Beruflich Dokumente
Kultur Dokumente
In 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.
Subsequent parts of the case, covered in Units Three, Four, and Five deal with financial (quantitative)
analysis and then credit structuring, approval, documentation, and administration.
Now begin Part One of the case study and then complete the exercises that follow.
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. Nevertheless, he instructed the secretary
to show Mr. Scorpio into one of the conference rooms.
Mr. Bruno Scorpio, the general manger of Orion and in his early forties, introduced himself. “Your friend
George Virgo from the Running Club gave me your name as a reference. We just had lunch nearby, so I
look the liberty of dropping in.” On two previous occasions, Virgo had recommended that people talk with
Aries, mostly for financial advice. Both 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. He 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/Political Background
Andromeda is a medium sized, quiet, democratic country with a population of about 29 million people.
Historically, the economy had been based on agriculture, but a significant industrial infrastructure has
developed in the past 15 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
1980s, 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 maximizing the yield of exports due to the country’s
considerable deposits of basic raw materials.
The gross domestic product (GDP) of Andromeda is about US$ 62 billion resulting from positive but
modest levels of growth during the early and mid 1980s. More recently, GDP growth rates have been in
the range of 4% to 5%, and one of the more dynamic sectors of the economy has been manufacturing,
with growth in the 6% to 7% range over the past two years.
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CASE STUDIES
Monetary and fiscal policy in Andromeda has been fairly stable. Relatively 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 15% to 18% range.
The monetary unit of Andromeda is the Lcy, currently valued at Lcy 40/1 US$. During the past three years
the Lcy has devalued at the rate of about 10% to 12% per year, which is consistent with the inflation
differential between Andromeda and the hard currency countries with which it trades.
Libra Bank and the Pegasus Region
Andromeda has 24 commercial banks and several specialized 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.
Libra Bank is one of these regional banks, located in the Pegasus region about 300 km from the capital.
Pegasus has traditionally been an agricultural region, but in recent years has sustained considerable
growth in the industrial sector. This region is home to a major automobile manufacturing and assembly
operation established eight years ago by a well-known multinational auto producer. This car plant has
spawned numerous parts manufacturers that supply the assembly plant, many of which are partially
owned or affiliated with foreign car parts makers.
Libra Bank is a full service bank with about Lcy 10 billion in assets. It has contributed to the industrial
growth of the region by financing several major manufacturing projects and by offering extensive short
term financing facilities and other traditional banking services. The industrial sector represents about
40% of the Libra loan portfolio as a result of marketing efforts in the last several years to capture major
segments of this sector around Pegasus.
Orion Industries and Mr. Bruno Scorpio
“Mr. Aries, thank you for seeing me on such short notice. Please let me tell you about Orion Industries.
We are medium sized metal works with annual sales of about Lcy 250 million. We have been in business
for 24 years in Perseus (bout 60 km away), manufacturing different types of high precision metal
products. During 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 Works.
More recently we have been producing universal assemblies and rear axles for the Pegasus Automobile
Plant. This is just the beginning of our involvement with the car sector, which we believe has a very high
potential within the country.”
Scorpio 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 size.
Three years ago, the Taurus brothers were introduced to Scorpio. He had a degree in mechanical
engineering from a good university (the University 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. He saw a good
opportunity at Orion because of the high-quality products and the business potential in the nearby
Pegasus region. Scorpio invested some of the personal savings in Orion and became the general
manager and one-third shareholder, with an option to purchase a majority position.
The two brothers, now in their late fifties, are still active in the company on the production side. Scorpio
has streamlined operations by eliminating some marginal products with small profit margins and
emphasizing the tractor subcontracting work and the diversification into the auto sector. Orion has been
delivering for three months under its contract with the Pegasus Automobile Plant, achieving good quality
and a strong on-time production record.
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CASE STUDIES
Financing Request
“The reason for my visit, Mr. Aries, is that we are looking for new banking relationship. Currently, we are
working mostly with the local branch of the Gemini Bank and they provide adequate services for payrolls
and a limited amount of lending. However, they do not have the expertise or resources to deal with our
projected future needs. We are looking for a long-term relationship with a large regional full service bank
such as yours. Our mutual friend, George Virgo, mentioned your name and your bank, so here I am.
“We would like to establish a short-term facility for Lcy 40 million (equivalent to US$ 1,000,000). We
would want periodic drawdowns for working capital purposes, mostly to help us finance receivables or to
stock up on raw materials for particular jobs. Although I 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.
“We anticipate future capital needs for upgrading or relocating the plant, but that’s still a long way off. We
would, however, like to establish financial relationships now so that when these futures needs arrive, we
can count on the necessary financing. We have a couple of other prospective banks, but have come here
first because of your bank’s reputation for thoroughness and imaginative financing.”
Invitation to Visit
“We would like to invite you for a visit to our factory, at your earliest convenience, so that you can meet
our people and judge Orion Industries for yourself. Our external auditor, the well-known firm of Capricorn
& Centauri, will have our annual report finished in about two weeks and I will instruct them to send it to
you as soon as it is ready. I would prefer to have you visit us before then so we can get the ball rolling as
soon as possible. We 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.”
Aries and Scorpio said good-bye. “An interesting meeting,” thought Aries, “he seems to know what he’s
talking about.” Aries liked Scorpio 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 organize 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.
Aries was intrigued enough to see a prospective deal, and schedule a plant visit. Through the questions
in the Progress Check you saw how he should organize his data and plan what he would accomplish
during his upcoming plant visit.
In Part Two of the Orion case, Aries displays resourcefulness in obtaining some valuable references. He
then proceeds with the plant visit where he gathers a great deal of qualitative information. He tries to
organize the information using the bank’s standard qualitative data forms.
Apparently satisfied that Orion Industries still represents potential business for the bank, Aries starts to
think about the next two steps in the credit process. These include (1) the financial analysis of the Orion
statements when they arrive, and (2) the formal credit and risk analysis to structure a deal and frame a
potential credit recommendation.
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CASE STUDIES
Checkings
Before driving out to the Orion factory, Aries decided to call Aurora Borealis, a banker at Gemini Bank
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. Some credits had
been renegotiated over the years, but this was normal for a company like Orion that was continually
taking on different jobs.
Aurora mentioned that Gemini Bank wished to maintain its relationship with Orion by continuing to offer
current account and payroll services – and by maintaining its exposure levels at about the present level.
But due to Gemini’s small size, 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 Libra Bank’s own account officer for the Andromeda Tractor Works (ATW) 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 ATW 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.
Libra Bank did not have a banking relationship with the Pegasus Auto Plant since the auto producer dealt
only with four top-tier Andromeda banks. Nevertheless, Aries wanted to get some feedback from the auto
producer as to Orion’s product quality and reliability. Aries assumed that the reference would be a good
one, but he wanted to make sure. He decided to leave this matter for later.
Visit to the Orion Factory
Plant and Equipment
A few days later, Leo Aries drove to Perseus to visit the Orion plant. He found that the concrete block
plant building was old but in fairly good condition, owned by the company, and free of liens. It was located
in an old area that had good access to the highway connecting it to the heart of the Pegasus region.
However, the location was slightly off the beaten track and far from the newer industrial areas that had
developed near the Pegasus Automobile Plant. Electricity and water supplies in the area were adequate.
Inside, 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
collateralized existing long-term debt with the Gemini Bank 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 utilized.
Controls 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 here; 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 subsidized the workers’ lunches, with the workers paying only a normal price.
“We have also agreed to implement an employee stock ownership plan that will allow them to purchase
up to 20% of the Orion company stock on a deferred basis. This will preempt any possibilities of setting
up a labor union, which had been talked about a couple of years ago when we had to reduce the size of
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CASE STUDIES
the labor force. This 20% will eventually come from the Taurus brothers’ holdings and will help ensure an
orderly transfer in ownership when they retire.
“Since this is one of the few industrial enterprises in Perseus, we have no problem getting qualified
people to work for us. In fact, many of our workers have been with us for many years, and we have
several instances of fathers and sons working in the plant. Our employee turnover is very low compared
to other industrial companies. At the same time, it puts pressure on us to even out our seasonal work
flows to avoid layoffs.”
The Taurus Brothers
Aries was introduced to Max and Nick Taurus, who were in their late fifties, comfortably dressed in work
clothes, and very much at home in the plant. They welcomed Aries and proudly informed him of the
history of the company, and of the old-fashioned uncompromising craftsmanship that went into their
products. “ We’re not high tech around here, but we make a good product that we can be proud of.”
During the conversation, it became clear that they were more secure about Orion’s future now that
Scorpio was handling the administrative affairs. This allowed them to dedicate their time to production and
supervising the workers, while Scorpio counted the numbers and dealt with the bankers. They didn’t much
care for business details, especially financial ones.
Due to their very conservative and unsophisticated business approach, the firm never had adequate cost
accounting controls. “We just kept growing without really understanding how our increasing costs wiped
out any increasing profits, ”said Max to Aries. “Now, with Bruno’s systems, we have much better
information about how much our products cost and how much we should charge. This has enabled us to
be more effective and profitable, and we can enjoy our work again while Bruno manages the numbers.”
Systems and Human Backup
After his conversation with the brothers, Aries went back to Scorpio and directed the discussion to these
systems and the human resources in the firm. Aries was getting the feeling that the company might be
relying too heavily on Scorpio for systems, as well as general and financial management.
Scorpio explained that he had implemented standard cost accounting systems to track unit variable costs
and profits by product line, as he had done in other companies where he had worked. These other
companies were subsidiaries of major U.S. multinationals. “I learned a lot with these companies,” said
Scorpio. “But I left several years ago to try my own hand in the business world, and to look for
independence.
As part of these new tracking systems, we have also implemented a rudimentary management
information system to track productivity and work defects by product line,. This helps us achieve our goal
to improve quality and cut down on factory returns. We have never had many returned goods, but it has
now been over seven months since any customer has returned even one axle,” said Scorpio.
Scorpio continued. “These systems, plus our budgeting process, also help us bring along some promising
young people by allowing us to delegate more while maintaining standards for judging performance.
Right now, we are a little thin in the more senior management levels, and one of my principal goals over
the next year is to provide more structure in the company to allow for our future growth.
We’re limited in terms of how much we can grow strategically into new products and areas with the
present managerial staffing level, although we could add some new business in our current lines. Yet we
feel there’s a big market out there with a strong growth potential for a firm with our capabilities. We must
have an adequate structure with trained, experienced management people to permit our growth with it.
“Our principal focus now is to strengthen our relationship with the Pegasus Automobile Plant (also known
as PAP), and to grow with them. This is an excellent opportunity for us. If we can maintain our good
production record with them, we’ll have some export potential with the multinational company that owns
the plant. At the very least, with the credibility we’re achieving with PAP, we should be able to write our
own ticket with other automotive sector companies. There are comparatively few companies in the
country that are capable of producing at our level of quality and volume, “said Scorpio.
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CASE STUDIES
“Maybe we are getting ahead of ourselves with this. However, it is the goal we have in mind and we thing
our potential for achieving it is strong,” said Scorpio enthusiastically.
Trade Terms and Relationships
Aries asked Scorpio some questions about Orion’s trade terms. Scorpio indicated that they offer 90-day
credit terms to the Tractor Works, but ATW normally pays a little late. “We would prefer to grant less
credit so that we could reduce our working capital needs; but, in the case of the Pegasus Auto Plant, we
have to offer 90 days to be competitive. This will increase our financing needs and is one of the principal
reasons why we have come to you.”
Almost all of Orion’s raw materials were sourced domestically from the few Andromedan steel mills and
foundries (Andromeda Steel Works, Andromeda Mining and Metals), and the quality of these products
was good. Purchase terms for Orion were the standard 30 to 60 days. A few specialized 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.
Regarding inventory levels, Scorpio figured he would have to maintain present levels of between three
and four months. “I 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. We 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.
“I’m sure you will have more questions on the financial side once you get our figures,” continued Scorpio.
“You’ll see that, financially speaking, we have improved the quality of our income stream by eliminating
some unprofitable operations and focusing on our more lucrative product lines. You should have the
numbers next week so you can see for yourself.”
Aries returned to the bank to consider what he had learned about Orion Industries. “An interesting
opportunity,” he thought. So far he had a positive feeling for the potential relationship and for Scorpio.
Aries admired entrepreneurs who were willing to invest their own capital in an enterprise. Apparently,
Scorpio 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 Scorpio was being too
ambitious,” mused Aries. “But he has demonstrated drive and determination which, let’s face it, most
people never attain.”
Call Report
Aries was anxious to get the financial statements to complement his analysis so far and provide a more
comprehensive perspective of the situation. He figured that the numbers, once available, would reflect an
improving picture over the last couple of years. In the meantime, and while the visit was fresh in his mind,
Aries decided to complete the call report and finish the BIR for Orion Industries. He also requested credit
references from the suppliers.
PURPOSE:
- Plant visit for possible credit relationship
- Meeting of key management people
- Review of management systems and managerial focus
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CASE STUDIES
RESULTS:
- Plant is old but in good order
- Met other owners and executives
- Had fruitful discussion as to production, market position, future
- In general, had favorable impression of management
- Apparent improvement in systems and infrastructure since arrival of Scorpio, but some
shortcomings with lack of depth
- Grooming of additional management people is high priority
Leo Aries
Relationship Manager Supervisor
OWNERSHIP
Closely held corporation: 2/3 Taurus brothers, 1/3 Bruno Scorpio, latter with option for 51% control.
Employee stock ownership plan to be effected for 20% out of Taurus brothers’ holdings. These
independent owner/managers are apparently highly committed to the success of the firm.
General Manager Bruno Scorpio, early 40’s, mechanical engineer from University of
Andromeda. Experienced in prior positions with subsidiaries of major multi-
nationals. Strong background in manufacturing and cost/management
systems.
Production Max and Nick Taurus, late 50’s, immigrant founders, self-made men.
Excellent craftsmen but not sophisticated managers.
HISTORY
Company was formed by Taurus brothers 24 years ago to produce high precision metal parts. Have
had ongoing and positive relationship with Andromeda Tractor Works – and more recently initiated
higher precision production for Pegasus Auto Plant. Product quality has been good, but spotty recent
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CASE STUDIES
history in dependability and profits. Arrival of Scorpio three years ago has helped remedy this in
productivity turnaround.
BANKING AND OTHER FINANCIAL RELATIONS
Principal bank is Gemini. Products include short-term lending, occasional equipment loans, and
payroll and current account products. Relationship has been unsophisticated due to lack of
management financial know-how. Checkings indicate good experience, with occasional past rollovers.
OPERATIONS Page 2
- High precision metal works, with variety of products capability
PRODUCTS
- Primarily tractor axle and transmissions
- Now producing higher precision automobile universal and rear
axle assemblies
- Some seasonality
- Perceived high quality workmanship
Sales breakdowns: Tractors 55% - Automobile 45%
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CASE STUDIES
Scorpio
- Firm dependent on Scorpio for managerial direction and know
ORGANIZATIONAL how
CHARACTERISTICS - Taurus brothers excellent craftsmen only
AND DEPTH - Present lack of depth
- New systems for delegation to permit attempt at developing
new people
- Present centralized authority OK for level of operations but not
for growth into new products
- Scorpio has strong manufacturing background with particular
BACKGROUND strength in cost accounting and management systems to track
AND LEVEL OF result
KEY MANAGERS - Scorpio experience gained with Andromeda subs of major
multinationals
- Taurus brothers have strong background as craftsmen, with
credibility for quality
- Brothers weak on administrative side
- Commitment to quality and excellence
WORK HABITS - Reputation for thoroughness and on time delivery although
AND MARKET some slippage here before
REPUTATION - Work force apparently well trained
- Work force motivated with productivity pay
- Employee turnover apparently healthy, lower than normal
- Firm has good reputation for integrity
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Case Study
ORION INDUSTRIES
Introduction
We now return to the Orion Industries case, which was introduced in Unit One. In Part One we were given
some background on the economic and political situation in the Third World country of Andromeda and the
Pegasus region of the country. We were introduced to Orion Industries and Bruno Scorpio and witnessed
the origination of a potential credit relationship with Leo Aries of Libra Bank.
In Part 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 organized this
information in anticipation of receiving the financial statements.
In Part Three of the case history, the financial numbers are put into a spreadsheet format. The banker must
analyze the financial statements of the Orion Company to:
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. It also raises some additional questions about what can be reasonably anticipated in
the future.
Arrival of Financial Statements
The financial statements for Orion Industries for the years 19X1, 19X2, and 19X3 arrived in the bank on
February 21. They had been audited by the firm of Capricorn and Centauri, a respected national accounting
firm that was listed as one of Libra Bank’s accepted auditors.
Aries briefly perused the statements, which included several notes about certain accounts. For example, the
“other long-term liabilities” account was defined as long-term accruals for the workers’ pension fund. He
reviewed these notes and concluded that there were no hidden or significant issues in the information.
The banker then entered the balance sheet and income statement figures into the bank’s electronic
spreadsheet model. (The printout of this effort is attached. It includes the balance sheet, income statement,
ratios, net worth and fixed asset reconciliations, operating/non-operating cash generation statement, and
supplementary data.)
Task
Aries now had to make a financial analysis of the Orion numbers. His principal concern at this point was to
determine the financial strength of the firm and to measure historical cash generation capacity. The
analysis should tell him a great deal about Scorpio’s managerial capabilities, and help consolidate his
thoughts about the overall credit risks with Orion.
In particular, Aries wanted to focus his financial analysis on comparing key figures from year to year,
evaluating the financial ratios, and examining the cash generation statement. This analysis might then
surface additional questions that he would raise with Scorpio.
To help you understand how this analysis would be accomplished, continue to Progress Check 2.4 which
follows the “Comparative Statement of Financial Condition.”
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Case Study
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Case Study
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Case Study
* Check (Net Operating Cash Generation – Total Non-operating Needs + Total Non-operating Sources)
SUPPLEMENTARY INFORMATION
Net Fixed Assets Breakdown
Land 6,721 6,721 6,721
Buildings 21,520 21,520 24,036
Machinery & Equipment 41,387 43,522 44,567
Vehicles 1,767 1,371 1,628
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Case Study
Long-term Debt
Gemini Bank 6,422 5,276 4,130
Sagittarius Bank 9,827 6,344 3,151
Andromeda Develop. Bank 24,118 10,265 9,206
40,367 21,885 16,487
Less: Current Portion 7,120 5,433 5,255
33,247 16,452 11,232
Inventory
Finished Goods 23,630 16,032 19,377
Work in Process 4,423 2,461 3,855
Raw Material 46,667 38,479 30,236
74,720 56,972 53,468
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 Scorpio came to the bank
in the first place. It 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. But 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 analyzed, while indispensable for the financial and overall credit analysis
of the firm, are history – 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.
He has to calculate the situation under a growth profile with a heavier debt load, anticipating
takedowns under an assumed new line of credit with Libra Bank. To do this, the banker should
prepare some projections to compare with the company’s forecasts.
This can be done informally, projecting 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 Scorpio sufficient information to build these informal projections. Specifically, he
needs to know:
anticipated sales growth;
cgs/sales and other key margins;
reasonable assumptions for –
- days receivable,
- days inventory,
- days payable, and
- other current assets and other current liabilities;
anticipated capital expenditure levels;
payment terms for existing long-term debt;
dividend policies; and
any anticipated other new external funding.
Let’s continue to Part Four of the case and find out how Aries gets the needed information and performs the
projection exercise.
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Case Study
ORION INDUSTRIES
Follow-up Discussion with Scorpio Regarding Historical Figures
The banker called Bruno Scorpio 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 Scorpio to provide a copy of the receivables aging report.
At the meeting, Aries quickly reviewed the aging report with Scorpio and concluded that the information
did not indicate any problems with stale receivables. “We did experience some problems in 19X1 and had
to write off some uncollectibles for two small jobs we did,” said Scorpio. “This write-off affected earnings
in that year, which you can see on our financial statements.
“It was this type of experience that drove us away from many of the smaller jobs,” continued Scorpio in
response to the banker’s questions. “The margins may be better, but they involve a lot of headaches with
retooling, cost accounting for specific jobs, and working with some difficult customers. That is why we are
presently dealing only with the Andromeda Tractor Works (ATW) and the Pegasus Auto Plant (PAP). Even
though we have no collectibility problems, the market strength of these two companies forces us to grant
longer credit terms than we would prefer. We’re working on this and hope to negotiate something better
this year, but we’re not counting on it.
“We realize that limiting ourselves to two basic clients for now perhaps does not diversify us as much as we
would like. However, 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.
We hope to enter into even longer term contracts when the present twelve-month deals we have signed over
the past two years with PAP expire.”
In response to questions about the reduction in days payable, Scorpio indicated that in earlier years the firm
bought from a greater number of suppliers. Some of them offered longer terms, probably because the
quality of their product was inferior. “In fact,” said Scorpio, “this was one of our problems. The mixed
quality of raw materials affected our own product quality. We 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.”
Information on Other Credit Relationships
Aries also inquired about some of the other creditors that appeared in the notes appended to the audited
statements, specifically about Sagittarius Bank and the Andromeda Development Bank. Scorpio informed
Aries that the relationship with Sagittarius Bank was being liquidated by paying down the long-term
equipment loan as it came due. This was also part of the reason why Scorpio had approached Libra in the
first place.
The reason for terminating the relationship was because Sagittarius Bank had recently experienced
financial difficulties. “Our relationship with them has been cordial and proper,” said Scorpio, “but we
don’t feel we can count on them in the future for new short-term takedowns.” Aries accepted this
explanation since he knew about the situation with Sagittarius. In fact, several other Sagittarius clients had
recently requested significant credit increases at Libra. Nevertheless, Scorpio made a mental note to
request checkings from Sagittarius.
Several years ago, the Taurus brothers had approached the Aquarius Financial Company 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. Because of their
inconvenient terms, these loans were also among the first to be put on a liquidation basis after the arrival of
Scorpio.
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The credit with the Andromeda Development Bank (ADB) had been arranged by Gemini under a line of
credit available to local banks to finance the purchase of some German equipment under a German export
promotion program. “Part of the loan was financed in local currency and part in German Marks,” said
Scorpio. “When I 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 German Mark portion of the loans. The local
currency portion is being paid down as due, with about three years left on the loan.” This explanation
confirmed what Aries had figured when he saw the ADB listed as a creditor in the notes attached to the
audited financial statements.
Discussion Pertaining to Goals and Future Plans
In response to the banker’s questions about return on equity (ROE) and goals in this area, the customer
responded: “The receivables writeoffs I mentioned earlier caused the overall ROE for the year 19X1 to be
about 2%. You can see from our statements that our ROE has improved considerably during the past two
years.”
“In 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 2%,
which translates to an ROE of about 22%.”
“We ultimately would like to improve beyond this to achieve an ROE of about 25%, which would be about
10% above inflation. We are being selective with any potential new contract, requiring that it contribute to
achieving this goal within our own projections.
We are rejecting those contracts that could become a drag on earnings. Having put our house in order, we
must avoid tying up our resources in marginal or underproductive deals as we have done in the past. We
believe that our current product quality puts us in an advantageous position, and the time for pricing
concessions is past.”
Specific Short-term Goals
Aries then asked questions about projected numbers. “Now 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. What are you budgeting for sales, net income, current account levels, capital
expenditures, dividends, etc.?”
“For this year, we anticipate renewed growth, but only in our current product line. We 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,” said Scorpio. “With the contracts we already have, we are budgeting annual sales of Lcy
290 million which would be about a 19% sales increase. This figure is quite firm, and it will go up if we
can negotiate a production increase in our contract with the Pegasus Auto Plant.”
Scorpio continued. “We have been discussing this with Pegasus for a couple of weeks. If we agree on
terms soon, beginning around May or June our production could build incrementally up to about a 25%
increase in volume by December. This would mean an average sales increase of about 35% for the year,
instead of the 19% we are projecting now. Even if we don’t get the increase with PAP, we should be able to
take on another job, perhaps as a subcontractor. This should enable us to reach an overall 25% sales growth
even under the most conservative circumstances.
“In terms of net income, we’re shooting for a return on sales (ROS) of 8% based on a decrease to 71% in
the CGS/Sales margin and to 11.5% in selling, general, and administrative expenses/sales. 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.
We also anticipate lowering our effective tax rate to 30% due to certain tax credits from recent investments
in fixed assets. For these reasons, we believe our 8% ROS goal is quite achievable.
“On the balance sheet, we anticipate about the same relative levels in current assets, days receivable, and
days payable. We may increase inventory slightly if we take on the additional work with the PAP.
“As to non-operating cash needs,” continued Scorpio, “we’ll be paying a level of about 5 million in
dividends since this is the main source of the shareholder funds for making payments under the stock
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Case Study
purchase plans. We’ll also need about 5 million more for capital expenditures to replace some aging fixed
assets. Because of these equipment acquisitions and those of recent years, we expect annual depreciation to
climb to about 7 million.”
Longer-term Goals
The banker asked Scorpio about long-term goals. He replied that over the long term, he hoped to position
Orion as one of the larger and more significant component producers in the country. “We 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.”
“The export market is especially interesting to us. In order for major multinational car producers, such as
those in the USA, 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. We feel our quality is now
approaching theirs, but our prices in dollars are cheaper.”
“We see global markets as the future for industry in Andromeda. This is what successful Asian countries
have done, and I don’t see why we can’t do the same in Andromeda – produce a high quality medium tech
product for global companies.”
“The difficulty is getting our foot in the door. Our relationship with the Pegasus Auto Plant is extremely
valuable because the major U.S. multinational owner of PAP has its own needs in the USA. 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. We realize, however, that this
is a long way off and we don’t expect to get there tomorrow.”
The meeting ended and Scorpio left the banker’s office. Aries thought about the conversation. “Scorpio
has a great deal of drive and ambition,” he thought. “He’s an impressive guy, seems to know what he’s
talking about, and has the company financial numbers to give him credibility. I think we can work with
him, but just 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.”
Before turning to other matters, Aries asked the administrative assistant to request routine bank checkings
on Orion from the Sagittarius Bank and from the Andromeda Development Bank. “A few more numbers,
and we should be about ready to put a credit proposal package together,” thought Aries.
Financial Projections
Aries immediately looked at the numbers he had written down in the meeting. With these he would put
together some quick, informal one-year projections to see what the situation would look like as of 12/31/X4
under Scorpio’s assumptions. To be conservative, he also wanted to project 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 Scorpio. He estimated other
figures, such as level of cash, other current assets, and prepaid expenses, from trends in the balance sheet
and/or anticipated general growth. These accounts were quite small and, therefore, had less of an impact on
cash determination.
Customer Sensitivity
Sales Growth 35 % 20 %
CGS/Sales 71.0 % 73.0 %
SGA/Sales 11.5 % 13.0 %
Interest 12,000 16,000
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Days Payable 40 30
Accruals Level 13,000 11,000
Taxes Payable Level 5,000 4,000
But projections are only as valid as the assumptions on which they are based. If the assumptions are
optimistic, the figures will probably come out fine. If they are too pessimistic, the numbers will be
mediocre. The important considerations are to anticipate the most likely scenario and to understand the
sensitivity of the numbers in order to focus on the risk of not achieving the expected results.
Orion Projections
The projections found on the following pages were prepared by the banker based both on the customer’s
assumptions and on his own more pessimistic sensitivity figures. Please study the numbers and then go on
to Progress Check 2.5.
BALANCE SHEET
Cash & Marketable Securities 3,254 4,000 3,000
Accounts Receivable 54,114 73,051 81,168
Inventory 53,468 71,316 82,954
Other Current Assets 4,126 4,126 5,000
Prepaid Expenses 2,455 2,455 3,000
Current Assets 117,417 154,948 175,122
Net Fixed Assets 38,406 36,406 38,406
Investments 0 0 0
Other Non-current Assets 6,107 7,107 7,107
Intangibles 0 0 0
Non-Current Assets 44,513 43,513 45,513
TOTAL ASSETS 161,930 198,461 220,635
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INCOME STATEMENT
Net Sales 243,504 328,730 292,205
Cost of Goods Sold 175,310 233,399 213,310
% of Sales 72.0 % 71.0 % 73.0 %
Selling, General, Admin. Expense 30,896 37,804 37,987
% of Sales 12.7 % 11.5 % 13.0 %
RATIOS (Annualized)
Sales Growth Rate % -9.9 % 35.0 % 20.0 %
Net Income/Average Net Worth % 16.0 % 27.6 % 12.6 %
Net Income/Average Assets % 7.8 % 15.0 % 6.1 %
Sales/Average Assets 1.4 1.8 1.5
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Days Payable 39 40 30
Leverage (Debt Equity) 0.87 0.83 1.25
Long-term Leverage 0.28 0.20 0.21
RECONCILIATIONS
Net Worth
Beginning Net Worth 76,491 86,580 86,580
Plus : Period Net Income 13,035 26,969 11,641
Plus: Fresh Capital 0 0 0
Total Increases 13,035 26,969 11,641
Less: Dividends, Other 2,946 5,000 0
Net Increase/Decrease 10,089 21,969 11,641
Ending Net Worth 86,580 108,549 98,221
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CASH GENERATION
Net Income 13,035 26,969 11,641
Depreciation 6,539 7,000 7,000
Gross Operating Funds Generation 19,574 33,969 18,641
* Check (Net Operating Cash Generation – Total Non-operating Needs + Total Non-operating Sources)
Match the financial situation with the conclusions that can be drawn about Orion
Industries.
____ Quality of liquidity 1) Management is aware that profitability is still not what it
should be in terms of return on equity.
____ Capital sufficiency
2) The company is in a good position because it has a strong base
____ Operating effectiveness
to grow from and the capability to take on debt if necessary.
____ Earnings sufficiency
3) Aging of receivables and inventory is satisfactory so there
____ Cash generation sources doesn’t appear to be any difficulty with current assets.
4) It appears that the company will return to a combination of net
income (plus depreciation), operational credits, and outside
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From the projections we can appreciate that, if the margins and indices continue at or near present levels,
the company will probably do very well financially. We can also anticipate that if the potential growth is
achieved, additional limited short-term funding needs will arise. According to the customer projections, the
increase in short-term bank debt levels under this scenario is projected at only three million pesos.
However, if some of the numbers fall short, either in profitability or in larger than proportional increases in
receivables or inventory, additional bank debt will be necessary, and in potentially considerable amounts.
Also, capital expenditures could easily climb above projected levels if equipment in the old plant fails and
has to be replaced, or if new equipment must be purchased beyond the levels anticipated.
Because of Orion’s present strong capitalization, the firm has a great deal of creditworthiness to bank on.
They should easily be able to obtain funds from a bank, be it Libra or another. In the pessimistic sensitivity
scenario, the leverage ratio increases to only 1.25, which is well below historical levels.
What Is the Next Step for Leo Aries?
The banker has been gathering a great deal of credit information about Orion Industries, both qualitative
and quantitative. He has also been analyzing this information in order to draw conclusions about the merits
of a credit with Orion – the desirability of initiating a banking relationship with the company and what the
terms of the relationship should be.
Up to this point, Aries has been acting essentially under his own initiative. Since he cannot act alone to
approve a credit facility for Orion, now is the time to decide if he wishes to promote the potential credit
within the bank and, if so, to put together a credit proposal package. This will involve structuring a deal
and compiling a credit recommendation for the consideration of the credit committee. We will see how this
is done in the units that follow.
ORION INDUSTRIES
Introduction
In Part Five of the Orion Case Study, the banker must decide whether to proceed with a formal credit
recommendation for Orion. He obtains additional financial information to construct a cash inflow/outflow
budget in order to structure a potential deal.
Orion Cash Inflow / Outflow
A few days after putting together the Orion customer and sensitivity projections for 19X4, Aries felt he
needed one last piece of financial information to prepare a cash inflow/outflow budget for Orion. Aries
knew that the projections he had made, although extremely useful, provided a projection of average figures.
But this did not account for the seasonality of the business, which Scorpio had mentioned on couple of
occasions. The cash flow budget would help define the structuring for the potential new facility. It would
provide a more detailed picture of the cash flows during the year in addition to the situation at the end of
the year.
Besides, Aries was a computer buff and could utilize the cash inflow/outflow model that he had just
finished devising on his personal computer. The model was similar to that used by other banks, with a
couple of features that Aries had added. With the model, it would take no more than a few minutes to
compile the data and print it out.
He spoke over the phone with Scorpio. The customer said, “It’s good that you called. It looks like we’ll be
getting the contract for increased production that we have been negotiating with PAP. We have adjusted our
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monthly sales budget, with production increasing significantly beginning in June and total annual sales now
projected at Lcy 348 million. By September we expect to be producing about 50% more than we are now
producing.”
Scorpio assured the banker that Orion could handle the volume. “Remember, we were producing at just
below these volumes a couple of years ago, but at unprofitable levels. Now we expect to make some
money. Since we’ll be producing the same products, all we have to do is hire a few more people and
schedule about 25% more overtime than at present. But to be conservative, we should budget a little more
for capital expenditures. We’ll also have to acquire a couple of new machines and keep the old ones as
backups to make sure we don’t have any equipment problems. Except for the sales figures I mentioned, the
other assumptions would be about the same as we discussed a few days ago.”
Interpreting the Results
After Aries completed the cash inflow/outflow numbers, he made notes of some observations. These will
be included in his overall financial analysis of Orion as part of his credit recommendation, should he decide
to go ahead with the Orion deal. The numbers also will be valuable in structuring the credit and
anticipating when drawdowns would most like be requested.
CASH INFLOW / OUTFLOW BUDGET
Name: ORION INDUSTRIES Location: Andromeda Auditor: Capricorn & Centauri Begin ST
Debt: 15,060
Currency: Lcy Assumptions: Minimum Cash: 4000 Interest Rate %: 24 Amount of Line:
15000
Amounts: Thousands
Period: Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov De
X4
Starting Cash 3254 4000 4000 4000 4000 4000 4000 4000 4000 4000 4000 40
Net Sales 20000 22000 24000 24000 24000 30000 32000 34000 36000 36000 36000 30
(Accounts Receivables 20000 22000 24000 24000 24000 30000 32000 34000 36000 36000 36000 30
Opened)
Accounts Receivables 27056 27056 27056 20000 22000 24000 24000 24000 30000 32000 34000 36
Collected
Other Operating
Revenues
Inflows from Operations 27056 27056 27056 20000 22000 24000 24000 24000 30000 32000 34000 36
Total Purchases 13464 14688 14688 14688 18360 19584 20808 22032 22032 22032 18360 18
(Accounts Payable 13464 14688 14688 14688 18360 19584 20808 22032 22032 22032 18360 18
Taken)
Accounts Payable Paid 18998 13464 14688 14688 14688 18360 19584 20808 22032 22032 22032 18
General & Admin. Cash 2940 3060 3180 3180 3180 3540 3660 3780 3900 3900 3900 35
Outflows
Other Operational 2376 2592 2592 2592 3240 3456 3672 3888 3888 3888 3240 32
Outflows
Interest Payments 713 688 543 541 611 655 722 835 941 1046 1024 9
Taxes Paid 3447 2000 2000 20
Outflows from 25027 19804 24450 21001 21719 28011 27638 29311 32761 30866 30196 28
Operations
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Non-Operational Inflows 0 0 0 0 0 0 0 0 0 0 0
Net Cash Inflow 2029 7252 106 -3501 -2219 -6639 -5638 -5311 -5261 1134 3804 52
(Outflow)
Cash Balance 5283 11252 4106 499 1781 -2639 -1638 -1311 -1261 5134 7804 92
Short Term Loans Taken 0 0 0 3501 2219 6639 5638 5331 5261 0 0
Short Term Loans Paid 1283 7252 106 0 0 0 0 0 0 1134 3804 52
Ending Cash 4000 4000 4000 4000 4000 4000 4000 4000 4000 4000 4000 40
Short Term Debt 13777 6525 6419 9919 22138 18777 24415 29726 34987 33853 30048 24
Outstanding
Short Term Line 15000 15000 15000 15000 15000 15000 15000 15000 15000 15000 15000 15
Available
Excess (Deficit) of Line 1223 8475 8581 5081 2862 -3777 -9415 - - - -
14726 19987 18853 15048 97
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so crucial to the success of the firm. In 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 Goals
Aries also considered the related risk that perhaps Scorpio’s goals were overly ambitious and he
was trying to achieve too much, too soon. It was possible he was overextending the company
and himself. Aries had jokingly brought up the subject with Scorpio on one occasion. The
customer responded, “Perhaps, 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.”
Age of the Plant
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 Scorpio, who assured
him that, with the addition of a few new machines, the plant was capable of producing under their
contracted obligations. But Scorpio 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 Risks
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. World 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.
Since Orion no longer had any foreign currency debt, devaluation was not a risk, and the mini-
devaluations 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 major potential source of foreign currency earnings, and devaluation would probably
make these exports even more competitive – particularly since a major portion of the components
was sourced domestically.
Balancing Opportunities with Risks
Growing Company
Leo Aries felt quite strongly that he had a solid potential credit. He liked Orion Industries because
it was a growing middle-size 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.
Professional, Experienced Personnel
The management personnel at Orion were professional and experienced. They had a practical
focus, high standards of quality and the ability to maximize 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 and/or expansion, and to provide
letters of credit or other trade services for exports.
Quality Product
Aries also thought about Orion’s product. There was a strong demand for parts in Andromeda’s
rapidly expanding automotive sector. In 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.
Strong Financial Situation
The financial situation of the company was quite strong. The statements clearly reflected how
Scorpio reduced the size 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
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strong with a leverage of only 0.87 on 12/31/X3, reduced by more than half in only two years.
However, borrowing would reverse that.
Strong Leadership
In particular, Aries admired Scorpio. The potential customer was an impressive person, soft-
spoken but commanding of respect. He was a good manager with strong credibility established
by his impressive turnaround of the Orion financial situation. He was a rare combination of a
numbers and operations man, with a strong grasp and attention to detail. He was a man that
Aries felt he could trust and work with comfortably.
Structuring the Credit
Aries felt that Scorpio’s request for a short-term line of credit, with drawdowns up to a maximum
Lcy 40 million, was the appropriate structure. The amount seemed high in relation to projected
needs, especially considering that Gemini Bank currently offered about Lcy 15 million in short-
term facilities. But Aries was willing to go with the amount in order to compete favorably with
Gemini 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 180 days, or to discount receivables. The company to its own cash flow
cycle could adjust that way the borrowing.
Credit Recommendation Terms
The basic terms of the credit recommendation are as follows:
Facility: Uncommitted line of credit, permitting multiple
draw downs for loans up to 180 days, or discount
of receivables
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Support: Accounts receivable from ATW and/or PAP for 120% of outstandings,
duly endorsed
Personal guarantee of B. Scorpio and Taurus Brothers
Life Insurance contract for B. Scorpio to be endorsed to bank
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Aries said, “I think we can work on this basis and I’ll start the approval machinery moving right
away, Of course, you realize this is not our final position until all approvals are obtained up the
line.” 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 Scorpio and Aries ended, the client mentioned his concern about how
much longer this approval process would take. “It’s already been about four weeks,” he said,
“and, now that we have the contract for increased production for PAP, we’ll need funds availability
soon. Can we have a commitment from your bank in one week’s time?”
Aries answered that this should be sufficient time. He knew that Scorpio must be thinking in terms
of obtaining financial backstop availability very soon. If something went wrong with the Libra Bank
negotiations now, Scorpio would have very little time to patch something together with another
bank. But these were just hypothetical problems, figured Aries. “Nothing will go wrong.”
Credit Package
Aries had all of the elements of the credit package ready except for the credit memo, which he
stayed late that night to finish. Given the amount of exposure recommended for Orion, Aries
knew that the credit would have to be approved by his department head and the Senior Credit
Officer of the Libra Bank, who was at the second highest level, below the Board of Directors.
When 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 Scorpio.
The credit package was then routed to the Senior Credit Officer (SCO) of the Libra Bank. Aries
had met with the SCO on two or three occasions and had been impressed with the depth of the
SCO’s credit knowledge, which Aries thought fully justified the SCO’s strong reputation.
Review of the Credit Package
The SCO’s policy was to read the material carefully once and make a quick decision one way or
the other. If there were any loose ends to tie up, he would discuss them with the author in person
and ask the credit officer to quickly adjust them. If he agreed with the credit proposal, he would
sign the Credit Proposal/Approval form when this was done. If there were fundamental problems,
he would discuss them immediately with the author and see if a cure could be found. If not, the
credit would be disapproved.
On the following pages, you will see a reproduction of the Orion credit package. It includes:
Credit Proposal/Approval Form,
Basic Information Report (BIR),
Addendum to BIR – Management Assessment,
Comparative Statement of Financial Condition (spreads),
Customer and Sensitivity Projections,
Cash Inflow/Outflow Budget,
Summary of Assumptions for 19X4 Inflow/Outflow Budget, and
Credit Memo.
Most of this material has been developed in earlier parts of the Orion Case and is presented
again to demonstrate what a credit package looks like. Carefully read the Credit Memo on page
4-24 to understand the style and methodology of the credit presentation and to be prepared to
answer subsequent questions for analysis.
LIBRA BANK CREDITS APPROVAL NO. X4-042
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Security/Support:
Pledge receivables from PAP and ATW for 120% of outstandings duly
endorsed to bank (on loans)
Continuing Letter of Guarantee (CLG) signed by Orion to evidence
recourse on discounted trade bills
CLG signed by B. Scorpio and M. and N. Taurus for full amount of facility.
HISTORY
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Company was formed by Taurus brothers 24 years ago to produce high precision metal parts.
Have had ongoing and positive relationship with Andromeda Tractor Works, and more recently
initiated higher precision production for Pegasus Auto Plant. Product quality has been good, but
spotty recent history in dependability and profits. Arrival of Scorpio three years ago has helped
remedy this in productivity turnaround.
BANKING AND OTHER FINANCIAL RELATIONS
Principal bank has been Gemini, with some lending by Sagittarius. Latter relationship being
terminated, due to bank’s problems. Gemini products include short-term lending, occasional
equipment loans booked through Andromeda Development Bank, and payroll and current
account products. Relationship has been unsophisticated due to lack of management financial
skill. Checkings indicate good experience, with occasional past rollovers.
OPERATIONS Page 2
PRODUCTS - High precision metal works, with variety of products
capability
- Primarily tractor axle and transmissions
- Now producing higher precision automobile universal
and rear axle assemblies
- Some seasonality
- Perceived high quality workmanship
- Sales breakdowns: Tractor 55% – Automobile 45%
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* Check (Net Operating Cash Generation – Total Non-operating Needs + Total Non-operating
Sources)
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Long-term Debt
Gemini Bank 6,422 5,276 4,130
Sagittarius Bank 9,827 6,344 3,151
Andromeda Develop Bank 24,118 10,265 9,206
40,367 21,885 16,487
Less: Current Portion 7,120 5,433 5,255
33,247 16,452 11,232
Inventory
Finished Goods 23,630 16,032 19,377
Work in Process 4,423 2,461 3,855
Raw Material 46,667 38,479 30,236
74,720 56,972 53,468
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ORION INDUSTRIES
12 month 12 month 12 month
Actual Customer Sensitivity
Thousands of Lcy 12/31/X3 Projection Projection
BALANCE SHEET
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Option to accelerate One of the basic premises of the term loan document is the legal ability to accelerate the
repay borrower’s repayment obligations. If the borrower fails to comply with all pertinent
ment clauses (e.g. if an event of default as specified should occur), the creditor has the legal
option to accelerate the maturity of the loan.
In practice, there is often considerable flexibility exercised by the creditor when there is a
breach of covenants. In many situations involving defaults other than payment defaults,
the borrower is normally given time to “cure” the default. In more serious situations, if
the default is in good faith, the creditor may renegotiate terms. Even if it is rarely used,
the bank’s legal right to accelerate gives it negotiating powers with the borrower, and
perhaps with other creditors.
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The overall financial situation of the firm was quite sound, and the quarterly financial statements verified
that leverage was below 1.00. Profitability was maintained at the level anticipated in the optimistic
projections and Scorpio’s credibility was confirmed as actual profit numbers closely matched earlier
projections.
Leo Aries maintained frequent contact with Orion. This allowed him to provide good service to the
customer and to anticipate additional needs, such as cash management products in conjunction with
collection of Orion receivables. It also provided a deeper understanding of the business sector, which the
bank used to refine the risk asset acceptance criteria and identify potential banking relationships in that
sector. in fact, two other potential relationships that surfaced from the industry study were now being
analyzed within Libra Bank.
How Loan Request
Aries kept track of Orion’s cash needs and offered to study any new proposals that might come along for
equipment financing. Scorpio then asked Libra Bank to consider a Lcy 60 million package for replacing
some old equipment, adding new machinery, and constructing a new wing to house the new machinery.
Total cost of the Orion project was estimated to be Lcy 80 million.
Funds were to be sourced from a special fund of the Andromeda Development Bank for equipment imports,
and the loan was to be booked through Libra in Lcy. The approved tenor within this program was for five
years. Scorpio thought that the machinery could be installed and working within six months of ordering.
Because Aries had come to know the company so well, and had maintained updated financial information,
the banker was able to quickly put together five year projections for the company to complement the
forecast given by Orion. The realistic scenario of the projections indicated a cash generation availability
for long-term debt reduction of Lcy 18-20 million per year, beyond the present annual needs of Lcy 5.3
million.
Despite his earlier experience of having been overconfident with the original Orion credit approval, Scorpio
felt that the new credit recommendation would sail right through approval channels. The bank had a better
understanding of auto parts producers and had identified this sector as a prime growth area. Also, Orion
was now an established credit relationship within the bank. As a matter of fact, the account plan for Orion
called for exploring these term financing needs which had been anticipated since the initial credit approval.
Term Loan Structuring
Commitment Letter
Leo Aries’ task now was to structure a deal to recommend for approval in an updated credit package.
Specifically, his task was to write up a commitment letter that would contain all the pertinent details of the
proposed term financing, including all conditions and covenants. He would include the commitment letter
in the credit approval package and, once approved by the bank and the customer, it would serve as the basis
for the bank’s lawyer to draft the necessary term loan documentation.
The commitment letter began as follows:
Borrower: Orion Industries, Inc.
Lender: Libra Bank
Funds Source: Equipment financing facility of the Andromeda Development
Bank
Amount: Lcy 60,000,000
Purpose Equipment financing
Tenor: 5 years, including 1 grace
Payments: Quarterly installments beginning 12 months after signing
loan documents
Interest: ADB floating base rate + 4% p.a., payable quarterly in
arrears
Commitment Fee on
Unused Balances: ¼% p.a. on undrawn balances
Negotiation Fee: 1% paid upon signing loan documents
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Like affirmative covenants, the basic idea of the negative covenants is to preserve the
attractiveness of the borrower to potential lenders. In addition, they attempt to prevent the
company’s risk profile from deteriorating. When 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 utilized here (the
amount of depreciation for the year) is a fairly standard device. If 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.
Financial Covenants: Orion pledges to maintain:
- a minimum current ratio of 1.8 as
measured at the end of each quarter.
- a maximum leverage of 1.5 as
measured at the end of each quarter. For
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.
In the financial covenants, all financial terms such as current ratio and leverage should be defined
within the loan contract to avoid misunderstanding. For example, current liabilities (for the current
ratio definition) should specify that all outstandings under all credits should be included (as they
may be subject 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 tw o ratios
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above. But sometimes these latter two measures can be included separately as well. It
may depend on the specific needs of the bank or on negotiations with the customer.
Events of Default: The bank may declare its obligations under this loan
agreement terminated and all outstandings
immediately due upon the occurrence of:
- 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-default*).
- a judicial lien or embargo placed against any of
the borrower’s assets.
- bankruptcy or insolvency of the borrower.
* 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. It
is not to be confused with the cross-acceleration clause which only gives the creditor the right
to demand acceleration if another creditor accelerates.
.
SUMMARY
Because term loans have longer maturities, and therefore, more risk, they require a greater depth
of analysis and a more complicated legal documentation process.
In addition to the basic terms of the contract, a term loan agreement sets forth other important
terms and conditions, including:
borrower’s representations and warranties,
conditions to be met prior to creditor’s disbursement of funds,
borrower’s affirmative, negative, and financial covenants, and
events of default and acceleration.
We looked at a possible structure for a term loan to Orion industries to replace equipment, add
machinery, and construct a new wing.
You have completed the section of Unit Four that covers “Term Lending.” Complete Progress
Check 4.2 and then continue to Part 2 – Unit Five Managing Credit Risk.
ORION INDUSTIRES – Part 10
Credit Administration Procedures
The term loan for Orion was granted and disbursed as recommended. The Orion credits were
then administered as part of the Libra Bank loan portfolio. The day-to-day administration of the
portfolio involved tracking loan maturities under normal collection procedures, which included
sending a notice of payment 15 days before maturity and circulating a list of maturities to the
credit staff.
Every month, a list was prepared of past-due maturities in excess of 10 days, and appropriate
reminder letters were sent at 15-days intervals. If a loan was listed as past due for 90 days, it
was placed on a cash basis on the bank’s own financial statements, and all accrued but unpaid
interest was reversed against earnings. Since Orion was careful to maintain a good repayment
record, it never appeared on the past-due list.
Since the bank was a beneficiary of a life insurance contract on Bruno Scorpio and
comprehensive insurance on the fixed assets held as collateral, follow-ups were necessary on
quarterly premium payments and the annual policy renewal. This was done by the administrative
assistant within the credit department. Since the Orion term facility was backed with tangible
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collateral, it was necessary to make quarterly inspections to verify good working order and proper
care.
Periodic reviews for documentation discrepancies were performed by Libra Bank’s internal
auditor. The documentation needs for Orion were fairly straightforward and the documents were
always in order. These procedures constituted the more mechanical aspects of loan
management, and were part of the overall management of the relationship.
Management of the Relationship
Leo Aries, as relationship manager, had an overall responsibility for the credit, which required
understanding the customer’s business and its risks, and anticipating needs or potential
problems. It also involved marketing aspects related to opportunities for cross selling other bank
services, such as treasury and foreign trade products and cash management services.
Aries tried to maintain a fairly close relationship with the customer by visiting the Orion plant at
least quarterly and maintaining more frequent telephone contact with Scorpio. These contacts
were documented in the credit files with call reports. Aries also reviewed the Orion financial
statements quarterly and compared these to budgeted figures. The banker continually updated
his information, his understanding of the customer’s business dynamics, and his assessment of
management capabilities and sufficiency. Orion’s actual figures were usually close to budget and
deviations were always explained –- which positively reflected on management’s capacity and
control over the company.
Anticipating a customer’s potential problems involves tracking the credit risk and detecting
situations that could deteriorate or have an adverse impact on operations. The idea is to keep
options open and to act quickly to protect the customer and the bank. In one situation, a transport
strike tied up the raw materials supply of one of Orion’s key suppliers, adversely impacting
operations for a couple of weeks. The problem did not turn out to be serious, but a contingency
plan requiring the bank’s financial and institutional backing had to be drawn up (but not
implemented), and it was necessary to extend the maturity dates of two draw downs under the
short-term credit line.
Aries also continuously “kept his ear to the street,” to update formal and informal credit references
regarding Orion’s people, products, quality, reliability, and business reputation.
Requirements of the Term Loan Agreement
In maintaining his control over the relationship, Leo Aries had kept track of the term loan contract
requirements. He knew the payment experience had been good on interest payments. (No
principal payments were due yet since the term loan was still within the grace period.) He also
kept an eye on the obligations imposed by the affirmative and negative covenants.
During the first quarter of the year 19X5, Scorpio asked permission to sell some old equipment
that could be eliminated as the new machinery was installed. The customer needed the bank’s
permission, since the amount involved was greater than the annual depreciated budgeted for
19X5 (as limited by the loan agreement). Even though the sale had not yet been made, Aries
obtained a waiver from the bank, since it would not be productive to keep the unused machinery.
Annual Revision of the Orion Relationship
The first annual revision of the Orion relationship was coming due soon. The credit assistant in
the monthly listing of administrative maturities had flagged the date. In anticipation of this review,
routine credit checkings had been requested and received. These indicated continued strong
references both from creditors and suppliers.
The credit assistant forwarded this and other information to Aries in the Annual Revision Checklist
(see the attached form). Information about insurance coverage and confirmation of compliance
with obligations was attached to the checklist, along with the quarterly collateral inspection
reports and the account profitability form. This latter form indicated an account profitability ratio
(APR)of 2.4% which was comfortably above the bank’s institutional requirement of 2.1% for all
credit relationships.
The banker already had the spreads for the quarterly figures. These financial statements had
been delivered to the bank well within the deadlines stipulated in the term loan contract. The
spreads indicated general conformity of actual results with budgeted figures, and the current ratio
and leverage figures were comfortably within requirements of the term loan agreement.
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The banker now had to prepare a Term Loan Check. From the updated financial spreads,
reworked annual projections, updated basic background information, and fresh insights from
nearly one year of operations with Orion, the banker would prepare his updated credit analysis of
the Orion Company. From this he would then prepare an account plan to outline the future
direction of the relationship with this customer.
The Annual Revision Checklist that Aries received from the credit assistant appears on the next
page. Using the information above and from the checklist, complete the Term Loan Check form
on page 5-24.
ANNUAL REVISION CHECKLIST
CUSTOMER: Orion Industries OFFICER: Leo Aries
AMOUNT OF AGGREGATE CREDIT FACILITIES APPROVED:Lcy 100,000,000
PAYMENT OF RECORD:
Good X Fair Unsatisfactory
Trend on Punctuality: Good, with no need for follow-ups
ITEMS CHECKLIST:
Received/Done
Yes/No . Status
FOLLOW-UP:
Account Plan to be completed by Leo Aries
COMMENTS:
Regarding the collateral inspections, the inspector noted arrival of the new
machines. Some of these were still packed in crates and, hence, not yet
operating; although they were to be installed shortly. All plant infrastructures had
been completed. The situation appeared normal, with adequate safeguards over
the pledged assets.
EXERCISE
Directions: From the foregoing information, complete the Term Loan Check for the Orion
relationship for the first quarter.
TERM LOAN CHECK
PAYMENT DATES
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SUGGESTED SOLUTION
TERM LOAN CHECK
PAYMENT DATES
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