DEANNCO FINANCIAL ENTERPRISES
Specializing in Credit Training to the Banking Industry
Loan Structuring and
Lending Strategy Seminar Outline
SUMMARY:
This 3-day seminar is designed as a sequel to the Accounting, Cash Flow and Ratio
Analysis Seminar (a prerequisite for this seminar). The terminology, concepts and understanding of accrual
accounting (established in the prerequisite seminar) sets the foundation for this class to concentrate on
larger, accrual oriented borrowing relationships.
It begins with a review of selected credit issues and accrual concepts (operating profits and loan margins)
important for successful relationship lending. The focus then turns to loan structuring (seasonal and nonseasonal operating loans and lines of credit, and term loans) and the financial conditions and boundaries
appropriate for each loan type. It concludes with developing lending strategies and an introduction of the
concept of sustainable growth and the factors that influences a company’s ability to expand.
The material has been specifically designed for the Farm Credit System with an emphasis on practical
lending techniques and tools as they apply to agricultural lending. Emphasis will be on adapting these
principles to borrowers whose financial statements are already in reasonable accrual format (balance sheets
and profit & loss statements), and the audience is expected to have a basic working knowledge of accrual
statements.
SESSION 1 -- A Review of Cash Budgets, Accrual Profits, Basic Cash Flow and Ratios
8:00
Introductions and administrative matters
• Background and expectations
• Responsibilities and homework
• Overview of logistics and normal daily schedule
• Rewards, quizzes and survey
• Pre-class exercise -- the foundation for a head-start
• Semantics and terminology: Glossary of Terms
• The goal of analysis -- Developing a Lending Strategy (Liquidity & Profitability)
[#1]
Notebook organization, color keys and sequencing pattern
• Complete Table of Contents – shows ALL the material, by general topic, in a sequence
• Major articles – provided as a pre-class download; insert into notebook NOW
• Color scheme (AS SHOWN ON THE OVERHEAD TRANSPARENCIES)
Brief overview of pre-class exercise – Important concepts to study and thoroughly understand
• Converting cash budgets into accrual balance sheets and P&L statements
• Identification of operational profits and why it must be adequate
• Using selected balance sheet changes to convert accrual to cash flow (and vice a versa)
• Being familiar with sources & uses, and what constitutes operational cash flow
• Ability to reconstruct FA & LTD and determine “Target OCF”
• Looking at selected ratios which examine relevant issues
Brief Introduction of participants & overview of experiences
Quiz – Developing Financial Statements
• Review the components of an accrual profit & loss statement
• Develop the structure of a basic accrual balance sheet
Overview and basics of all commercial lending-- laying the foundation
• The key to loan repayment is knowing why businesses borrow
Mailing Address: 4790 Irvine Blvd., Suite 105 - 125, Irvine, CA 92620-1973
(714) 538-1131 FAX (714) 538-0302 Email: deannco@pacbell.net or www.deannco.com
3-Day/Sequel/Detailed Outline (2/20/10)
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DETAILED OUTLINE – Loan Structuring and Lending Strategy (Ag Sequel)
• There are only THREE ways to generate cash to repay debt
Review of lending principles and philosophies
• Review of Summary of Lending Philosophies – the subtly foundation of culture
• Seeing how assets and equity are allocated: The Stripped Balance Sheet
• Separating the two basic credit types
• Understanding the Connection Between “Core” Working Capital & CPLTD
• Understanding the Credit Principles of Crop and Production Lending
Quiz – Determining Basic Operational Cash Flow
• Identifying the adequacy of profits…looking back and looking forward: A-1
• Determining operational cash flow and its adequacy: A-2
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Review of cash flow, basic lending concepts and terminology
• Cash flow can come from three sources:  in assets;  in debt;  in equity
• Profit is the primary and only sustainable source that produces operational cash flow
• Review of useful visual aid -- the Funnel Concept
• A Visual Understanding of Where Cash Flow is Generated and Consumed
[#08]
• Two basic credit issues centering on cash flow
• The basic components common to ALL Operational Cash Flow (OCF) formats
• There basic components common to ALL Operational Cash Flow (OCF) formats
• Reconstructing selected accounts
• Comparison of Indirect and Direct Statements of Cash Flow
[#09]
• The primary purpose -- see if enough cash (coming from NOP) is available to pay CPLTD
• Secondary purpose -- see how and where management allocated or supplemented profits
It is important to have a point of reference for evaluating OCF
• A Visual Understanding of What “Target” OCF Should Be
• Identifying TARGET OCF: enough traditional cash flow (“C/F”) was available to:
• There are TWO basic debt coverage ratios -- and the expectations of what to find
• Seeing the Difference Between the Two Basic Cash Flow Issues
• Understanding the Value of a Practical Cash Flow Presentation
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Understanding the asset that generates cash flow --- what’s the business do?
• Four basic types:
• In agriculture, this might be expanded to seven types of operations:
• Common to all businesses: AR, INV, AP, Prepaids, Accruals, Taxes & Bank Op Loan
Lunch break
Quiz – Identifying OCF & Anticipating Future Profit Requirements
• Calculating basic operational cash flow (OCF)
• Determining the adequacy of profits and OCF
• Anticipating minimum profits needed for the coming year
• Calculating turnover levels – days AR, INV & AP
• Identifying the cash flow impact of changing turnover levels
• Estimating the cash flow impact of changing loan advance rates
• OPTIONAL: Reconstructing FA, LTD and determining Target OCF
Many AG borrowers are cash-based -- different than accrual – it’s a special challenge!
• A Visual Way to See the Differences Between Cash and Accrual Reporting
• Understanding how the “Big-3” and “Minor-2” connect cash & accrual
• How Cash Income and Accrual Profits Differ
• How operational cash flow and cash income can be manipulated
• Credit Analysis Worksheet
Quiz – Determining a ‘TARGET’ Level of Profits for a Cash-Taxpayer
• Identifying the amount of pre-tax income is needed to pay CPLTD
• Converting target taxable income into target taxable profits
• Anticipating alternative repayment sources when NI is inadequate
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Understanding the deferred tax liability (DTL) challenge
• Cash or Accrual, BOTH type borrowers need to meet "A-1" & "A-2" criteria!
• Deferring the income (profits) & accelerating the expenses defers the taxes -- DTL
DETAILED OUTLINE – Loan Structuring and Lending Strategy (Ag Sequel)
3
• How DTL applies to fixed assets...the lien that often is ignored
• Asset value lending is dangerous! What is NBV to the bank, is INCOME to Uncle Sam
• Many small agricultural operations that focus on cash budgets ignore the issue
5:00
Quiz – Determining Working Capital Needs from Cash Budgeting Information
[#18]
• Practice lending on cost, not future market value
• Extracting profit margins from cash budges
• Setting an expectation about minimum equity needs in the crop
• Determining the amount of operating expenses - we don’t want to underwrite losses
Discussion of extracting selected credit information from cash budgets
• Q&D method to determine core equity in project: Min Eq #1
• Q&D method to determine core equity to cover operating expenses: Min Eq #2
Overview of Alamo’s Cash Flow Statement Homework Assignment
[#19]
• Foundation is B/S -- Statement of Balance Sheet Changes
• Enhanced by reconstructing NFA, LTD & Retained Earnings
• Reorganized to better understand operational activities from all else
Scheduled adjournment
SESSION 2 -- Loan Structuring: Seasonal, Production, Revolving & Term
8:00
Wake-up Quiz – Reviewing Operational Cash Flow
[#20]
• Adequacy of profits
• Activities that impact cash flow
• Practice calculating turnover and loan advance ratios
• Determining the cash flow impact of AR turnover changes
• Calculating OCF before and after the Bank Line of Credit
Review homework – Alamo’s Cash Flow Packet Solutions
[#21]
• The mechanics and results of developing a statement of cash flow: indirect & direct
• Review reconstruction of FA and LTD
• Interpreting the results: were they A-1?...and A-2 (Ex: was “TARGET” OCF achieved?)
• Q&D technique to “read”:  circle the top 3, 4, or 5 sources & uses (different colors)
• Review the common components of all cash flow statements
• Reconciling why results differ
• Anticipating patterns to continue, and if not, what’s the implication?
A review of ratio analysis issues – Financial Ratios & Comments on Alamo
• Income statement ratios -- stability of the net profit components
• Balance sheet ratios -- allocation of equity & assets and leverage
• Turnover ratios -- liquidity, utilization and cash flow
Loan structures and their respective characteristics
• What’s the need: Temporary or permanent?
• Three basic types of loan structures
The issue of collateral support:
• Unsecured lending and its characteristics
• Collateralized lending
• Having trading asset collateral is different than having real estate collateral
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Quiz -- Common Credit Issues for All Long-Term Loans
• Adequacy of profits -- committed and uncommitted
• Anticipating next year’s need for profits
• Sensitivity to change in NOP% before jeopardizing CPLTD repayment
• Fixed asset equity and leverage -- is that an issue
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Long-term loans – the NOP Dependent loan
• Characteristics of Long-Term Loans (D/W is NOT important)
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• Term loans limit growth -- once made they consume funds and that restricts sales growth
• Basic requirement of the debt --- be profitable!
• Key coverage ratios – there are TWO issues, so there really needs to be TWO ratios!
DETAILED OUTLINE – Loan Structuring and Lending Strategy (Ag Sequel)
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Leverage (D/W) is NOT the primary issue….lack of the cash flow IS
Common ratios for long-term debts – may be helpful, but are not focused on key issues
Seeing How Profits and Trading Capital Interrelate
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Guidelines for Granting Term Loans
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Quiz -- Anticipating Future Liquidity and Profitability Needs
• Anticipating the adequacy of profits
• Profitability levels needed to support debt servicing
• Determining trading capital and its relationship to sales
• Linking minimum trading capital requirements to debt servicing demands
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Lunch Break
Short-term loans – the NBV-Dependent Loan
• Characteristic of Short-Term Loans -- the NBV-dependent loan
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• Basic requirements of these credits: 1) T/O, 2) Sufficiently above, 3) w/o Diversion
• Short-term loans support growth – they help fund the growth of the trading asset
• Leverage (D/W) IS an primary issue….but turnover is more critical
• Common ratios for short-term debts – seasonal or ‘permanent’ working capital
• Key coverage ratios – there are TWO issues; one a ratio, one an absolute number
The Interrelationship of Leverage, Liquidity and Loan Advance Rate
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• Four issues that increase the lender’s exposure….monitor core equity for DOGS!
• Evergreen or revolving lines of credit --- collateral continually turns
• Liquidity – the amount and proportion of existing trading capital
• The Basics of Loan Covenants -- things to remember and keep in perspective
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Quiz -- Practicing Trading Ratio Concepts
• Identifying excess or inadequate liquidity
• Structuring a model to find minimum trading capital
• Determining minimum liquidity ratios: trading ratio and trading leverage
• Identifying minimum sales needed to repay CPLTD
• Determining minimum trading capital needed to repay upcoming CPLTD
• Estimating the changes in trading capital needed with changes in profitability
General discussion of accounts receivable lending
• Establishing acceptable collateral -- what is and is not eligible
• Accounts Receivable Aging
• What factors help to determining the bank’s loan advance rate
• Procedures to maintain loans in proportion to collateral
• Exposures which have proven costly for lenders (past mistakes)
• Class Exercise: Structuring Accounts Receivable Loans
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General discussion of inventory lending -- crops, grains, livestock and projects
• Funding capitalized purchases of labor, materials and/or overhead
• Identifying the acceptable collateral -- what is and is not eligible
• Methods of monitoring collateral
• Determining the loan advance rate -- on owned cost!
• Procedures to maintain loans in proportion to collateral
• Exposures which have proven costly for lenders (past mistakes)
Special type of short-term lending -- crop or production loans
• Graph of a Project, Crop, Development or Construction Loan
• Why project lending requires greater core equity than 'evergreen' lending.
• The need to ensure adequate equity before the project begins
• Focus on input cost, not potential future sale price….(some exceptions)
• Exposure of lending on "yet to be made" profits -- advance as % of sale price
• Establishing a reasonable proportion of equity to absorb adversity
• Following the on-time, on-budget principles
• Why seasonal lending requires more working capital than non-seasonal lending
Unique differences between crop and project loans and revolving lines of credit
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DETAILED OUTLINE – Loan Structuring and Lending Strategy (Ag Sequel)
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Temporary versus permanent need for funding
Cash budgets versus balance sheets as single most important financial tool
Loan based upon sale price versus asset's cost
The issue of adequate equity to cushion adversity
Quiz - Test Your Understanding – Linking Liquidity & Cash Income
[#34]
• Determining the funds needed and equity in a projected crop
• Determining the funds needed to cover operating expenses during the production period
Overview of operating lines of credit – key issues to remember
• Maintaining control of collateral  knowing the value and location
• Ensuring adequate loan margin or equity  Trading Capital
Homework: Quiz - Loan Structuring and Lending Strategy – Asset Based Borrower
• Identify future profit requirements
• Determine the amount of inadequate or excess liquidity
• Examining inventory loans --- checking for required loan margin
• Ensuring that the equity is greater the farther away from cash the asset is
• Identify minimum trading capital
5:00
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Scheduled adjournment
SESSION 3 -- Developing a Practical Lending Strategy
8:00
Wake-up Quiz -- Determining Basic Financial Boundaries
• Current and future A-1 concepts
• Determining minimum TC
• Identifying excess or inadequate liquidity
• Estimating need for TC if sales grow 1%
• Calculate minimum TC needed to repay CPLTD
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Brief review of working capital lending issues
• The principles of all 'working capital' lending
• Brief discussion about A/R and INV lines of credits and their use in quizzes
Review of Homework Quiz
• Identify future profit requirements
• Determine the amount of inadequate or excess liquidity
• Examining inventory loans --- checking for required loan margin
• Ensuring that the equity is greater the farther away from cash the asset is
• Identify minimum trading capital
Quiz -- Determining the Funds Need to Grow
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The Cash Cycle-- great tool for explaining how sales, turnover and leverage impact liquidity
• Extended Cash Cycle -- Adapting the model to the bank's operating loan structure [#39]
Quiz -- Establishing a Loan Structure and Determining Trading Capital
• Determining a company’s trading capital needs
• How an added inventory loan impacts equity and loan margins
• Discussion about how to better structure an asset dependent line of credit
• Identifying loan structuring that promotes unhealthy growth
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A Cash Flow Approach to Sustainable Growth – a tool that ties key pieces together
• A great tool for insight into lending strategy and what to control
• Overview of the two basic approaches
• A Visual Understanding of the Factors that Impact Sale Growth Potential
• The factors which influence sustainable growth
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Quiz -- A Simple Means to Estimate Sustainable Growth
• Establish a reasonable TC/Sales model from historical or pro-forma information
• Project next year’s profits and the claims against them
• Interrelate the uncommitted profits with TC/Sales
• What will added trading capital generate?
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DETAILED OUTLINE – Loan Structuring and Lending Strategy (Ag Sequel)
6
A practical way to utilize and communicate sustainable growth information
• Hints for explaining growth limitations to a borrower
• Identifying how much equity will be needed to increase sales by a certain amount
• Deriving the impact of what an extra $1 will do from profits or less SUM
How sustainable growth impacts permanent level trading asset companies
• The key is operating line leverage ---> trading leverage
• How each influencing factor contributes to growth
• Why sustainable growth calculations are inappropriate for project-type loans
Lunch break & check-out (if applicable)
Quiz -- Interrelating Basic Financial Concepts
• Determining the adequacy of profits
• Anticipating future profitability levels needed to service CPLTD
• Identifying core trading capital and the existence of excess or inadequate liquidity
• Identifying a liquidity boundary and sales growth support level
• Linking liquidity and profitability
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Discussion of how the quizzes set up a thinking process….focused on issues, not numbers!
• Review the “process” and practice the visual tools
• Look ahead…anticipate what the greatest risk is: lack of equity or profits
• Practice testing for sensitivity in connecting CPLTD and NOP%
• Evaluating Liquidity and Profitability for an Agricultural Borrower
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Establishing two perspectives on analyzing credits
• The Lender’s FOOTBALL Field of Play
• Identifying the sales ranges -- Minimum & Maximum Sales
• Identifying the characteristics of the borrowers -- Winner-Loser Graph
• LIQUIDITY and PROFITABILITY Index – a Two Dimensional Approach
• A Perspective on Lending Strategy
Quiz -- Testing Your Understanding -- Linking Liquidity & OCF
• Practice thinking through the flows -- backwards!
• Practice quickly developing a pro-forma B/S to derive TC from historical data
• Developing your communicating style with a focus on liquidity & debt servicing
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Review of the liquidity-profitability process and ramifications of it
• Modification to TC requirements when D/E is used to repay CPLTD
• Testing for sensitivity to changes in profitability
• Testing for sensitivity to changes in trading asset leverage
Class exercise – Pete’s Primary Products, Inc.
• Identifying minimum cash flow
• Determining minimum accrual profits
• Estimating minimum break-even sales
• Projected core level of trading assets
• Calculating amount of spontaneous trade support
• Deriving minimum equity requirements
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Review and discuss group exercise – Pete’s Primary Products, Inc. Solution
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Overview of tools and techniques in maintaining a satisfactory borrowing relationship
• Determine why the need (use) and whether it is permanent or not
• Identifying basic credit analysis issues
• Identifying existing financial position and corresponding boundaries
• Determine maximum inventory cost at peak of season & how it's funded
• Anticipating adversity
• Articulate ways in which to communicate the key issues
4:45
Completion of course surveys & hand-out certificates of completion
5:00
Scheduled adjournment