefore, the following documents are necessary:
• Copies of their credit history / reference
• Banking Statements from their existing bank is necessary
• A business plan (with financials)
A thorough and in-depth analysis is needed to determine the viability of the hotel. The value of the home doesn’t necessarily mean that’s how much it will be sold. It must be established whether this is just an ambitious dream or something that can actually work. A visit and an interview at the hotel would shed light on some of these concerns.
Lending customer’s deposits is a very risky business therefore, we must minimize our risks. Though we don’t want to lose a potentially good customer, the above factors shift more to NO decision.
a.) The Farming business is a highly complex industry consisting of three (3) main types of farming of operations which are:
Crop farming operations involves the use of the land for growing crops for sale & consumption. This activity involves planting, harvesting and selling the crops. Major crops include fruits, barley and vegetables. Timing is very important as it relates to when revenue would be available for this farmer.
Livestock Farming operations involves breeding, raising and caring of livestock for sale and consumption. Chicken and cattle are two types of livestock. Farmer should be aware of birth timing, market prices and climate since they are all factors that affect his business.
Daily Farming operating involves nurturing female cattle and other mammals for their milk for processing and the eventual sale. Dairy farming operations is considered the simplest form of cash flow for a farm. Revenue from sales is received monthly.
b.) A Limited Company is regarded as a separate legal entity, members and directors are not personally liable for the debt of the company. However, a guarantee by the director of a company means that the director is liable for the debt; if all fails the bank can call on the guarantor for repayment. Below are a few advantages and disadvantages of taking a guarantee as security:
Ease: Guarantees are easy to take and enter into, far easier that a mortgage.
Enforceable: The guarantee is easily enforceable, it only takes a simple court action.
Protection: A well-drawn up Guarantee gives the bank maximum power and protection.
Pressure: In the case of default, the pressure the bank puts on the guarantor will be transferred to the borrower. Recovery efforts are greater since you have more parties to pursue regarding the debt.
Multiple Guarantors: A single loan can have multiple guarantors putting the bank in an even more comfortable position.
Recovery: When the guarantee is backed by adequate supporting security the possibility of recovery is far greater than without adequate security.
Uncertainty of Valuation: Guarantees that are not supported by cash or another form of security always face the possibility valuation risk, whereas a change in someone’s personal financial situations could change value of the guarantee.
Strain in Relationship: You can lose a good customer that acts as a guarantor when enforcing a guarantee.
Time: In the absence of a supported security, litigation to enforce payment may be necessary which may take a long time to finalize.
Technicality: Carelessness when taking the security can prove to be very disadvantageous to the bank if discovered during court action.
c.) Calculating Gross Output & Rental Equivalent
Significance of Rental Equivalent Expressed at a % of Gross Out & On a Per Acre Basis
Rental Equivalent Expressed as a Percentage
144.77 = 11%
Rental Equivalent - On a Per Acre Basis: This is important because it tell you that farmer is spending £144.76 per acre in finance cost to achieve its operations on 150 acres.
Rental Equivalent - Expressed as a % of gross output: This tells you that out of farmers total sales 11% goes towards cost for the land (rental equivalent).
d.) The Cash Flow Statement is the third of the major financial statements, its projections are important since it provides a forecast for future cash requirements that a business owner and a potential lender would find useful in avoiding a liquidity crisis.
Cash flow projection is simply a forecast of what may transpire during a specified time. Therefore, it is important to note that a lender should not rely too heavily on cash flow projections alone since other external factors are at play. Two very common factors that may adversely affect the outcome of a cash flow projection are unexpected expenses and uncollected sales (receivables).
a.) The key areas that should be considered by a lending banker when completing a ratio analysis are the following statements Profit and Loss, Balance Sheets and Cash Flows. From this analysis the lending banker can formulate trends within the business. It is also imperative that the lending banker consider the type of business and the industry in which the business operates. It is wise for the banker to also evaluate whether the industry is contracting or expanding and what type of repayment schedules are normal within this industry. The lender should also evaluate and compare the ratios to industry norms.
b.) Generally speaking, ratio analyses are very important to a lender in that they help the lender examine the performance of the company, which ultimately influences their decision. This analysis tells the lender whether the company is improving or deteriorating.
Simply put this ratio acts as a warning gauge to the lender since it tells the lender whether the company is able covers its cost, by identifying sales volume requirement needed to facilitate full coverage of all cost in order for profit to be realized.
Gross Margin %
Stock Turnover Ratio:
This ratio serves as a good indication of a company’s production and purchasing efficiency taking into account the number of times stock is converted into sales over a given period. A lender should view low turnover as a cautionary indicator since it implies poor sales.
Cost of Goods Sold
Gross profit ratio is a profitability ratio that tells the lender how the business is performing (by evaluating the profit earned and the relationship between gross profit and total net sales revenue.
This ratio tells the lender the company's ability to covert its current assets into cash, it is particularly important to the lender since it speaks to the company’s ability to repay their debt.
Cash + Accounts Receivables + Marketable Securities
Interest Cover (Interest Ratio)
Interest Cover Ratio is a tool that the lender can use to measure whether a company is having challenges generating enough cash flow to satisfy the interest required to pay its debt. A ratio close to 1 suggests that the company is in trouble anything over 1.5 signifies the opposite.
Net Profit Before Interest and Tax
Subsequent to a full analysis the lender should compare results with previous figures in order to complete a trend analysis. The lender should follow up with by taking a closer look at account details which should be supplemented by an interview with the customer.
Lending is the heart of any bank. The trade and foreign business is huge business in the UK, therefore banks play a key role in this financing this activity.
As Vice President of Strategic Development it is Denise Vega’s responsibility to find ways to expand her company, WoodU Ltd. located in the UK. Denise Vega contacts the bank requesting advice on possible facilities that could help expand WoodU Ltd. to wider markets throughout Europe.
Below is the bank manager’s reply to her email.
The bank has four (4) special products that you helpful towards achieving your business goals. The four (4) facilities are:
• Documentary credits
• Performance bonds
• Forwards contracts
• Acceptance credits
To satisfy your goal of importing raw materials from European suppliers you have the option of a Documentary Credit. For example, you arrange to purchase unfinished wood from Manufactures Inc. in Germany for £75,000. Manufactures Inc. asks you to open a Documentary Credit at your bank in favour of them. In your case, we (BIFS Bank) would act as a guarantor on your behalf to your supplier once the wood is received as stipulated in the contract.
In your quest to expand your sales / exports beyond UK boarders you can take out Performance Bond, which is guarantee by your bank to reassure the foreign buyer that 100% payment will be made in the event the WoodU Ltd. fails to meet the conditions of the contract. An example is: WoodU Ltd requests a Performance Bond from BIFS Bank to reassure Shepherd Motel in Scotland that their purchase of 500 cabinets for £200,000 within 6 weeks. The bank provides a guarantee that 100% of the transaction will be paid in the event WoodU Ltd. fails to perform as per the contact.
Another facility you will find beneficial during your expansion to foreign territories is a Forward Contract. Consider the example used for the Documentary Credit, in which WoodU Ltd. arranges a guarantee from BIFS Bank to purchase £75,000 worth of unfinished wood from its supplier, Manufacturers Inc. in Germany. Let’s say for this this scenario that payment for the wood is due in 5 months and must be in € Euro therefore WoodU Ltd. wishes to lock in the exchange rate available on the purchase date which will also be available in 5months time even if the rate were to change. Therefore it will supplement the Documentary Credit with a Forward Contact from its bank to lock the exchange rate. This facility is particularly helpful in mitigating risks associated with changes in exchange rates.
Finally, as an exporter you have the option of arranging an Acceptance Credit, this establishes an arrangement by the bank (or an Acceptance House) in the exporter’s country to establish a revolving line of credit for a stipulated amount, similar to an overdraft facility on behalf of a creditworthy importer to whom you are selling goods and service.
The aforementioned facilities are all based on contractual relationships comprising of three (3) different, they are:
1. Exporter / seller / contractor - responsible for actually performing the work or providing the raw materials.
2. The importer / beneficiary /buyer refer to the person purchasing the good or service or directly benefiting from the service performed.
3. The Guarantor is the third party that guarantees the performance payment in the event the conditions of the contract are not, this can be a bank or insurance company.
Like all credit, these contingent liabilities are susceptible to credit risks and based on their nature there is always the possibility that something could go wrong due to the uncertainty of future events. Default in payment is one of the biggest challenges associated with credit risk. This can be time consuming and can be very costly to the bank. The bank can even lose its customers deposits.
These services are normally offered to creditworthy companies only, if they fail to satisfy a contract the bank will forced to pay and can sometimes lose the funds since the customer is unable to meet reimbursement obligations. The bank will downgrade its customer’s creditworthiness followed by a possible suit. Another impact this has on the customer is that it limits their total borrowing power, more scrutiny of their financials and future requests will have to be supported by liquid assets (cash.)
Please note that the information provided on these facilities is very limited, should you require additional information please don’t hesitate to visit my office where we can discuss even further.
As one of the most important pieces of banking legislation, it was the rules of The Clayton’s that established the order in which credits offset debits on an account. The rule is based on the first-in, first-out (FIFO) principle which says that the first debt on an account is the first to be paid off by the first credit made.
According to the article Rule Clayton’s Case by Muhammad Haidar, the principle of Clayton’s Case originates from the case Devaynes Vs Noble in the year 1816. The case follows the relationship of Mr. Clayton who operated an account with the firm Devaynes, Dawes, Noble, Croft & Barwick. The firm continued to operate under the same name even after Devaynes died; at which point Clayton had a credit balance on his account of £1,713. It is important to note that Clayton continued to operate his account eventually exceeding his credit balance taking the account into overdraft. Shortly thereafter, the firm filed bankruptcy. Clayton filed a claim against the deceased estates for £1,713 which he thought was due to him on the date of Devaynes death. It was held that the estate of Devaynes was not liable since the surviving partners of the firm paid the checks drawn by Clayton himself completely discharging the firm’s liability to him.
Consider the following example, assume that December 1st you open a new current account with a £8,000. On December 6, you withdraw £7,500. On December 7 a deposit £2,500 is made to the same account. On December 13 you withdraw £3,200. December 14, you deposit £300 to the account.
DATE DR £ CR £ BALANCE
01-Dec Cash CR 8000
06-Dec Check 7500 CR 500
07-Dec Cash 2500 CR 3000
13-Dec Check 3200 DR 200
14-Dec Cash 300 CR 100
At the conclusion of these transactions, £100 remains in the account. In this scenario, the account was in a credit due to the deposit made on December 1 of £8,000. Though there were multiple deposits it is the debit December 1 of £3,200 that fully cancels out the credit made on December 1 and the remaining credit balance on the account eventually and leaving the account with debit balance. This debit balance is eventually paid off by £200 from the £300 deposit made on December 14.
Lorimer, G. “Appropriation of Payments” Credit & Lending, Unit 1, p. 8-9
Lorimer, G. “Bridging Loans” Credit & Lending, Unit 1, p. 6
Lorimer, G. “The Canons of Lending” Credit & Lending, Unit 1, p. 23-63
Lorimer, G. “The Canons of Lending” Credit & Lending, Unit 1, p. 23-63
Lorimer, G. “Farming” Credit & Lending, Unit 2, p. 111-118
Lorimer, G. “Finance for Foreign Business” Credit & Lending, Unit 2, p. 119-128
Lorimer, G. “Ratio Analysis” Credit & Lending, Unit 2, p. 41-51
Lorimer, G. “Why is Security Taken” Credit & Lending, Unit 2, p. 1-31
Madura, J. (2009), “Financial Markets & Institutions, Abridged 8th Ed.” South-Western, a part of Cengage Learning
BusinessDictionary. Acceptance Credit. (online). BusinessDictionary.com. Available at: http://www.businessdictionary.com/definition/acceptance-credit.html#ixzz2mozeH9NH. Access Date: December 8, 2013
Business Dictionary. Documentary Credit . (online). Business Dictionary.com. Available at: http://www.businessdictionary.com/definition/documentary-credit.html. Access Date: December 8, 2013
Business Dictionary. Performance Bonds. (online). BusinessDictionary.com. Available at: http://www.businessdictionary.com/definition/performance-bond.html#ixzz2mkrGRnVx Access Date: December 7, 2013
Demonstrating Value. Financial Ratio Analysis. (online). DemonstratingValue.com. Available at: http://www.demonstratingvalue.org/resources/financial-ratio-analysis. Access Date: December 8, 2013
Haidar, M. (2009). Rule in Clayton’s Case. (online). Qard.Info.com. Available at: http://qard.info/index.php/rule-in-claytons-case/. Access Date: December 6, 2013
HSBC. Banking Services – Forward Contract Booking.(online). HSBC. Available at: http://www.commercial.hsbc.com.hk/1/2/commercial/online-services/faq/banking-services/forward-contract-booking. Access Date: December 8, 2013
Investopedia. Ratio Analysis. (online). Investopida.com. Available at: http://www.investopedia.com/terms/r/ratioanalysis.asp
Access Date: December 6, 2013
Toohey, Mark. Director Guarantees Explained. (online). Accelawrate Legal Propulsion Lab. Available at: http://www.accelawrate.com/director-guarantees-explained/. Access Date: December 5, 2013