C&I/Asset Based Lending: Evaluation, Structure, and Management

C&I/Asset Based Lending: Evaluation, Structure, and Management

What is C&I Lending? C&I is secured lending based on a formula applied to commercial accounts receivable and inventory to generate immediate working capital. Typically receivables less ineligibles are included in the borrowing base at 75% to 85% of invoice total. Typically raw materials and finished goods inventory are included in the borrowing base at not greater than 50% of cost or liquidation value. The borrowing base is adjusted on a periodic basis via a Collateral Loan Report.

Prospective C&I Borrowers Manufacturing Distribution Wholesaling Importing Service All Companies which deal in business to business transactions where goods and services are passed and receivables and inventory is present.

Keys to Successful C&I Lending Transactions Appropriate Credit Underwriting Effective Evaluation of Underlying Collateral (A/R and Inventory) Appropriate Transaction Structure (Advance Rates) Appropriate Secured Transaction Loan Documentation Effective and Successfully Executed Monitoring Plan

MODULE 1: Evaluation of and Lending on Accounts Receivable

Tools for General Evaluation of Accounts Receivable: Who is the Receivable from? What are the terms? Is the sale complete? Is there the possibility of dispute of the receivable? How long is the collection cycle (A/R turnover)?

Prime Time Accounts Receivable Sale to: Sale of: Coca Cola, Amazon, Home Depot, etc. A commodity product Invoice Size: Large, but not too large ($5,000-10,000) Delivery: Due: Picked Up and Signed For In 15 Days

Application of Tools: Who is the Receivable from? Large, Well Capitalized Company - Most Desirable Publicly traded Companies, Larger Private Companies (Coca Cola, WalMart, etc.) - Company in Financial Distress or Less Credit Worthy - Least Desirable Small Independent Businesses, Individuals, etc. (Contractors, restaurants, etc.

What are the terms? Standard Terms or Less Extended or Unusual Terms Dated Receivables (Seasonal) Consignment / Guaranteed Sale - Most Desirable - Least Desirable

Is the sale complete? Complete with Documentation (Bill of Lading, Verification, Etc.) - Most Desirable Lacks Shipment or Additional Work to Be Complete - Least Desirable Percentage Billings (payments based on % completed) Progress Billings (payments made at set intervals until completion)

Is there the possibility of dispute of the receivable? No Dispute, Sale Complete and Verifiable - Most Desirable Possibility of Dispute due to workmanship or Completion of Sale - Least Desirable

How long is the collection cycle (A/R turnover)? Consistent with or Better than Industry Averages - Most Desirable Extended Collection Cycle, Higher than Industry Averages - Least Desirable

Standard Ineligible Categories for Accounts Receivable: Accounts Over 60 or 90 Days from Invoice Date Cross Aged Receivables Receivable balances over predetermined credit limit Contra Accounts Credit Memos Governmental Accounts Foreign Accounts Intercompany or Affiliated Accounts Progress Billings Guaranteed Sales

Rules of Thumb in Establishing Account Receivable Advance Rates: Accounts Receivable Advance Rates typically range from 65 to 90%. The most typical advance rate is 75-85%. The higher the quality of Accounts, the higher the advance rate. A general formula for estimating A/R advance rates = 100% minus (past due percentage + 10%) or 100% minus (dilution percentage + 10%)

Clients to Avoid Construction Receivables Medical A/R Progress bill A/R Sub-contract bill A/R International Receivables Inventory at numerous locations Inventory in transit from foreign countries Foreign inventory

MODULE 2: Evaluation of and Lending on Inventory

Editorial Comment: Underwriting Accounts Receivable is a Science. Underwriting Inventory is Witchcraft. and: It s 5 o clock somewhere.

Tools for General Evaluation of Inventory: What makes up the Inventory? How is it accounted for? How is it valued? Is there a ready market for the Inventory? What must be done to prepare Inventory for sale? How long is Inventory sales process?

Prime Time Inventory What is it: Where is it: A commodity good (lumber, gold, etc) A third party Bonded Warehouse Accounted for: Perpetual Accounting System Valued: Buyers: Public Exchange Many

Application of Tools: What makes up the Inventory? Commodity Good - Most Desirable Components of Manufactured Goods - Least Desirable How is accounted for? Perpetual, real-time inventory accctg. - Most Desirable Periodic count, count-based acctg. - Least Desirable How is it valued? Price Set By Exchange - Most Desirable Market Driven - Least Desirable

Is there a ready market for the Inventory? Large Number of Potential Buyers - Most Desirable Limited Number of Industry Competitors - Least Desirable What must be done to prepare Inventory for sale? Completed and Ready for Shipment - Most Desirable Assembly Required - Least Desirable

How long is Inventory sales process? Immediate Buyers Available - Most Desirable Extended Sales Process - Least Desirable

Rules of Thumb in Establishing Inventory Advance Rates: Inventory Advance Rates typically are much less than against accounts receivable. Typical ranges are 25-50%. The more liquid the Inventory the higher the Advance Rate. The more commodity in nature the Inventory, the higher the Advance Rate. The more control a lender may exercise over the inventory, the higher the Advance Rate.

MODULE 3: Structuring a Working Capital Line of Credit

The Ultimate Structure of the Line of Credit Should Reflect: Collateral Risk which should be collectible in a liquidation Appropriate Advance Rates based on prudent underwriting of the collateral Availability which allows the borrower to accomplish its business plan The Credit Risk Profile of the Bank

Issues to Consider in Accounts Receivable Availability Performance of Accounts Concentrations (Both Historical and Seasonal) Quality of Customer Base Seasonality of Business

Issues to Consider in Inventory Availability How close is it to 5 o clock. Maximum Exposure (both seasonal and non seasonal) Limits on Inventory Advances Hard Dollar Percentage of A/R Availability

Protecting the Downside: Inventory Caps and Limits Hard Dollar Cap are the absolute maximum dollar amount of exposure the lender is willing to take on certain inventory under any circumstances. Example: $1,000,000 line of credit, with an 80% advance on eligible A/R and a 40% advance on Inventory, with an Inventory Cap of $300,000.

Percentage of A/R Limits reduce the inventory exposure to a percentage of what a borrower can access to a percentage of accounts receivable availability. Example: $1,000,000 line of credit, with an 80% advance on eligible A/R and a 40% advance on Inventory, limited to 50% of accounts receivable availability.

The best way to protect your downside is with a structure which references both. Example: $1,000,000 line of credit, with an 80% advance on eligible A/R and a 40% advance on Inventory, limited to the lesser of $350,000 or 50% of accounts receivable availability.

MODULE 4: Administration of Lines of Credit

The Collateral Loan Report is the primary document used to monitor a C&I or ABL Loan. The quality of information provided in the Collateral Loan Report is critical to the collectability of the loan.

The Collateral Loan Report is a reconciliation of all changes to the Collateral Base; that brings Borrower and Lender up to the present.

The Collateral Loan Report Should Reflect: A) The collateral underlying the Loan at a point in time and B) What changes have occurred in the collateral base since the last report.

Frequency of Reporting The Frequency of Reporting should be determined based on: Percentage Line Utilization Quality of Collateral Strength of Credit (earnings, leverage, etc.) Quality of Accounting Function Most bank C&I Loans require monthly reporting, but do not hesitate to require more frequent reporting.

Frequency of Reporting Recommendations Monthly Reporting: Business Profitable Strong Balance Sheet Vendors within Terms Collateral Performing Line usage at 70% or less of total availability

More Frequent Reporting should be considered if: Business is having profitability issues (get on this early!) Balance Sheet is weakend by a specific event or is weakend over time. Vendor payable turnover is increasing, or there are signs of vendor pressure. The collateral performance (turnover of A/R and Inventory) is weakening. Line usage is increasing.

The Collateral Loan Report should have supporting documentation. The Report should be supported by the following: Completed collateral loan report as of month end. A report of new billings (sales journal) for the month. A report of collections (cash receipts journal) for the month. An A/R Aging as of month end. An inventory listing as of month end. A monthly P&L and Balance sheet.

A Simple, Idiot Proof Monthly Checklist that Allows Lenders and Credit Officers to Sleep at Night (or Not) Review the month end A/R Aging. Do the following: 1. Review Summary Columns to see if Ineligible A/R has increased (Over 90 days). 2. Compare Gross A/R on the Collateral Loan Report to Month End A/R Aging (Check 1) and A/R on the Balance Sheet (Check 2). Do they reconcile? Review the month End Inventory Report. Do the following: 1. Compare Total Inventory on the Collateral Loan Report to Month End Inventory Report (Check 3) and Inventory on the Balance Sheet (Check 4). Do they Reconcile?

Review the Monthly Sales Journal. Do the following: 1. Compare Total of Monthly Sales Journal to Sales on the Income Statement (Check 5) and Additions to Accounts Receivable on the Collateral Loan Report (Check 6). Do they reconcile? Review the Loan Balance on the Collateral Loan Report. 1. Compare the Loan Balance on the Collateral Loan Report to the Balance Sheet (Check 7) and Bank Records (Check 8). Do the reconcile?

Thank You Arkansas!