DEBT, LENDING AND GENERAL

PRINCIPLES OF LENDING
BY
K S ADEYEMI

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 DEBT/LOAN
• Debt or Loan?
• Simply, debt is something that has to be repaid while
loan is money granted to another party and which must
be repaid.
• Debt can be in form of money, goods or services that one
party is obliged to pay to another in accordance with an
expressed or implied agreement
• Debt may or may not be secured.
• Whatever happens, the issue of repayment at a future
date is non-negotiable
• Whether debt/loan, it is an obligation that has to be
redeemed. 2
 DEBT/LOAN (CONTD)
• Debt is also a general name for bonds, notes,
mortgages and other forms of paper evidencing
amounts owed and payable on specified dates or on
demand.
• Repayment usually takes the form of Int. + Principal
• Sometimes, such paymt can be exotic e.g. commodities,
shares, etc
• Interest may be fixed, regular or variable until
principal/capital plus interest are finally extinguished
• Also, principal can be spread evenly or paid in
tranches or even as a lump sum at the expiry or due
date of the repayment.
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 LENDING
 Lending is the process of extending
money to a borrower with the
expectation of being repaid usually
with interest.
 Lender is the individual or corporate
body that performs lending.
 Lenders create debt and in the event of
liquidation, they must be paid off
before the shareholders. 4
 LENDING (Contd)
• Lending usually takes different forms and
tenors:
– Short-term (Repayable in < 1 year)
– Medium-term (Repayable between 1 & 7 years)
– Long-term (Repayable in > 7 years)

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 LENDING (Contd)

• SHORT-TERM :
– Overdraft
– Trade Credit
– Factoring
– Bills of Exchange
– Acceptance Credits

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 LENDING (Contd)

– MEDIUM-TERM:
– Term Loan
– Hire Purchase
– Leasing

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 LENDING (Contd)

– LONG-TERM:
– Mortgage Loan
– Agricultural Loan
– Infrastructural Loan
– Social Loan (HSF, Students Loan
Scheme, Sanitation Loan, Water
Loan, etc
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 GENARAL PRINCIPLES OF LENDING
• Each lending episode has to be taken on its own
merits although there are general principle to
guide decision making.
• A lender does lend money and does not give
money away!
• The lender views the future and rhetorically ask if
the borrower would be able to pay back as at when
due.
• There is always some risk that the brrower will be
unable to pay and it is the assessment of this risk
that the lender need to demonstrate skill,
judgement and tact/shrewdness.
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 GENERAL PRINCIPLES (Contd)

• Lender needs to assess the extent of risk & try to

reduce or ameliorate the amount of uncertainty or
the potentiality for default.
• There is no magic formula
• Number crunching can never be enough; thus the
need for experience & caution.

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 The Professional Approach
• There will always be pressure from customers,
shareholders, biz influencers, high connections,
etc.
• True professionals must resist outside pressures &
insist on sufficient time and info.
• It is the lender or the intermediary who is taking
the risk and so wrong conclusion must not be
reached.

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 The Professional Approach (Contd)
Following Principles to be applied:
•Detailed fin info takes time to absorb
•If possible, get the paperwork before the interview
•Do not be too proud to ask a second opinion
•Get all info from customers & do not assume or fill in the
missing detail
•Do not take the customers’ statements at face value & ask
for evidence to provide independent corroboration
•Distinguish betw facts, estimates and opinions
•Think again when your ‘gut reaction’ suggests caution even
though everything looks good. 12
 The Methodology of Appraisal
• 5 STAGES TO ANALYSIS OF A NEW
LENDING PROPOSAL:
– Introduction of Customer.
– The Application by Customer
– Review of the Application
– Evaluation
– Monitoring & Control

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 Introduction of the Customer
• Account Opening procedure. This is important the
banker must ascertain customers’ honesty &
trustworthiness. Thus KYC
• Track record of customer is important. Is he/she a cancerous
customer who moves from bank to bank to borrow? Has the
proposal already been rejected at another bank?
• Introduction from professional advisers such as accountants,
solicitors and colleague bankers does not make the new customer
holy. Caution is the watch word.
• Some introducers try to pressurise the lender by suggesting that
further introductions may be dependent on the particular
proposal.
• The lender must not succumb to such a blackmail.

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 The Application
– This can take and consist of many things/forms:
• The plan for repayment
• Assessment of the contingencies that might arise
• How the customer intends to deal with such
contingent liabilities Should they arise
• Such explanation may be written in detail or
verbal by customer but the lender documents
every relevant info.
• All the risks of money not returning must be
assessed including the body language of the
borrower and the introducer. 15
 Review of the Application
– At this stage, all relevant info reqd must be tested
– Other data must be sought if necessary
– Formally or informally, the lender applies what we normally
refer to as the CANONS OF GOOD LENDING
– The main commonalities to all lending appraisals are what
we refer to as canons of good lending.
– It is often difficult to remember all the points to cover during
interview of customer
– So we often use mnemonics and the most popular ones are:
• CCCCC
• CCCPARTS
• PARSER
• CAMPARI

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Review of the Application (contd)
Character:
-It is impossible to assess somebody’s char. At first sight
-Facts, not opinion are crucial
-How reliable is the customer’s word in respect of details
of proposition & promise of repaymt
-Does the customer make unrealistic & too optimistic
claims? Is his/her track record good? Was there any
previous borrowing; was it repaid without problem?
-If a new customer, why is the bank being approached &
can bank statements be seen, assessed and reliable?

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Review of the Application (contd)
• Ability:
• Borrower’s ability to manage financial affairs&
similar to character
• Is ther a good management team fo the coy in
terms of skill & experienceDoes management
team hold relevant professional qualifications?
• Is the team committed & loyal to the coy?
• If borrowing is for a particular purpose, is team
experienced in that area of biz.?
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Review of the Application (contd)
– Margin:
– Agreement to be reached ab initio regarding
interest margin, commission & relevant fees.
– Interest margin reflects the perceived level of
risk
– Commission + other fees treflect the amount
and complexity of work in processing and
consummating the proposal.
– Profits and ROE should always be at the bck of
the bankers’mind
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 Review of the Application (contd)
– Purpose:
– Purpose of borrowing must be acceptable to the banker
– Customers do overlook problems & risks in their
optimism.
– It is more beneficial to the borrower when the bank
brings a high degree of realism into the proposition of
the customer than agreeing to the advances right away.

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 Review of the Application
(Contd)
– Amount:
– Is the customer requesting for too much/little?
– Dangers in both; therefore establish that amount
requested is correct and accurate as much as
possible. A good borrowing will include
contingencies.
– Amount requested should be in ratio of customers’
own resources/contribution.
– A reasonable contribution indicates commitment as
well as shock absorber should problem arise.

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 Review of the Application
(Contd)
– Repayment:
– The real risk in lending is the assessment of
repayment proposals
– Source of repaymt must be clear from beginning
– The banker mest convince himself that the
covenanted funds will be received as at when due
– Where the source of repaymt is income/cashflow,
their projections must be realistic, robust and
unimpaired by other commitments.

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 Review of the Application
(Contd)
– Insurance/Security:
– The other canons of lending should be satisfied
irrespective of the collateral security held
– Security is the final recourse in the event of
unredeemable default.
– It is important that the provider of security esp. third
party, fully understands the consequences of charging
the assets to the bank.
– It is also important that advances should be allowed
draw down until security is perfected or it is at a stage
where perfection no longer requires the attention of the
borrower. 23
 Review of the Application
(Contd)
OTHER MODELS:
CCCCC (5C’s)
. C1 = Character
. C2 = Capacity/Capability
. C3 = Cashflow
.C4 = Collateral
. C5 = Connection

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 Review of the Application
(Contd)
CCCPARTS
–C1 = Character
–C2 = Capital
–C3 = Capasbility
–P = Purpose
–A = Amount
–R = Repayment
–T = Terms
–S = Security

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 Review of the Application
(Contd)
PARSER:
–P = Person
–A = Amount
–R = Repayment
–S = Security
–E = Expediency
–R = Remuneration

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 EVALUATION
– Once all the info has been assembled, an evaluation of the proposal need to
be done; this is done in two ways:
– Assessment of the feasibility of borrower’s plan of repayment.
– A critical appraisal of what might realistically go wrong and the bank’s
position in such a situation.
– The purpose of evaluation is to assess the level of risk and how the customer
will cope with it. Listing all pros/cons of a proposal is very helpful.
– Once lending has been made, the risk lies in the way customer handles
emerging issues/challenges. The banker thus has to assess the borrower’s
ability to handle risks involved.
– Realisation of security may provide repaymt of a last resort but the sale of
security is not that straight forward.
– Also security valuations in practice, often differ from the book value.
– Sometimes when proposal is not well put together, the bank can often re-
engineer the proposal to help a good customer.

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 EVALUATION (Contd)
– Once lending has been made, the risk lies in the way
customer handles emerging issues/challenges. The
banker thus has to assess the borrower’s ability to
handle risks involved.
– Realisation of security may provide repaymt of a last
resort but the sale of security is not that straight
forward.
– Also security valuations in practice, often differ from
the book value.
– Sometimes when proposal is not well put together, the
bank can often re-engineer the proposal to help a good
customer.
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MONITORING & CONTROL
– It is unlikely that customer’s expectations and
strategies will go as planned.
– It is necessary for the bank to review
regularly/periodically to take remedial action. If
problems are identified early, they can be solved;
this is a win-win situation for borrower & lender.
– Regular monitoring of accounts also enhances the
lenders’ image before the customers.
– A monitoring plan should be established from the
beginning before draw down. Where regular info
has to be provided by customers, the process should
be clearly agreed.
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Thank for Listening

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