Intro to the credit process. Matching the type of loan to the purpose is critical or the issuer risks either refinancing risk or overpaying for long-term capital for a short-term need. Shorter-term debt supports the short-term needs like working capital, where the expectation is that the assets will convert to cash quickly. Longer-term loans generally support longer-term assets where the profits are also longer term. For shorter-term loans, generally, a revolving credit facility is used, often called a revolver, sometimes called a swing line. For longer-term debt, there are more options. A term loan is the most common form of bank loan. The longer a loan is outstanding, the more risk is involved and therefore, the price usually goes up. We will discuss additional types of loans as we move throughout the module. The process of making a loan is as follows. Usually, a relationship banker or product team generates a loan opportunity. The credit team will then perform a credit analysis on the borrower. They will assess the business risk, the financial risk and develop an initial risk assessment. Depending on whether that meets the bank's criteria, it could result in a fail, and in which case, the bank would reject the credit. Should it pass, the bankers are now responsible to structure the loan. Once the loan is structured, a credit memo will be prepared. Credit memo is then presented to a credit or commitments committee, which we'll discuss whether or not the bank's capital can be put at risk. Sometimes, at that point, the project will fail to meet standards. Should it pass or should the bank accept the loan opportunity, the loan will either be made or in the case of a larger loan, it will go to the syndicate team who will work on pricing and selling down the bank's exposure to the loan to a bank group. Final terms between the banks will be negotiated and funds will be dispersed. The next step is to then monitor the loan to make sure that the borrower is meeting its obligations under the loan. As discussed, lenders require the return of their capital at the end of the term. To accomplish this, lenders must assess the ability and willingness of the borrower to meet future financial obligations on time and in full. To do this requires an understanding of the operations of the business. Most banks lend based on cash flows, the ability of a company to generate cash to pay back interest and principal. Some are asset-based lenders securing the loans solely with the assets of the company. Banks use credit analysis to assess the likelihood of default and make allocations, loan structuring and pricing decisions accordingly. This credit analysis is an internal version of what is also performed by the public rating agencies.
