Orion Industries Credit Risk Management Case Study

CREDIT RISK ANALYSIS CASE STUDY
ORION INDUSTRIES
CASE HISTORY Introduction
This case study is a multi-part exercise that illustrates various elements of the credit process. Your study of the Orion case begins with issues pertaining to target marketing and qualitative analysis. As the case develops you will be introduced to the entire gamut of the credit process including additional data gathering activities further qualitative analysis financial analysis credit structuring approval administration and account management. !n the first part of the case you will be introduced to the potential customer and the bank the need that brings them together and important background information regarding the country"s macroeconomic scenario and the customer"s operations. The second part of the case also in this unit takes you on a plant visit where you will gather additional qualitative information. #ubsequent parts of the case covered in $nits Three %our and %ive deal with financial &quantitative' analysis and then credit structuring approval documentation and administration. (ow begin Part One of the case study and then complete the exercises that follow.
Part 1 First Customer-Ban er !eetin"
)eo Aries a senior account executive with the )ibra *ank located in the +egasus region of Andromeda was catching up on paperwork. ,is secretary advised him that a -r. #corpio from Orion !ndustries was in the office and wished to speak with him about possible financing. Aries was surprised because a screening process within the unit"s target market definition first identified most potential customers and there was very little walk-in business. Also he knew most of the companies in the region but had only vaguely heard of Orion. (evertheless he instructed the secretary to show -r. #corpio into one of the conference rooms. -r. *runo #corpio the general manger of Orion and in his early forties introduced himself. .Your friend /eorge 0irgo from the 1unning 2lub gave me your name as a reference. 3e 4ust had lunch nearby so ! look the liberty of dropping in.5 On two previous occasions 0irgo had recommended that people talk with Aries mostly for
CREDIT RISK ANALYSIS CASE STUDY financial advice. *oth times Aries had quickly determined over the phone that the potential customers did not fit into the unit"s target market definition. Aries was interested in developing business with medium to large industrial enterprises that had good growth potential. ,e actually preferred the smaller companies within this range firms which could grow along with the bank but were not first tier enterprises that could demand premium pricing and a lot of favors.
Economic#Po$itica$ Bac "round
Andromeda is a medium si6ed quiet democratic country with a population of about 78 million people. ,istorically the economy had been based on agriculture but a significant industrial infrastructure has developed in the past 9: years. This development was part of an economic plan for employment generation and business sector diversification. As a result of an economic slowdown in the early and mid 98;<s the country"s economic development in recent years has been directed more towards the export sector particularly those exports that provide a high product integration percentage &value added content'. There is significant potential for maximi6ing the yield of exports due to the country"s considerable deposits of basic raw materials. The gross domestic product &/=+' of Andromeda is about $#> ?7 billion resulting from positive but modest levels of growth during the early and mid 98;<s. -ore recently /=+ growth rates have been in the range of @A to :A and one of the more dynamic sectors of the economy has been manufacturing with growth in the ?A to BA range over the past two years. -onetary and fiscal policy in Andromeda has been fairly stable. 1elatively small deficits in government expenditures have been financed internally but these deficits and the recent rapid growth in several economic sectors have resulted in moderate but persistent annual inflation in the 9:A to 9;A range. The monetary unit of Andromeda is the )cy currently valued at )cy @<C9 $#>. =uring the past three years the )cy has devalued at the rate of about 9<A to 97A per year which is consistent with the inflation differential between Andromeda and the hard currency countries with which it trades. %i&ra Ban and t'e Pe"asus Re"ion Andromeda has 7@ commercial banks and several speciali6ed agrarian and development banks. The commercial banks are permitted nationwide banking although only the top six banks maintain a truly national presence. A second tier of eight regional banks maintains an influential position in important but geographically limited regions of the country. )ibra *ank is one of these regional banks located in the +egasus region about D<< km from the capital. +egasus has traditionally been an agricultural region but in recent years has sustained considerable growth in the industrial sector. This region is home to a ma4or automobile manufacturing and assembly operation established eight years ago by a well-known multinational auto producer. This car plant has spawned numerous
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CREDIT RISK ANALYSIS CASE STUDY parts manufacturers that supply the assembly plant many of which are partially owned or affiliated with foreign car parts makers. )ibra *ank is a full service bank with about )cy 9< billion in assets. !t has contributed to the industrial growth of the region by financing several ma4or manufacturing pro4ects and by offering extensive short term financing facilities and other traditional banking services. The industrial sector represents about @<A of the )ibra loan portfolio as a result of marketing efforts in the last several years to capture ma4or segments of this sector around +egasus. Orion Industries and !r( Bruno Scor)io .-r. Aries thank you for seeing me on such short notice. +lease let me tell you about Orion !ndustries. 3e are medium si6ed metal works with annual sales of about )cy 7:< million. 3e have been in business for 7@ years in +erseus &bout ?< km away' manufacturing different types of high precision metal products. =uring the past few years we have produced a variety of products. Our main product has been axle and transmission assemblies for tractors working as a subcontractor to Andromeda Tractor 3orks. -ore recently we have been producing universal assemblies and rear axles for the +egasus Automobile +lant. This is 4ust the beginning of our involvement with the car sector which we believe has a very high potential within the country.5 #corpio explained the company"s history. Two brothers who immigrated to Andromeda thirty years ago started Orion. The Taurus brothers excellent craftsmen and honest entrepreneurs successfully managed the firm for many years. Eventually the scope of operations became more than a large family business could handle and profits started to slip. Even though they took on extra business training more people and purchasing more equipment profits stayed at the same level as when they were half the si6e. Three years ago the Taurus brothers were introduced to #corpio. ,e had a degree in mechanical engineering from a good university &the $niversity of Andromeda' and had spent many years working with a large Andromeda company in the metal products sector. Over the years he had built up expertise in administration especially in the area of cost control for manufacturing operations. ,e saw a good opportunity at Orion because of the high-quality products and the business potential in the nearby +egasus region. #corpio invested some of the personal savings in Orion and became the general manager and one-third shareholder with an option to purchase a ma4ority position. The two brothers now in their late fifties are still active in the company on the production side. #corpio has streamlined operations by eliminating some marginal products with small profit margins and emphasi6ing the tractor subcontracting work and the diversification into the auto sector. Orion has been delivering for three months under its contract with the +egasus Automobile +lant achieving good quality and a strong on-time production record.
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Financin" Re*uest .The reason for my visit -r. Aries is that we are looking for new banking relationship. 2urrently we are working mostly with the local branch of the /emini *ank and they provide adequate services for payrolls and a limited amount of lending. ,owever they do not have the expertise or resources to deal with our pro4ected future needs. 3e are looking for a long-term relationship with a large regional full service bank such as yours. Our mutual friend /eorge 0irgo mentioned your name and your bank so here ! am. .3e would like to establish a short-term facility for )cy @< million &equivalent to $#> 9 <<< <<<'. 3e would want periodic drawdowns for working capital purposes mostly to help us finance receivables or to stock up on raw materials for particular 4obs. Although ! have made every effort to even out the workflow at the plant some degree of seasonality is unavoidable. The credit line will help us here. .3e anticipate future capital needs for upgrading or relocating the plant but that"s still a long way off. 3e would however like to establish financial relationships now so that when these futures needs arrive we can count on the necessary financing. 3e have a couple of other prospective banks but have come here first because of your bank"s reputation for thoroughness and imaginative financing.5 In+itation to ,isit .3e would like to invite you for a visit to our factory at your earliest convenience so that you can meet our people and 4udge Orion !ndustries for yourself. Our external auditor the well-known firm of 2apricorn F 2entauri will have our annual report finished in about two weeks and ! will instruct them to send it to you as soon as it is ready. ! would prefer to have you visit us before then so we can get the ball rolling as soon as possible. 3e anticipate some short term financing needs in about six to eight weeks and if your bank is not interested we would have to pursue other avenues.5 Aries and #corpio said good-bye. .An interesting meeting 5 thought Aries .he seems to know what he"s talking about.5 Aries liked #corpio for his easy open and unpretentious manner. Aries wasn"t sure what to make of this customer falling into his lap but thought that pursing the opportunity would be worthwhile. All he had to lose at this point was a little time and in any event it would be interesting to visit the customer"s factory. That way he could identify the qualitative parameters of a potential banking arrangement to decide whether or not to continue with a complete risk analysis. The banker had to organi6e the information he gained from the initial interview with the potential client and decides what information he should get during his visit to the plant.
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ORION INDUSTRIES - Part . Introduction
!n +art One of the Orion case we were introduced to the banker the potential customer and the economic setting of the case. 3e saw that although the bank did not have a precise definition of its target market the potential customer apparently fit within the broad parameters established by the bank and within the country"s macroeconomic situation. Aries was intrigued enough to see a prospective deal and schedule a plant visit. Through the questions in the +rogress 2heck you saw how he should organi6e his data and plan what he would accomplish during his upcoming plant visit. !n +art Two of the Orion case Aries displays resourcefulness in obtaining some valuable references. ,e then proceeds with the plant visit where he gathers a great deal of qualitative information. ,e tries to organi6e the information using the bank"s standard qualitative data forms. Apparently satisfied that Orion !ndustries still represents potential business for the bank Aries starts to think about the next two steps in the credit process. These include &9' the financial analysis of the Orion statements when they arrive and &7' the formal credit and risk analysis to structure a deal and frame a potential credit recommendation. C'ec in"s *efore driving out to the Orion factory Aries decided to call Aurora *orealis a banker at /emini *ank whom he had met in a credit course they both attended last year. Aurora confirmed that her bank had been dealing with Orion for many years and the relationship was generally positive. #ome credits had been renegotiated over the years but this was normal for a company like Orion that was continually taking on different 4obs. Aurora mentioned that /emini *ank wished to maintain its relationship with Orion by continuing to offer current account and payroll services G and by maintaining its exposure levels at about the present level. *ut due to /emini"s small si6e it was already near the legal lending limit and could not meet all of Orion"s lending need. Another bank would have to finance Orion"s proposed growth. Aries also contacted )ibra *ank"s own account officer for the Andromeda Tractor 3orks &AT3' and asked him to track down information on Orion"s reputation for quality and timely delivery of the axle and transmission assemblies. After a couple of phone calls the AT3 account officer advised that the tractor producer was happy with the Orion relationship. The quality of work was excellent and reliability of delivery had improved considerably over the past year. Apparently Orion had experienced some difficulties in the past that resulted in late deliveries but this problem had now been solved. )ibra *ank did not have a banking relationship with the +egasus Auto +lant since the auto producer dealt only with four top-tier Andromeda banks. (evertheless Aries wanted to get some feedback from the auto producer as to Orion"s product quality and v
CREDIT RISK ANALYSIS CASE STUDY reliability. Aries assumed that the reference would be a good one but he wanted to make sure. ,e decided to leave this matter for later. ,isit to t'e Orion Factor/ +lant and Equipment A few days later )eo Aries drove to +erseus to visit the Orion plant. ,e found that the concrete block plant building was old but in fairly good condition owned by the company and free of liens. !t was located in an old area that had good access to the highway connecting it to the heart of the +egasus region. ,owever the location was slightly off the beaten track and far from the newer industrial areas that had developed near the +egasus Automobile +lant. Electricity and water supplies in the area were adequate. !nside the plant was clean and well lighted but quite crowded with numerous large machines. The machines though not new appeared to be well maintained and were logically positioned to handle the workflows. They were all imported and looked expensive. Aries was informed that some of the machines collaterali6ed existing longterm debt with the /emini *ank and other long-term sources but outstandings were low compared to the replacement market value of the machines. The machines were insured at their present market value which was net of depreciation. There were several warehouse areas within the building for storing raw materials but these areas were randomly placed due to the cramped conditions inside the plant where every inch of space was utili6ed. 2ontrols over inventories appeared to be adequate with locked wire mesh compartments. The administrative area was quite austere with old furniture wooden floors and old photographs on the wall. There was no formality hereH the administrative staff was friendly and comfortably dressed &no ties' and odors from the kitchen could be detected throughout the offices. Aries was informed that the company subsidi6ed the workers" lunches with the workers paying only a normal price. #
Almost all of Orion"s raw materials were sourced domestically from the few Andromedan steel mills and foundries &Andromeda #teel 3orks Andromeda -ining and -etals' and the quality of these products was good. +urchase terms for Orion were the standard D< to ?< days. A few speciali6ed products such as drill bits and other tools were imported due to the inferior quality of local products. These purchases were relatively minor and were made on a cash basis using foreign exchange bought on the free market. 1egarding inventory levels #corpio figured he would have to maintain present levels of between three and four months. .! wish our production schedule was more consistent from month to month but we must adapt to our buyers and unfortunately this means some fluctuation in production volumes. 3e have to keep greater stocks of raw material on hand to enable production flexibility. Over the next year however we hope to reduce our average inventory to between two and three months.
.!"m sure you will have more questions on the financial side once you get our figures 5 continued #corpio. .You"ll see that financially speaking we have improved the quality of our income stream by eliminating some unprofitable operations and focusing on our
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CREDIT RISK ANALYSIS CASE STUDY more lucrative product lines. You should have the numbers next week so you can see for yourself.5 Aries returned to the bank to consider what he had learned about Orion !ndustries. .An interesting opportunity 5 he thought. #o far he had a positive feeling for the potential relationship and for #corpio. Aries admired entrepreneurs who were willing to invest their own capital in an enterprise. Apparently #corpio had been successful at turning a relatively unsophisticated operation into a more modern and efficient company with prospects for considerable growth. .On the other perhaps #corpio was being too ambitious 5 mused Aries. .*ut he has demonstrated drive and determination which let"s face it most people never attain.5 Ca$$ Re)ort Aries was anxious to get the financial statements to complement his analysis so far and provide a more comprehensive perspective of the situation. ,e figured that the numbers once available would reflect an improving picture over the last couple of years. !n the meantime and while the visit was fresh in his mind Aries decided to complete the call report and finish the *!1 for Orion !ndustries. ,e also requested credit references from the suppliers.
2)!E(TI *1A(2,I CA%% P%AN AND REPORT Orion !ndustries !nc. =ATEI 9? %ebruary 98J@ )ibra *ank +egasus 2ity )eo Aries +1O=$2TI 2redit +rospect
2A))!(/ O%%!2E1I
2A))!(/ O(I *runo #corpio 2EO
+$1+O#EI 1E#$)T#I +lant is old but in good order -et other owners and executives ,ad fruitful discussion as to production market position future !n general had favorable impression of management Apparent improvement in systems and infrastructure since arrival of #corpio but some shortcomings with lack of depth /rooming of additional management people is high priority TA1/ET =ATE =one 77 %ebruary *y month end *y month end *y month end +lant visit for possible credit relationship -eeting of key management people 1eview of management systems and managerial focus
-ATTE1# %O1 %O))O3-$+I - 1equest references from suppliers - 1eceive audited financial statements - Analy6e audited financial statements - 1eceive formal bank checkings - Obtain references from +egasus Auto +lant
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%eo Aries 1elationship -anager BASIC INFOR!ATION REPORT *1A(2,I 2)!E(TI A==1E##I )ibra *ank -ain *ranch =ATEI Orion !ndustries !nc +erseus 7C9?CJ@ *$#!(E##I O*TA!(E=I O0NERSHIP 2losely held corporationI 7CD Taurus brothers 9CD *runo #corpio latter with option for :9A control. Employee stock ownership plan to be effected for 7<A out of Taurus brothers" holdings. These independent ownerCmanagers are apparently highly committed to the success of the firm. DIRECTORS AND !ANA1E!ENT /eneral -anager *runo #corpio early @<"s mechanical engineer from $niversity of Andromeda. Experienced in prior positions with subsidiaries of ma4or multinationals. #trong background in manufacturing and costCmanagement systems. -ax and (ick Taurus late :<"s immigrant founders self-made men. Excellent craftsmen but not sophisticated managers. -anagers have good reputation for reliability and integrity based on feedback from suppliers etc. HISTORY 2ompany was formed by Taurus brothers 7@ years ago to produce high precision metal parts. ,ave had ongoing and positive relationship with Andromeda Tractor 3orks G and more recently initiated higher precision production for +egasus Auto +lant. +roduct quality has been good but spotty recent history in dependability and profits. Arrival of #corpio three years ago has helped remedy this in productivity turnaround. BAN2IN1 AND OTHER FINANCIA% RE%ATIONS +rincipal bank is /emini. +roducts include short-term lending occasional equipment loans and payroll and current account products. 1elationship has been unsophisticated due to lack of management financial know-how. 2heckings indicate good experience with occasional past rollovers. OPERATIONS +age 7 +1O=$2T# - ,igh precision metal works with variety of products capability - +rimarily tractor axle and transmissions - (ow producing higher precision automobile universal and rear axle assemblies - #ome seasonality - +erceived high quality workmanship Sales breakdowns: Tractors 55% - Automobile 45% - Own plant located in +erseus ?< km away #!(2EI
#upervisor +age 9 (CA
-etal +roducts 1eference
+roduction
%A2!)!T!E#
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Out of the way location but good access Own concrete block building free of mortgage Adequate energy and water infrastructure !mported machinery -- used but in good shape %ull insurance for depreciated market value 3arehouse controls adequate but crowded Employees appeared to be well trained Employee relations positive, with ood productivity
#$++)!E1# A(= T1A=E 1E+$TAT!O(
- Andromeda #teel 3orks and Andromeda -ining and -etals for local supplies of base metals - Kuality of local supply is good - Terms between D< and ?< days - #ome purchases of foreign materials paid on cash basis from free market foreign exchange !heckin s have been "avorable - =irect sales to Andromeda Tractor 3orks and more recently to +egasus Automobile +lant - All sales on credit terms mostly 8< days - Other miscellaneous sales when have spare capacity with varying terms /ood references from AT3 as to quality and delivery timeliness AFFI%IATED CO!PANIES AND RE%ATED BUSINESS No a33i$iated &usiness ADDENDU! TO BIR4 !ANA1E!ENT
=!#T1!*$T!O( A(= #E))!(/ TE1-#
+age D
/OA)# O1!E(TAT!O( A(= 2O--!T-E(T
- /oals to produce more for the automobile sector - +erception of ownerCmanagement commitment with .hands on 5 involved approach - -anagement committed to quality serious - 3orker productivity apparent with upcoming employee stock ownership plan. - %irm now has more focused orientation since arrival of #corpio - %irm dependent on #corpio for managerial direction and know how - Taurus brothers excellent craftsmen only - +resent lack of depth - (ew systems for delegation to permit attempt at developing new people - +resent centrali6ed authority OM for level of operations but not for growth into new products - #corpio has strong manufacturing background with particular strength in cost accounting and management systems to track result - #corpio experience gained with Andromeda subs of ma4or multinationals - Taurus brothers have strong background as craftsmen with credibility for quality - *rothers weak on administrative side
O1/A(!LAT!O(A) 2,A1A2TE1!#T!2# A(= =E+T,
*A2M/1O$(= A(= )E0E) O% MEY -A(A/E1#
i#

3O1M ,A*!T# A(= -A1MET 1E+$TAT!O( - 2ommitment to quality and excellence - 1eputation for thoroughness and on time delivery although some slippage here before - 3ork force apparently well trained - 3ork force motivated with productivity pay - Employee turnover apparently healthy lower than normal - %irm has good reputation for integrity - (ew systems fill vacuum of prior management - 2ost accounting systems have brought back profitability vs. prior marginal results - -anagement information systems track productivity and work defects by product line - *udgeting systems permit controlCdelegation - +roduct is craft but not .high tech5 - -achinery appears adequate for needs - -achinery apparently maintained by own supervision of Taurus brothers - Technology at hand appears to be adequate
-A(A/E-E(T #Y#TE-# A(= 2O(T1O)#
A22E## TO TE2,(O)O/Y
staff
under
Case Study
ORION INDUSTRIES Introduction
3e now return to the Orion !ndustries case which was introduced in $nit One. !n +art One we were given some background on the economic and political situation in the Third 3orld country of Andromeda and the +egasus region of the country. 3e were introduced to Orion !ndustries and *runo #corpio and witnessed the origination of a potential credit relationship with )eo Aries of )ibra *ank. !n +art Two of the case the banker obtained some additional information from third parties and visited the Orion plant. At the plant he met the rest of the Orion team and gathered a considerable amount of qualitative data about the company how it operated and its people. The banker then organi6ed this information in anticipation of receiving the financial statements. !n +art Three of the case history the financial numbers are put into a spreadsheet format. The banker must analy6e the financial statements of the Orion 2ompany toI determine the financial soundness of the firm and measure historical cash generation capacity. The analysis allows him to draw some conclusions about the relative risk and creditworthiness of Orion as a potential borrower. !t also raises some additional questions about what can be reasonably anticipated in the future.
COMPARATIVE STATEMENTS OF FINANCIAL CONDITION ENCLOSED
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Case Study
ORION INDUSTRIES Looking to the Future
At Orion #corpio has come in to .clean house5 financially and has reduced both the scope of operations and the si6e of the balance sheet. The banker must ask how far this .downsi6ing5 will go and what will happen in the future. The financial statements will probably level off soon and perhaps start to grow again which could mean additional external financing needs for the firm. This is the reason #corpio came to the bank in the first place. !t is likely that some of the historical figures &such as reduction of current assets' are not indicative of near term future operations of the firm. *ut other figures such as profitability and efficiency ratios probably are indicative of future results under the present management. The anticipated future financial growth is now a more pressing concern for the banker. The statements that are being analy6ed while indispensable for the financial and overall credit analysis of the firm are history G yet any extension of credit will be for the future. The banker must therefore have an idea of the likely near-term financial development of the firm. ,e has to calculate the situation under a growth profile with a heavier debt load anticipating takedowns under an assumed new line of credit with )ibra *ank. To do this the banker should prepare some pro4ections to compare with the company"s forecasts. This can be done informally pro4ecting out key balance sheet accounts for one year to measure increased funding needs and the effect on the balance sheet ratios. The banker should therefore obtain from #corpio sufficient information to build these informal pro4ections. #pecifically he needs to knowI anticipated sales growthH cgsCsales and other key marginsH reasonable assumptions for G days receivable days inventory days payable and other current assets and other current liabilitiesH anticipated capital expenditure levelsH payment terms for existing long-term debtH dividend policiesH and any anticipated other new external funding.
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Case Study )et"s continue to +art %our of the case and find out how Aries gets the needed information and performs the pro4ection exercise. +A1T-@ %ollow-up =iscussion with #corpio 1egarding ,istorical %igures The banker called *runo #corpio to schedule a meeting. The purpose of the meeting was to discuss some questions about the Orion financial statements future goals and assumptions for this year"s financial operations. Aries asked #corpio to provide a copy of the receivables aging report. At the meeting Aries quickly reviewed the aging report with #corpio and concluded that the information did not indicate any problems with stale receivables. .3e did experience some problems in 98J9 and had to write off some uncollectibles for two small 4obs we did 5 said #corpio. .This write-off affected earnings in that year which you can see on our financial statements. .!t was this type of experience that drove us away from many of the smaller 4obs 5 continued #corpio in response to the banker"s questions. .The margins may be better but they involve a lot of headaches with retoolin , cost accountin "or speci"ic &obs,
and workin with some di""icult customers' That is why we are presently dealin only with the Andromeda Tractor (orks )AT(* and the +e asus Auto +lant )+A+*' Even thou h we have no collectibility problems, the market stren th o" these two companies "orces us to rant lon er credit terms than we would pre"er' (e,re workin on this and hope to ne otiate somethin better this year, but we,re not countin on it'
.3e reali6e that limiting ourselves to two basic clients for now perhaps does not diversify us as much as we would like. ,owever these are the types of relationships we hope to build for the future. Although the net income per unit sold is not great the volume of work is attractive and we can gradually improve profits by reducing unit costs. The work provides stability over the longer term which is also quite attractive to us. 3e hope to enter into even longer term contracts when the present twelve-month deals we have signed over the past two years with +A+ expire.5 !n response to questions about the reduction in days payable #corpio indicated that in earlier years the firm bought from a greater number of suppliers. #ome of them offered longer terms probably because the quality of their product was inferior. .!n fact 5 said #corpio .this was one of our problems. The mixed quality of raw materials affected our own product quality. 3e are now purchasing from three prime suppliers that have the best quality materials but they are more demanding in terms of timely payment. Our days payable have been reduced from prior years because we are not a big enough customer for them to grant concessions on trade terms. Although we had hoped to limit our need for other working capital financing by relying on trade credit we have been unable to do so.5
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Case Study !nformation on Other 2redit 1elationships Aries also inquired about some of the other creditors that appeared in the notes appended to the audited statements specifically about #agittarius *ank and the Andromeda =evelopment *ank. #corpio informed Aries that the relationship with #agittarius *ank was being liquidated by paying down the long-term equipment loan as it came due. This was also part of the reason why #corpio had approached )ibra in the first place. The reason for terminating the relationship was because #agittarius *ank had recently experienced financial difficulties. .Our relationship with them has been cordial and proper 5 said #corpio .but we don"t feel we can count on them in the future for new short-term takedowns.5 Aries accepted this explanation since he knew about the situation with #agittarius. !n fact several other #agittarius clients had recently requested significant credit increases at )ibra. (evertheless #corpio made a mental note to request checkings from #agittarius. #everal years ago the Taurus brothers had approached the Aquarius %inancial 2ompany during a cash crunch and some loans had been hastily arranged with cash collateral provided by the Taurus brothers. Although the finance company was owned by acquaintances of the brothers it charged high spreads for these loans since it normally did not provide financing to the industrial sector. *ecause of their inconvenient terms these loans were also among the first to be put on a liquidation basis after the arrival of #corpio. The credit with the Andromeda =evelopment *ank &A=*' had been arranged by /emini under a line of credit available to local banks to finance the purchase of some /erman equipment under a /erman export promotion program. .+art of the loan was financed in local currency and part in /erman -arks 5 said #corpio. .3hen ! came to the company one of the first uses we made of current asset reductions was to eliminate the cross-currency exposure by prepaying the /erman -ark portion of the loans. The local currency portion is being paid down as due with about three years left on the loan.5 This explanation confirmed what Aries had figured when he saw the A=* listed as a creditor in the notes attached to the audited financial statements. =iscussion +ertaining to /oals and %uture +lans !n response to the banker"s questions about return on equity &1OE' and goals in this area the customer respondedI .The receivables writeoffs ! mentioned earlier caused the overall 1OE for the year 98J9 to be about 7A. You can see from our statements that our 1OE has improved considerably during the past two years.5 .!n the past two years we have spent some money installing some new machines and our new accounting and management information systems. These expenses have reduced our profits from what they could have been but with these systems in place we figure that our net margin can now be improved by about 7A which translates to an 1OE of about 77A.5
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Case Study
.3e ultimately would like to improve beyond this to achieve an 1OE of about 7:A which would be about 9<A above inflation. 3e are being selective with any potential new contract requiring that it contribute to achieving this goal within our own pro4ections. 3e are re4ecting those contracts that could become a drag on earnings. ,aving put our house in order we must avoid tying up our resources in marginal or underproductive deals as we have done in the past. 3e believe that our current product quality puts us in an advantageous position and the time for pricing concessions is past.5 #pecific #hort-term /oals Aries then asked questions about pro4ected numbers. .(ow that we have information on Orion"s operations and financial numbers for the past three years we would like to have some figures on financial goals for the rest of this year. 3hat are you budgeting for sales net income current account levels capital expenditures dividends etc.N5 .%or this year we anticipate renewed growth but only in our current product line. 3e have cut the scope of operations over the past two years about as far as we want to go which has restored strength to our balance sheet 5 said #corpio. .3ith the contracts we already have we are budgeting annual sales of )cy 78< million which would be about a 98A sales increase. This figure is quite firm and it will go up if we can negotiate a production increase in our contract with the +egasus Auto +lant.5 #corpio continued. .3e have been discussing this with +egasus for a couple of weeks. !f we agree on terms soon beginning around -ay or Oune our production could build incrementally up to about a 7:A increase in volume by =ecember. This would mean an average sales increase of about D:A for the year instead of the 98A we are pro4ecting now. Even if we don"t get the increase with +A+ we should be able to take on another 4ob perhaps as a subcontractor. This should enable us to reach an overall 7:A sales growth even under the most conservative circumstances. .!n terms of net income we"re shooting for a return on sales &1O#' of ;A based on a decrease to B9A in the 2/#C#ales margin and to 99.:A in selling general and administrative expensesCsales. This will be achieved through cost cutting and increased efficiency. Although we expect some increases in short-term borrowings the reduction of our term debt will keep interest expense at about the same level as last year. 3e also anticipate lowering our effective tax rate to D<A due to certain tax credits from recent investments in fixed assets. %or these reasons we believe our ;A 1O# goal is quite achievable. .On the balance sheet we anticipate about the same relative levels in current assets days receivable and days payable. 3e may increase inventory slightly if we take on the additional work with the +A+.
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Case Study .As to non-operating cash needs 5 continued #corpio .we"ll be paying a level of about : million in dividends since this is the main source of the shareholder funds for making payments under the stock purchase plans. 3e"ll also need about : million more for capital expenditures to replace some aging fixed assets. *ecause of these equipment acquisitions and those of recent years we expect annual depreciation to climb to about B million.5 )onger-term /oals The banker asked #corpio about long-term goals. ,e replied that over the long term he hoped to position Orion as one of the larger and more significant component producers in the country. .3e see a strong future for the automobile sector in Andromeda not only for the domestic market but for exports as well and we anticipate being an important part of this development. This would mean building a new plant in the not-too-distant future since our present facilities while adequate now and for the next couple of years are not enough to become large producers within our market.5 .The export market is especially interesting to us. !n order for ma4or multinational car producers such as those in the $#A to maintain the viability of their domestically produced cars they will have to maintain or lower costs by outsourcing many of the parts. This is where we come in. 3e feel our quality is now approaching theirs but our prices in dollars are cheaper.5 .3e see global markets as the future for industry in Andromeda. This is what successful Asian countries have done and ! don"t see why we can"t do the same in Andromeda G produce a high quality medium tech product for global companies.5 .The difficulty is getting our foot in the door. Our relationship with the +egasus Auto +lant is extremely valuable because the ma4or $.#. multinational owner of +A+ has its own needs in the $#A. Over the long term we hope to build a relationship with this multinational that will permit us to grow outside of Andromeda and insulate our business from the domestic economic situation. 3e reali6e however that this is a long way off and we don"t expect to get there tomorrow.5 The meeting ended and #corpio left the banker"s office. Aries thought about the conversation. .#corpio has a great deal of drive and ambition 5 he thought. .,e"s an impressive guy seems to know what he"s talking about and has the company financial numbers to give him credibility. ! think we can work with him but 4ust the same we had better keep a close watch on Orion to make sure they don"t get too far ahead of us or themselves.5 *efore turning to other matters Aries asked the administrative assistant to request routine bank checkings on Orion from the #agittarius *ank and from the Andromeda =evelopment *ank. .A few more numbers and we should be about ready to put a credit proposal package together 5 thought Aries.
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Case Study %inancial +ro4ections Aries immediately looked at the numbers he had written down in the meeting. 3ith these he would put together some quick informal one-year pro4ections to see what the situation would look like as of 97CD9CJ@ under #corpio"s assumptions. To be conservative he also wanted to pro4ect out some more pessimistic figures to gauge the sensitivity of the numbers. Aries then listed the assumptions both from the customer"s perspective and from the bank"s sensitivity scenario. The important numbers were sourced from his conversation with #corpio. ,e estimated other figures such as level of cash other current assets and prepaid expenses from trends in the balance sheet andCor anticipated general growth. These accounts were quite small and therefore had less of an impact on cash determination. The assumptions wereI 2ustomer #ales /rowth 2/#C#ales #/AC#ales !nterest !ncome Tax 1ate (et !ncomeC#ales 2ash F -arketable #ecurities )evel =ays 1eceivable =ays !nventory Other 2urrent Assets )evel +repaid Expenses )evel =ays +ayable Accruals )evel Taxes +ayable )evel 2apital Expenditures Other (on-current Asset !ncrease D: A B9.< A 99.: A 97 <<< D< A ;A @ <<< ;< 99< (o 2hange (o 2hange @< 9D <<< : <<< : <<< P9 <<< #ensitivity 7< A BD.< A 9D.< A 9? <<< D: A N D <<< 9<< 9@< : <<< D <<< D< 99 <<< @ <<< B <<< P9 <<<
1eduction of )ong-term =ebt : 7:: : 7:: Other )ong-term )iabilities )evel 9? <<< 9: <<< =ividends : <<< < The banker now had to put together some quick pro4ections using the customer"s more ambitious assumptions on one hand and more conservative numbers for a sensitivity analysis on the other.
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Financia$ Pro5ections are enc$osed

LOOKIN A!EAD
"h#t I$ Orion%$ Fin#nci#& Out&ook' The statements "or the past three years ive Scorpio a reat deal o" credibility' 0e has been able to mana e key variables skill"ully and e""ectively and, "rom the indications we have in the case, there is no reason to doubt that he can continue to do so 1 at least at the present or similar level o" operations' 2rom the pro&ections we can appreciate that, i" the mar ins and indices continue at or near present levels, the company will probably do very well "inancially' (e can also anticipate that i" the potential rowth is achieved, additional limited short-term "undin needs will arise' Accordin to the customer pro&ections, the increase in short-term bank debt levels under this scenario is pro&ected at only three million pesos' 0owever, i" some o" the numbers "all short, either in pro"itability or in lar er than proportional increases in receivables or inventory, additional bank debt will be necessary, and in potentially considerable amounts' Also, capital e#penditures could easily climb above pro&ected levels i" e3uipment in the old plant "ails and has to be replaced, or i" new e3uipment must be purchased beyond the levels anticipated' 4ecause o" 5rion,s present stron capitali6ation, the "irm has a reat deal o" creditworthiness to bank on' They should easily be able to obtain "unds "rom a bank, be it 7ibra or another' 8n the pessimistic sensitivity scenario, the levera e ratio increases to only $'%5, which is well below historical levels' "h#t I$ the Ne(t Ste) *or Leo Arie$' The banker has been atherin a reat deal o" credit in"ormation about 5rion 8ndustries, both 3ualitative and 3uantitative' 0e has also been analy6in this in"ormation in order to draw conclusions about the merits o" a credit with 5rion 1 the desirability o" initiatin a bankin relationship with the company and what the terms o" the relationship should be' 9p to this point, Aries has been actin essentially under his own initiative' Since he cannot act alone to approve a credit "acility "or 5rion, now is the time to decide i" he wishes to promote the potential credit within the bank and, i" so, to put to ether a credit proposal packa e' This will involve structurin a deal and compilin a credit recommendation "or the consideration o" the credit committee' (e will see how this is done in the units that "ollow' ORION INDUSTRIES Introduction 8n +art 2ive o" the 5rion !ase Study, the banker must decide whether to proceed with a "ormal credit recommendation "or 5rion' 0e obtains additional "inancial in"ormation to construct a cash in"low:out"low bud et in order to structure a potential deal' Orion C#$h In*&o+ , Out*&o+ A "ew days a"ter puttin to ether the 5rion customer and sensitivity pro&ections "or $;<4, Aries "elt he needed one last piece o" "inancial in"ormation to prepare a cash in"low:out"low bud et "or 5rion' Aries knew that the pro&ections he had made, althou h e#tremely use"ul, provided a pro&ection o" avera e "i ures' 4ut this did not account "or the seasonality o" the business, which Scorpio had mentioned on couple o" occasions' The cash "low bud et would help de"ine the structurin "or the potential new "acility' 8t would provide a more detailed picture o" the cash "lows durin the year in addition to the situation at the end o" the year' 4esides, Aries was a computer bu"" and could utili6e the cash in"low:out"low model that he had &ust "inished devisin on his personal computer' The model was similar to that used by other banks, with a couple o" "eatures that Aries had added' (ith the model, it would take no more than a "ew minutes to compile the data and print it out'
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0e spoke over the phone with Scorpio' The customer said, >8t,s ood that you called' 8t looks like we,ll be ettin the contract "or increased production that we have been ne otiatin with +A+' (e have ad&usted our monthly sales bud et, with production increasin si ni"icantly be innin in ?une and total annual sales now pro&ected at 7cy -4= million' 4y September we e#pect to be producin about 5@% more than we are now producin 'A
Scorpio assured the banker that 5rion could handle the volume' >Bemember, we were producin at &ust below these volumes a couple o" years a o, but at unpro"itable levels' Cow we e#pect to make some money' Since we,ll be producin the same products, all we have to do is hire a "ew more people and schedule about %5% more overtime than at present' 4ut to be conservative, we should bud et a little more "or capital e#penditures' (e,ll also have to ac3uire a couple o" new machines and keep the old ones as backups to make sure we don,t have any e3uipment problems' E#cept "or the sales "i ures 8 mentioned, the other assumptions would be about the same as we discussed a "ew days a o'A Inter)reting the Re$u&t$ A"ter Aries completed the cash in"low:out"low numbers, he made notes o" some observations' These will be included in his overall "inancial analysis o" 5rion as part o" his credit recommendation, should he decide to o ahead with the 5rion deal' The numbers also will be valuable in structurin the credit and anticipatin when drawdowns would most like be re3uested' CAS! INFLO" , OUTFLO" -UD ET Came: ORION INDUSTRIES 7ocation: Andro.ed# Auditor: C#)ricorn / Cent#uri 4e in ST Debt: $5,@.@ !urrency: Lc0 Assumptions: Mini.u. C#$h1 2333 8nterest Bate %: 42 Amount o" 7ine: 56333 Amounts: Thousands +eriod: ?an 2eb Ear Apr Eay ?un ?ul Au Sep 5ct Cov De <4 Startin !ash Cet Sales )Accounts Beceivables 5pened* Accounts Beceivables !ollected 5ther 5peratin Bevenues 8n"lows "rom 5perations Total +urchases )Accounts +ayable Taken* Accounts +ayable +aid Feneral G Admin' !ash 5ut"lows 5ther 5perational 5ut"lows 8nterest +ayments Ta#es +aid 5ut"lows "rom -%54 %@@@@ %@@@@ %/@5. 4@@@ %%@@@ %%@@@ %/@5. 4@@@ %4@@@ %4@@@ %/@5. 4@@@ %4@@@ %4@@@ %@@@@ 4@@@ %4@@@ %4@@@ %%@@@ 4@@@ -@@@@ -@@@@ %4@@@ 4@@@ -%@@@ -%@@@ %4@@@ 4@@@ -4@@@ -4@@@ %4@@@ 4@@@ -.@@@ -.@@@ -@@@@ 4@@@ -.@@@ -.@@@ -%@@@ 4@@@ -.@@@ -.@@@ -4@@@
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Case Study
5perations 7on Term Debt Taken !ash Sale o" Assets, 5ther Con-5perational 8n"lows +lant G E3uipment E#penditure +ayment 7on Term Debt Dividends +aid Con-operational 5ut"lows Cet !ash )5ut"low* !ash 4alance Short Term 7oans Taken Short Term 7oans +aid Endin !ash Short Term Debt 5utstandin Short Term 7ine Available E#cess )De"icit* o" 7ine 8n"low @ %@%; 5%=@ $%=4@@@ $-/// $5@@@ $%%@ /%5% $$%5% @ /%5% 4@@@ .5%5 $5@@@ =4/5 @ @ @ @ %5@@ @ %5@@ %.%= %5@@ %5@@ $@. 4$@. @ $@. 4@@@ .4$; $5@@@ =5=$ %5@@ --5@$ 4;; -5@$ @ 4@@@ ;;$; $5@@@ 5@=$ %5@@ -%%$; $/=$ %%$; @ 4@@@ %%$-= $5@@@ %=.% %.%= -..-; -%.-; ..-; @ 4@@@ $=/// $5@@@ --/// %@@@ -5.-= -$.-= 5.-= @ 4@@@ %44$5 $5@@@ -;4$5 @ -5-$$ -$-$$ 5--$ @ 4@@@ %;/%. $5@@@ $4/%. %5@@ %5@@ -5%.$ -$%.$ 5%.$ @ 4@@@ -4;=/ $5@@@ $;;=/ @ $$-4 5$-4 @ $$-4 4@@@ --=5$5@@@ $==5@ -=@4 /=@4 @ -=@4 4@@@ -@@4= $5@@@ $5@4= @ @ %@@@ @ @ @ @
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Summar/ o3 Assum)tions 3or 1678 Cas' In3$o9#Out3$o9 Bud"et #alesI A1 collectedI A1 termsI !nventoryI +urchasesI +urchase termI 2/#C#alesI #/A expensesI Other op. outI !nterestI TaxesI As per customer sales budget 9<<A on credit %rom 97CD9CJD balance sheet assume equal amount collected per month in Oanuary %ebruary and -arch 8< days 99< days as in 98JD ;:A of 2/# as per recent history D< days but made one month in advance B7A as in 98JD 97A of salesH assume :<C:< variableCfixed mix 9:A component of 2/# for labor and overhead 7@A on short-term payable monthly in arrearsH D<A on long-term payable monthly 98JD amount due in -archH 98J@ estimated paid quarterly in Oune #eptember and =ecember
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)T=I 2apital exp.I =ividendsI -inimum cashI *egin #T=I (o )T= takedowns on capital expendituresH semi-annual payments at end Oune and =ecember as contracted 2apex B<<< &same as deprec' in April -ay and Ouly : <<< as per customer indications As per customer indications now )cy @ million As per 97CD9CJD balance sheet
*efore continuing to the Orion 2ase #tudy complete +rogress 2heck D.7 which follows. ORION INDUSTRIES !n +art #ix of the case study Aries ties up some loose ends and analy6es the potential risks associated with this credit. ,e weighs the risk against the opportunity and decides to recommend the credit. %inally he decides on terms and conditions and structures the potential credit. %oose Ends 2heckings from #agittarius *ank At about the time that Aries was completing his numbers analysis )ibra *ank received favorable checkings from #agittarius *ank. The report confirmed that Orion had been a customer for several years and had a record for punctual payment. #agittarius was satisfied with the relationship but Aries knew that this bank had serious liquidity problems and couldn"t sustain the account. .Their loss is our gain 5 thought Aries. Kuality 2onfirmation from +A+ Aries was also able to obtain some information over the telephone from the +egasus Automobile +lant"s procurement manager concerning the quality of Orion"s products and the company"s reliability for timely delivery. The procurement manager reported .3e are pleased with the Orion relationship. Their product is top quality and management is serious about on-time delivery which helps us reduce our own inventory requirements. Orion continues to be one of our smaller suppliers but we are pleased that they have agreed to increase their volume with us. 3e intend to limit our suppliers to those that can best integrate their operations with ours.5 Aries noted the gist of the conversation in the reference section of the credit file. Although this was a strong reference Aries was now thinking about the possible risks with the potential credit G risks which must be considered along with the many positive factors for structuring a credit for Orion. Credit Ris s #mall 2ustomer *ase 3hile the +A+ procurement manager gave a good recommendation regarding quality and timeliness he flagged a potential risk that Aries had not yet considered. The risk was that in an economic downturn +A+ might view Orion as a marginal producer and eliminate the company as a supplier. ,owever the strong economic situation the growing market demand and the increased contract with +A+ seemed to neutrali6e this risk for the short term. Also Orion"s production quality was some insurance against loss of the relationship with +A+ or with the Tractor 3orks. 3hile Orion presently produced for these two principal customers there were other possibilities as well. -ost of the less profitable relationships had been terminated by #corpio over the past two years in order to focus on the more profitable clients. *ut #corpio had indicated that one of their ma4or thrusts during the next two years was to diversify even more and search out new buyers particularly in the export market. 3hile the current lack of a diversified customer base was a situation to keep an eye on Aries decided that it was an acceptable risk. !nsufficient -anagement =epth Another credit risk appeared to be #corpio"s overall importance to Orion and ironically his grasp of the company"s situation. #corpio tended to dominate the firm"s decision making to the point
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where it could be considered a .one man show.5 Administrative management was stretched thin. The Taurus brothers were important on the operational side but did not have the skills or interest to manage effectively. Aries had discussed this with #corpio and learned that two key people had been trained to maintain the integrity of the cost accounting and management information systems which were so crucial to the success of the firm. !n addition a new administrative manager would be hired when operations started to expand. The risk of insufficient management personnel appeared to be diminishing but it was something else to keep an eye on. Overly Ambitious /oals Aries also considered the related risk that perhaps #corpio"s goals were overly ambitious and he was trying to achieve too much too soon. !t was possible he was overextending the company and himself. Aries had 4okingly brought up the sub4ect with #corpio on one occasion. The customer responded .+erhaps but our track record over the past two years shows that although our balance sheet has shrunk rather than grown our profitability has grown tremendously. This should give us some credibility on that score.5 Age of the +lant The age of the plant could also be considered a risk especially considering the emphasis on quality and timely delivery of Orion products. Aries had discussed this with #corpio who assured him that with the addition of a few new machines the plant was capable of producing under their contracted obligations. *ut #corpio did acknowledge that within a couple of years a new plant with greater capacity would probably be necessary especially if additional contracts could be obtained. This would either involve expansion or relocation. Other 1isks There were other risks such as potential problems with availability of raw materials &most were produced domestically' and qualified labor but these risks were shared by practically all industrial producers and had never hampered Orion in the past. 3orld petroleum prices were relatively low at this time and were expected to remain low for the foreseeable future. Therefore fuel prices were not expected to negatively impact domestic or international demand for automobiles at least for the next several years. #ince Orion no longer had any foreign currency debt devaluation was not a risk and the minidevaluations even helped Andromedan exports remain competitive. Auto production costs in Andromeda were lower than in developed countries. Export of automobiles and parts had become a ma4or potential source of foreign currency earnings and devaluation would probably make these exports even more competitive G particularly since a ma4or portion of the components was sourced domestically. Ba$ancin" O))ortunities 9it' Ris s /rowing 2ompany )eo Aries felt quite strongly that he had a solid potential credit. ,e liked Orion !ndustries because it was a growing middle-si6e enterprise with a quality product in an improving market. The company matched well with his unit"s target market definition and appeared to be a company with continually growing needs. The situation was favorable for the bank to develop a mutually beneficial solid relationship. +rofessional Experienced +ersonnel The management personnel at Orion were professional and experienced. They had a practical focus high standards of quality and the ability to maximi6e their operation without frills or excessive investment in plant and buildings. Their plans indicated an excellent potential opportunity for the bank to finance the future plant relocation andCor expansion and to provide letters of credit or other trade services for exports. Kuality +roduct Aries also thought about Orion"s product. There was a strong demand for parts in Andromeda"s rapidly expanding automotive sector. !n addition Orion was able to produce other products including the existing line of tractor parts. The tractor market was not growing as fast as the automotive sector but continued to offer an attractive consistent demand for metal products. Orion"s products had a strong reputation for quality and because of this the company should be able to withstand an economic downturn. #trong %inancial #ituation
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Case Study
The financial situation of the company was quite strong. The statements clearly reflected how #corpio reduced the si6e of operations and made more efficient use of his assets. The company became more profitable because margins were improved and interest expense was reduced by the prepayment of long-term debt. The overall reduction in liabilities was accomplished by reducing current assets and not by investing in new fixed assets. The balance sheet was quite strong with a leverage of only <.;B on 97CD9CJD reduced by more than half in only two years. ,owever borrowing would reverse that. #trong )eadership !n particular Aries admired #corpio. The potential customer was an impressive person softspoken but commanding of respect. ,e was a good manager with strong credibility established by his impressive turnaround of the Orion financial situation. ,e was a rare combination of a numbers and operations man with a strong grasp and attention to detail. ,e was a man that Aries felt he could trust and work with comfortably.
Structurin" t'e Credit Aries felt that #corpio"s request for a short-term line of credit with drawdowns up to a maximum )cy @< million was the appropriate structure. The amount seemed high in relation to pro4ected needs especially considering that /emini *ank currently offered about )cy 9: million in shortterm facilities. *ut Aries was willing to go with the amount in order to compete favorably with /emini for the business and also to maintain a strong cushion of availability in case of unexpected additional needs. The bank operated under this mode with many other industrial enterprises and the structuring worked quite well. The facility would permit the borrower to draw down as needed for a determined period up to 9;< days or to discount receivables. The company to its own cash flow cycle could ad4ust that way the borrowing. ORION INDUSTRIES Finis'in" Touc'es Aries discussed the structure &proposed in +art #ix' with #corpio to confirm his agreement on the details. !n general the customer was in agreement. .Although much of the time we"ll be discounting receivables we prefer the flexibility of short-term loan availability as well. This will see us through 4ust fine 5 said #corpio. #corpio balked at the DA spread and 9A commission as a negotiating tacticH but knowing this was the market rate he finally accepted the terms. .(ext year we"ll be back asking you to reduce the spread after you see how strong our balance sheet comes out 5 said #corpio. Aries said .! think we can work on this basis and !"ll start the approval machinery moving right away Of course you reali6e this is not our final position until all approvals are obtained up the line.5 The banker had to cover himself since credit seniors might make some changes or additions to conditions on approval although he thought any changes would be minor. Aries felt confident that this credit request would sail through the approval chain because it was a strong credit and consistent with the type of client the bank wanted. As the meeting between #corpio and Aries ended the client mentioned his concern about how much longer this approval process would take. .!t"s already been about four weeks 5 he said .and now that we have the contract for increased production for +A+ we"ll need funds availability soon. 2an we have a commitment from your bank in one week"s timeN5 Aries answered that this should be sufficient time. ,e knew that #corpio must be thinking in terms of obtaining financial backstop availability very soon. !f something went wrong with the )ibra *ank negotiations now #corpio would have very little time to patch something together with another bank. *ut these were 4ust hypothetical problems figured Aries. .(othing will go wrong.5 Credit Pac a"e Aries had all of the elements of the credit package ready except for the credit memo which he stayed late that night to finish. /iven the amount of exposure recommended for Orion Aries
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knew that the credit would have to be approved by his department head and the #enior 2redit Officer of the )ibra *ank who was at the second highest level below the *oard of =irectors. 3hen he had finished Aries left the credit package along with the credit file on the department head"s desk. Aries had kept his credit supervisor informed of the progress with the potential credit so the supervisor was familiar with the situation and was able to sign off on the credit application quickly. The credit supervisor had provided some valuable thoughts during the analysis phase and had participated in a couple of meetings with #corpio. The credit package was then routed to the #enior 2redit Officer &#2O' of the )ibra *ank. Aries had met with the #2O on two or three occasions and had been impressed with the depth of the #2O"s credit knowledge which Aries thought fully 4ustified the #2O"s strong reputation. Re+ie9 o3 t'e Credit Pac a"e The #2O"s policy was to read the material carefully once and make a quick decision one way or the other. !f there were any loose ends to tie up he would discuss them with the author in person and ask the credit officer to quickly ad4ust them. !f he agreed with the credit proposal he would sign the 2redit +roposalCApproval form when this was done. !f there were fundamental problems he would discuss them immediately with the author and see if a cure could be found. !f not the credit would be disapproved.
On the following pages you will see a reproduction of the Orion credit package. !t includesI !redit +roposal:Approval 2orm, 4asic 8n"ormation Beport )48B*, Addendum to 48B 1 Eana ement Assessment, !omparative Statement o" 2inancial !ondition )spreads*, !ustomer and Sensitivity +ro&ections, !ash 8n"low:5ut"low 4ud et, Summary o" Assumptions "or $;<4 8n"low:5ut"low 4ud et, and !redit Eemo'
-ost of this material has been developed in earlier parts of the Orion 2ase and is presented again to demonstrate what a credit package looks like. 2arefully read the 2redit -emo on page @-7@ to understand the style and methodology of the credit presentation and to be prepared to answer subsequent questions for analysis.
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Case Study
%IBRA BAN2 CREDIT APPRO,A% NO( 78-:8. 2lientI ORION INDUSTRIES )ocationI Perseus *usinessI Metal Products 1evision =ateI 7; %ebruary 98J: =ateI $nitI March 10, 19X4 *ranchI Main a!ital "oods (one
2lassificationI
2redit %acility and TermsI &)cy <<<"s' Short#ter$ %ine o& redit G (ew %acility
AmountI +urposeI +aymentsI TenorI !nterestI 2ommissionI 2ommitment %eeI #upportI
Existing Aggregate %acilitiesI None
)cy @< <<< #hort-term loans or discount of trade bills with recourse !n full at maturity or as collected for trade bills $p to 9;< days *ase rate or discount rate P DA p.a. 9A flat on opening .7:A p.a. on undrawn facility 9' )ien on trade receivables for 97<A of outstandings for loans 7' +ersonal guarantee of *. #corpio and -. and (. Taurus for full amount of facility D' )ife insurance policy in name of *. #corpio endorsed to bank &)cy <<<"s' Approved
#ecurityC#upportI +ledge receivables from +A+ and AT3 for 97<A of outstandings duly endorsed to bank &on loans' 2ontinuing )etter of /uarantee &2)/' signed by Orion to evidence recourse on discounted trade bills 2)/ signed by *. #corpio and -. and (. Taurus for full amount of facility. Approved AmountI %c/ 8:;:::;::: 2redit 2ommitteeI Area ,eadI #eniorsI *oardI
BASIC INFOR!ATION REPORT +age 9 *1A(2,I 2)!E(TI A==1E##I %i'ra (an) Main Orion !ndustries +erseus =ATEI 7C9?CJ@ #!(2EI *$#!(E##I -etal +roducts O*TA!(E=I 1eference (CA
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Case Study
O0NERSHIP 2losely held corporationI 7CD Taurus *rothers 9CD *runo #corpio latter with option for :9A control. Employee stock ownership plan for 7<A out of Taurus *rothers holdings to be effected. These independent ownerCmanagers are apparently highly committed. DIRECTORS AND !ANA1E!ENT /eneral *runo #corpio early @<s mechanical engineer from $niversity of -anager Andromeda. Experienced in prior positions with subsidiaries of ma4or multinationals. #trong background in manufacturing and costCmanagement systems. +roduction -ax and (ick Taurus late :<s immigrant founders self-made men. Excellent craftsmen but not sophisticated managers. -anagers have good reputation for reliability and integrity based on feedback from suppliers etc. HISTORY 2ompany was formed by Taurus brothers 7@ years ago to produce high precision metal parts. ,ave had ongoing and positive relationship with Andromeda Tractor 3orks and more recently initiated higher precision production for +egasus Auto +lant. +roduct quality has been good but spotty recent history in dependability and profits. Arrival of #corpio three years ago has helped remedy this in productivity turnaround. BAN2IN1 AND OTHER FINANCIA% RE%ATIONS +rincipal bank has been /emini with some lending by #agittarius. )atter relationship being terminated due to bank"s problems. /emini products include short-term lending occasional equipment loans booked through Andromeda =evelopment *ank and payroll and current account products. 1elationship has been unsophisticated due to lack of management financial skill. 2heckings indicate good experience with occasional past rollovers. OPERATIONS +age 7 +1O=$2T# ,igh precision metal works with variety of products capability +rimarily tractor axle and transmissions (ow producing higher precision automobile universal and rear axle assemblies #ome seasonality +erceived high quality workmanship #ales breakdownsI Tractor ::A G Automobile @:A %A2!)!T!E# Own plant located in +erseus ?< km away Out of the way location but good access Own concrete block building free of mortgage Adequate energy and water infrastructure !mported machinery old but in good shape %ull insurance for depreciated market value 3arehouse controls adequate but crowded Employees appear to be well trained Employee relations good G good productivity
#$++)!E1# A(= T1A=E 1E+$TAT!O(
Andromeda #teel 3orks and Andromeda -ining and -etals for local supplies of base metals Kuality of local supply is good
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Case Study
Terms between D< and ?< days #ome purchases of foreign materials paid on cash basis from free market foreign exchange 2heckings have been favorable =!#T1!*$T!O( A(= #E))!(/ TE1-# =irect sales to Andromeda Tractor 3orks and more recently to +egasus Automobile +lant All sales on credit terms mostly 8< days Other miscellaneous sales &when spare capacity available' with varying terms /ood references from AT3 and +A+ as to quality and delivery timeliness AFFI%IATED CO!PANIES AND RE%ATED BUSINESS (o affiliated business ADENDU! TO BIR4 !ANA1E!ENT ASSESS!ENT /OA)# O1!E(TAT!O( A(= 2O--!T-E(T +age D
/oals to produce more for the automobile sector +erception of ownerCmanagement commitment with .hands on 5 involved approach -anagement committed to quality serious 3orker productivity apparent with ongoing employee stock ownership plan %irm now has more focused orientation since arrival of #corpio know-how Taurus brothers excellent craftsmen only +resent lack of depth (ew delegation system to develop new people +resent centrali6ed authority OM for level of operations but not for growth into new products %irm dependent on #corpio for managerial direction and
O1/A(!LAT!O(A) 2,A1A2TE1!#T!2# A(= =E+T,
*A2M/1O$(= A(= )E0E) O% -A(A/E1#
MEY
#corpio has strong manufacturing background with particular strength in cost accounting and management systems for tracking results #corpio experience gained with Andromeda subs of ma4or multinationals Taurus brothers have strong background as craftsmen with credibility for quality *rothers weak on administrative side 2ommitment to quality and excellence 1eputation for thoroughness and on-time delivery although previously some problems 3ork force apparently well trained 3ork force motivated with productivity pay Employee turnover apparently healthy lower than normal %irm has good reputation for integrity
3O1M ,A*!T# A(= -A1MET 1E+$TATO(
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Case Study
-A(A/E-E(T #Y#TE-# A(= 2O(T1O)#
(ew systems fill vacuum of prior management 2ost accounting systems have brought back profitability vs. prior marginal results -anagement information systems track productivity and work defects by product line *udgeting systems permit controlCdelegation +roduct is craft but not .high tech5 -achinery appears adequate for needs -achinery apparently maintained by own staff under supervision of Taurus brothers Technology appears to be adequate -
A22E## TO TE2,(O)O/Y
COMPARATIVE STATEMENT OF FINANCIAL CONDITION Came: ORION INDUSTRIES 7ocation: ANDORMEDA !urrency: LCY IN THOUSANDS Auditor: CAPRICORN & CENTAURI Date: Cumber o" Eonths Sales on !redit % BA%ANCE SHEET ASSETS !ash Earketable Securities Accounts Beceivable 8nventory 5ther !urrent Assets +repaid E#penses !urrent Assets Cet 2i#ed Assets 8nvestments 5ther Con-current Assets 8ntan ibles Total Con-current Assets Total Assets 78A4878T8ES G EH98TI Due 4anks, Short-term Accounts +ayable Accruals Ta#es +ayable 5ther !urrent 7iabilities !urrent +ortion 7 T Debt !urrent 7iabilities 7on -term Debt 5ther 7iabilities, 7on -term 7on -term 7iabilities Total 7iabilities -;,.$5 %.,/%@ $@,4%; %-@ /,$%@ =4,$$4 --,%4/ $;,/;4 5-,@4$ $-/,$55 -5,54% %@,4.= =,@/% %,$$. 5,4-.=,.-$ $.,45% $%,/-% %;,$=4 ;/,=$5 $5'@.@ $=,;;= =,-== -,44/ 5,%55 5$,$4= $$,%-% $%,;/@ %4,%@% /5,-5@ @ @ @ $%:-$:<$ $% $@@ Actual $,;;/ %,@@@ ./,-5@ /4,/%@ 5,4/. -,@$5 $54,55= 44,/.% @ %,;=. @ 4/,/4= %@%,-@. $%:-$:<% $% $@@ Actual $,/;% %,@@@ .$,=/% 5.,;/% %,.5@ %,.5$ $%/,;-/ 4$,$%/ @ 5,%4% @ 4.,-.; $/4,-@. $%:-$:<$% $@@ Actual $,=54 $,4@@ 54,$$4 5-,4.= 4,$%. %,455 $$/,4$/ -=,4@. @ .,$@/ @ 44,5$$.$,;-@
@ @ @
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Case Study
!ommon Stock Surplus G Beserves Betained Earnin s Total Cet (orth 7iabilities G Cet (orth --,@@@ %4,@@@ $$,$5$ .5,$5$ %@%,-@. -@,@@@ %4,4=$ %%,@$@ /.,4;$ $/4,-@. -@,@@@ %5,@=@ -$,5@@ =.,5=@ $.$,;-@
@ @ @
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Case Study
Came: Date: ORION INDUSTRIES $%:-$:<$ Actual %//,=./ %$-,-@. /.'= -=,;/% $4'@ %5,5=; ;'% 5,$%$ $=,=.% -./ $,5-; @'. -@4 @ $,%-5 @'4 $%:-$:<% Actual %/@,%-= %@%,5%= /4'; -%,5.. $%'$ -5,$44 $-'@ 5,-/4 $-,-%/ -$44 $.,%;; .'@ 4,;5; @ $$,-4@ 4'% $%:-$:<Actual %4-,5@4 $/5,-$@ /%'@ -@,=;. $%'/ -/,%;= $5'.,5-; $@,/.@ -;= $;,;@$ ='% .,=.. @ $-,@-5 5'4
INCO!E STATE!ENT Cet Sales !ost o" Foods Sold % o" Sales Sellin , Feneral, Admin' E#pense % o" Sales Fross Ear in % o" Sales Depreciation 8nterest E#pense 5ther 8ncome:)E#penses*, Cet Earnin s 4e"ore Ta#es % o" Sales 8ncome Ta#es E#traordinary 8tems Cet 8ncome % o" Sales RATIOS 7Annu#&i8ed9 Sales Frowth Bate % Cet 8ncome:Avera e Cet (orth % Cet 8ncome:Avera e Assets % Sales:Avera e Assets !urrent Batio Huick Asset Batio Days Beceivables Days 8nventory Days +ayable 7evera e )Debt:E3uity* 7on -term 7evera e RECONCILIATIONS Cet (orth 4e innin Cet (orth +lus: Cet 8ncome +lus: 2resh !apital Total 8ncrease 7ess: Dividends, 5ther 8ncrease:Decrease in C( Endin Cet (orth 2i#ed Assets 4e innin 2i#ed Assets 7ess: Depreciation Subtotal Endin 2i#ed Assets !apital E#penditure Came: ORION INDUSTRIES
@ @ @ @
$'; @'. $'-/ $'= @'= =/ $%. 45 %'$$ @'=$
-%'/ $.'@ .'@ $'44 $'; $'@ =% $@$ -. $'%= @'-=
-;'; $.'@ /'= $'45 %'$'$ =@ $$@ -; @'=/ @'%=
; 4
C:A $,%-5
.5,$5$ C:A 5,$%$ 44,/.% '
.5,$5$ $$,-4@ @ $$,-4@ @ $$,-4@ /.,4;$ 44,/.% 5,-/4 -;,-== 4$,$%/ $,/-;
/.,4;$ $-,@-5 @ $-,@-5 %,;4. $@,@=; =.,5=@ 4$,$%/ .,5-; -4,5== -=,4@. -,=$=
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Case Study
Date: Cumber o" Eonths CASH 1ENERATION Cet 8ncome Depreciation 5ther Con-!ash !har es Fross 5peratin 2unds Feneration 8ncrease in !ash G Earket Securities 8ncrease in Accounts Beceivable 8ncrease in 8nventory 8ncrease 5ther !urrent Assets 8ncrease +repaid E#penses Total 5peratin Ceeds 8ncrease in Accounts +ayable 8ncrease in Accruals 8ncrease Ta#es +ayable 8ncrease 5ther !urrent 7iabilities Total 5peratin Sources Cet 5peratin !ash Feneration !apital E#penditures Dividends 8ncrease in 8nvestments 8ncrease 5ther Con-!urrent Assets 8ncrease in 8ntan ibles Beduction Short-term 4ank Debt Beduction 7on -term Debt Total Con-5peratin Ceeds 2resh !apital:5ther C( 8ncrease 8ncrease 5ther 7on -term 7iabilities 8ncrease Short-term 4ank Debt 8ncrease 7on -term Debt Total Con-5peratin Sources J !heck )C5!F 1 TC5C K TC5S* $%:-$:<$ $% Actual $,%-5 5,$%$ C:A .,-5. $%:-$:<% $% Actual $$,-4@ 5,-/4 @ $.,/$4 -%@5 -5,4/= -$/,/4= -%,=%. --.4 -%.,.%$ -.,%5% -%,-5/ $,==. @ -.,/%-.,.$% $,/-; @ @ %,%5. @ /,@/$=,4=% %;,55@ @ -/,@.% @ @ -/,@.% @ $%:-$:<$% Actual $-,@-5 .,5-; @ $;,5/4 -5-= -/,/5= --,5@4 $,4/. -$;. -$@,5%@ -$,4/@ -$. $,--$ @ $// -@,%/$ -,=$= %,;4. @ =.5 @ $/,4=% 5,-;= -@,5@; @ %-= @ @ %-= @
' '
' ' '
' '
' ' '
Q 2heck &(et Operating 2ash /eneration G Total (on-operating (eeds P Total (on-operating #ources' Came: ORION INDUSTRIES $%:-$:<$ $% $%:-$:<% $% $%:-$:<$%
Date: Cumber o" Eonths SUPP%E!ENTARY INFOR!ATION Cet 2i#ed Assets 4reakdown
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Case Study
7and 4uildin s Eachinery G E3uipment Lehicles Subtotal 7ess: Accumulated Depreciation Cet 2i#ed Assets Due 4anks, Short-term Femini 4ank Sa ittarius 4ank Ac3uarius 2inancial 7on -term Debt Femini 4ank Sa ittarius 4ank Andromeda Develop 4ank 7ess: !urrent +ortion 8nventory 2inished Foods (ork in +rocess Baw Eaterial .,/%$ %$,5%@ 4$,-=/ $,/./ /$,-;5 %.,.-44,/.% .,/%$ %$,5%@ 4-,5%% $,-/$ /-,$-4 -%,@@/ 4$,$%/ .,/%$ %4,@-. 44,5./ $,.%= /.,;5% -=,54. -=,4@.
$-,;4/ $4,5/$ $$,@;/ -;,.$5 .,4%% ;,=%/ %4,$$= 4@,-./ /,$%@ --,%4/ %-,.-@ 4,4%4.,../ /4,/%@
$/,44@ ;,.55 5,44/ -%,54% 5,%/. .,-44 $@,%.5 %$,==5 5,4-$.,45% $.,@-% %,4.$ -=,4/; 5.,;/%
$5,@.@ @ @ $5,@.@ 4,$-@ -,$5$ ;,%@. $.,4=/ 5,%55 $$,%-% $;,-// -,=55 -@,%-. 5-,4.=
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Case Study
CLIENT AND SENSITIVIT: PRO;ECTIONS ORION INDUSTRIES $% month Actual $%:-$:<$% month !ustomer +ro&ection $% month Sensitivity +ro&ection
Thousands o" 7cy BA%ANCE SHEET !ash G Earketable Securities Accounts Beceivable 8nventory 5ther !urrent Assets +repaid E#penses !urrent Assets Cet 2i#ed Assets 8nvestments 5ther Con-current Assets 8ntan ibles Con-current Assets T5TA7 ASSETS 4ank Debt, Short-term Accounts +ayable Accruals Ta#es +ayable 5ther !urrent 7iabilities !urrent +ortion 7 T Debt !urrent 7iabilities 7on -term Debt 5ther 7on -term 7iabilities T5TA7 78A4878T8ES !ommon Stock Surplus and Beserves Betained Earnin s T5TA7 CET (5BT0 78A4878T8ES G CET (5BT0 INCO!E STATE!ENT Cet Sales !ost o" Foods Sold % o" Sales Sellin , Feneral, Admin' E#penses % o" Sales
-,%54 54,$$4 5-,4.= 4,$%. %,455 $$/,4$/ -=,4@. @ .,$@/ @ 44,5$$.$,;-@ $5,@.@ $=,;;= =,-== -,44/ @ 5,%55 5$,$4= $$,%-% $%,;/@ /5,-5@ -@,@@@ %5,@=@ -$,5@@ =.,5=@ $.$,;-@ $%:-$:<-
4,@@@ /-,@5$ /$,-$. 4,$%. %,455 $54,;4= -.,4@. @ /,$@/ @ 4-,5$$;=,4.$ $=,/4/ %5,;-$-,@@@ 5,@@@ @ 5,%55 ./,;-5 5,;// $.,@@@ =;,;$% -@,@@@ %5,.=@ 5%,=.; $@=,54; $;=,4.$
-,@@@ =$,$.= =%,;54 5,@@@ -,@@@ $/5,$%$ -=,4@. @ /,$@/ @ 45,5$%%@,.-5 .-,4@. $/,//. $$,@@@ 4,@@@ @ 5,%55 $@$,4-/ 5,;// $5,@@@ $%%,4$4 -@,@@@ %5,.=@ 4%,54$ ;=,%%$ %%@,.-5 !ustomer -%=,/-@ %--,-;; /$'@ % -/,=@4 $$'5 % Sensitivity %;%,%@5 %$-,-$@ /-'@ % -/,;=/ $-'@ %
%4-,5@4 $/5,-$@ /%'@ % -@,=;. $%'/ %
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Case Study
Fross Ear in % o" Sales Depreciation 8nterest E#pense 5ther 8ncome, Cet Earnin s 4e"ore Ta#es % o" Sales 8ncome Ta#es Cet 8ncome % o" Sales RATIOS 7Annu#&i8ed9 Sales Frowth Bate % Cet 8ncome:Avera e Cet (orth % Cet 8ncome:Avera e Assets % Sales:Avera e Assets !urrent Batio Huick Asset Batio Days Beceivables Days 8nventory Days +ayable 7evera e 7on -term 7evera e RECONCILIATIONS Cet (orth 4e innin Cet (orth +lus: +eriod Cet 8ncome +lus: 2resh !apital Total 8ncrease 7ess: Dividends, 5ther Cet 8ncrease:Decrease Endin Cet (orth 2i#ed Assets 4e in Cet 2i#ed Assets 7ess: Depreciation Subtotal Endin Cet 2i#ed Assets !apital E#penditure 5B85C 8CD9STB8ES /.,4;$ $-,@-5 @ $-,@-5 %,;4. $@,@=; =.,5=@ 4$,$%/ .,5-; -4,5== -=,4@. -,=$= $% months Actual $%:-$:<=.,5=@ %.,;.; @ %.,;.; 5,@@@ %$,;.; $@=,54; -=,4@. /,@@@ -$,4@. -.,4@. 5,@@@ $% months !ustomer +ro&ection =.,5=@ $$,.4$ @ $$,.4$ @ $$,.4$ ;=,%%$ -=,4@. /,@@@ -$,4@. -=,4@. /,@@@ $% months Sensitivity +ro&ection -;'; % $.'@ % /'= % $'4 %'$'$ =@ $$@ -; @'=/ @'%= -5'@ % %/'. % $5'@ % $'= %'$'$ =@ $$@ 4@ @'=@'%@ %@'@ % $%'@. % .'$ % $'5 $'/ '= $@@ $4@ -@ $'%5 @'%$ -/,%;= $5'- % .,5-; $@,/.@ -;= $;,;@$ ='% % .,=.. $-,@-5 5'4% 5/,5%= $/'5 % /,@@@ $%@@@ @ -=,5%= $$'/ % $$,55= %.,;.; ='% % 4@,;@; $4'@ % /,@@@ $.,@@@ @ $/,;@; .'$ % .,%.= $$,.4$ 4'@ %
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Case Study
Financia$ co+enants %inancial covenants may cover specific targets forI

E+ents o3 de3au$t
minimum current ratio minimum working capital maximum leverage minimum capitali6ation minimum profitability or others.
Events of Default and Acceleration The contract must specify which acts or omissions by the borrower constitute events of default and what specific remedies the creditor may have &e.g. disposition of pledged assets'. The first and most obvious event of default is non-payment. *ut others must be clearly identified within the loan contract and may includeI
proving any representation or warranty made by the borrower to be materially false non-compliance with any covenant non-compliance with obligations under contract &the so called cross-default clause' any other
placing of any 4udicial lien or embargo against any of the borrower"s assets or occurrence conditions. of bankruptcy insolvency or similar
O)tion to acce$erate re)a/ ment
5ne o" the basic premises o" the term loan document is the le al ability to accelerate the borrower,s repayment obli ations' 8" the borrower "ails to comply with all pertinent clauses )e' ' i" an event o" de"ault as speci"ied should occur*, the creditor has the le al option to accelerate the maturity o" the loan' 8n practice, there is o"ten considerable "le#ibility e#ercised by the creditor when there is a breach o" covenants' 8n many situations involvin de"aults other than payment de"aults, the borrower is normally iven time to >cureA the de"ault' 8n more serious situations, i" the de"ault is in ood "aith, the creditor may rene otiate terms' Even i" it is rarely used, the bank,s le al ri ht to accelerate ives it ne otiatin powers with the borrower, and perhaps with other creditors'
ORION INDUSTRIES P#rt < Introduction 8n +art Ei ht o" the 5rion case, the Senior !redit 5""icer approved the loan a"ter re3uestin an industry analysis to determine business sector risks with the credit' (e now proceed to +art Cine' A"ter the disbursement and establishment o" a credit relationship, the customer asks the bank to provide e3uipment "inancin "or new machinery' The bank approves the re3uest and has to structure a term loan document' Credit Re&#tion$hi) 5rion utili6ed the 7ibra 4ank short-term "acility durin the middle months o" the year when the company be an producin additional 3uantities "or the +e asus Automobile +lant' 9se o" the "acility was heavier than 5rion had anticipated because receivables and inventories remained at sli htly hi her levels than ori inally anticipated in the customer,s pro&ections, but in line with the additional 7cy $@ million that was
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Case Study
identi"ied in the sensitivity "i ures' +ayment e#perience was ood, repayment o" advances was timely, and there were no di""iculties collectin discounted bills' The overall "inancial situation o" the "irm was 3uite sound, and the 3uarterly "inancial statements veri"ied that levera e was below $'@@' +ro"itability was maintained at the level anticipated in the optimistic pro&ections and Scorpio,s credibility was con"irmed as actual pro"it numbers closely matched earlier pro&ections' 7eo Aries maintained "re3uent contact with 5rion' This allowed him to provide ood service to the customer and to anticipate additional needs, such as cash mana ement products in con&unction with collection o" 5rion receivables' 8t also provided a deeper understandin o" the business sector, which the bank used to re"ine the risk asset acceptance criteria and identi"y potential bankin relationships in that sector' in "act, two other potential relationships that sur"aced "rom the industry study were now bein analy6ed within 7ibra 4ank' !o+ Lo#n Re=ue$t Aries kept track o" 5rion,s cash needs and o""ered to study any new proposals that mi ht come alon "or e3uipment "inancin ' Scorpio then asked 7ibra 4ank to consider a 7cy .@ million packa e "or replacin some old e3uipment, addin new machinery, and constructin a new win to house the new machinery' Total cost o" the 5rion pro&ect was estimated to be 7cy =@ million' 2unds were to be sourced "rom a special "und o" the Andromeda Development 4ank "or e3uipment imports, and the loan was to be booked throu h 7ibra in 7cy' The approved tenor within this pro ram was "or "ive years' Scorpio thou ht that the machinery could be installed and workin within si# months o" orderin ' 4ecause Aries had come to know the company so well, and had maintained updated "inancial in"ormation, the banker was able to 3uickly put to ether "ive year pro&ections "or the company to complement the "orecast iven by 5rion' The realistic scenario o" the pro&ections indicated a cash eneration availability "or lon -term debt reduction o" 7cy $=-%@ million per year, beyond the present annual needs o" 7cy 5'million' Despite his earlier e#perience o" havin been overcon"ident with the ori inal 5rion credit approval, Scorpio "elt that the new credit recommendation would sail ri ht throu h approval channels' The bank had a better understandin o" auto parts producers and had identi"ied this sector as a prime rowth area' Also, 5rion was now an established credit relationship within the bank' As a matter o" "act, the account plan "or 5rion called "or e#plorin these term "inancin needs which had been anticipated since the initial credit approval' Ter. Lo#n Structuring !ommitment 7etter 7eo Aries, task now was to structure a deal to recommend "or approval in an updated credit packa e' Speci"ically, his task was to write up a commitment letter that would contain all the pertinent details o" the proposed term "inancin , includin all conditions and covenants' 0e would include the commitment letter in the credit approval packa e and, once approved by the bank and the customer, it would serve as the basis "or the bank,s lawyer to dra"t the necessary term loan documentation' The commitment letter be an as "ollows: Borrower: 5rion 8ndustries, 8nc' Lender: Funds Source: Amoun : Pur!ose Tenor: P"#men s: In eres : Comm$ men Fee on Unused B"%"nces: 7ibra 4ank E3uipment "inancin "acility o" the Andromeda Development 4ank 7cy .@,@@@,@@@ E3uipment "inancin 5 years, includin $ race Huarterly installments be innin $% months a"ter si nin loan documents AD4 "loatin base rate K 4% p'a', payable 3uarterly in arrears
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Case Study
M% p'a' on undrawn balances Ne&o $" $on Fee: A'"$%"($%$ #: Co%%" er"%: $% paid upon si nin loan documents 9p to . months a"ter si nin documents $* 7ien on machinery to be ac3uired )worth appro#imately 7cy 45 million* %* 7ien on e#istin machinery and mort a e on new construction with combined value o" 7cy %5 million
Terms and !onditions The banker had to "urther de"ine appropriate terms and conditions "or the potential term loan that would minimi6e the risk to the bank and also would be commercially acceptable to the borrower' The clauses should cover: representations and warranties conditions precedent affirmative covenants negative covenants financial covenants and events of default. The following are suggested clauses to be included within the loan agreement. #ome of these clauses are basic to all agreements while others are specifically tailored to the Orion situation. The list is not exhaustive and other clauses could be appropriate. Re!resentations and #tandard representations as toI *arranties+ powers legal incorporation ownership of fixed assets no prior existing liens financial situation of the company is as depicted in audited financial statements no lawsuits pending and schedule of company ownership -A2 clause use of proceeds That the company has an existing contract with +A+ and AT3 This last warranty is pertinent to the situation because the contracted output is important to reduce the risk with the credit. Other representations are standard in nature. ondition Precedent+ That Orion must invest its )cy 7< million in the new pro4ect prior to the bank"s obligation to provide funds under the contract. This may be accomplished by some sort of escrow agreement or deposit of funds by Orion with the bank. !t is standard practice that the borrower should invest its funds prior to the bank"s advances. ,&&ir$ati-e o-enants+ Orion is obliged to keep its contracts with the +A+ and AT3 valid and in force. All insurable physical assets of the company are to be duly insured. All assets mortgaged or otherwise given in lien to the bank must be duly insured with the bank named as beneficiary.
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Case Study
The company must provide the bank quarterly financial statements within ?< days of the end of each respective quarter. The company must provide the bank with annual financial statements audited by an external auditor acceptable to the bank within 8< days of fiscal year end. The company must maintain all other financial obligations up to date. The basic idea of the affirmative covenants is to maintain the status quo of the company"s operations and relations with the bank and to permit the bank to maintain its control over the situation. Another possible covenant here might be to obtain key-man life insurance with the bank as beneficiary. ,owever this is already required under terms of the short-term line and Orion has insurance coverage of fixed assets for the term portion of the credit relationship with the bank as loss payee. Ne"ati-e 3ithout the bank"s prior written consent Orion will notI o-enants+ merge any other company or enter into new lines of business. sell otherwise dispose of any fixed assets in excess of the amount of annual depreciation. change the general manager. pay any dividends in amounts greater than what is needed to comply with the existing share purchase agreements G- which cannot exceed G- amount in any one year.
)ike affirmative covenants the basic idea of the negative covenants is to preserve the attractiveness of the borrower to potential lenders. !n addition they attempt to prevent the company"s risk profile from deteriorating. 3hen a bank has decided based on a defined risk profile to grant a term loan it uses the negative covenants in the contract to preserve the situation. The limitation on capital expenditures is negotiated with the customer. The cap utili6ed here &the amount of depreciation for the year' is a fairly standard device. !f there will be ongoing investments beyond the purchases financed by this term loan the amounts should be negotiated with the customer and listed. The same applies to the amount of the dividend. The limitation should be measured and negotiated with the customer and stipulated clearly within the loan agreement. .inancial o-enants+ Orion pledges to maintainI a minimum current ratio of 9.; as measured at the end of each quarter. a maximum leverage of 9.: as measured at the end of each quarter. %or purposes of measuring this index any contingent liabilities from corporate guarantees should be included within the computation as if these were liabilities of the company. !n the financial covenants all financial terms such as current ratio and leverage should be defined within the loan contract to avoid misunderstanding. %or example current liabilities &for the current ratio definition' should specify that all outstandings under all credits should be included &as they may be sub4ect to acceleration' and the minimum current ratio should be reduced accordingly. Other financial covenants could be used to specify minimum working capital &which also should be defined' or capital requirements although these are implicitly covered by the two ratios above.
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Case Study
*ut sometimes these latter two measures can be included separately as well. !t may depend on the specific needs of the bank or on negotiations with the customer. E-ents o& De&ault+ The bank may declare its obligations under this loan agreement terminated and all outstandings immediately due upon the occurrence ofI non-payment of any principal or interest when due. proof that any representation made is false in any material way. - non-compliance with any of the covenants. non-compliance with any obligations under any other contract &cross-defaultQ'. a 4udicial lien or embargo placed against any of the borrower"s assets. bankruptcy or insolvency of the borrower.
Q The cross default is a useful device for the bank to insure that if any problems occur with another credit the bank may also accelerate the maturity of its loan. This clause is very useful to maintain payment discipline and to protect the bank"s interest in relation to other creditors. !t is not to be confused with the cross-acceleration clause which only gives the creditor the right to demand acceleration if another creditor accelerates. .
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Orion Industries Credit Risk Management Case Study

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Orion Industries Credit Risk Management Case Study

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CREDIT RISK ANALYSIS CASE STUDY

CREDIT RISK ANALYSIS CASE STUDY

CREDIT RISK ANALYSIS CASE STUDY

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CREDIT RISK ANALYSIS CASE STUDY

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