USAID – Workshop on agricultural sector financing THE5Cs OF A GOOD LOAN Workshop on July 22 and 23, 2011

PRELIMINARIES Being an analyst requires the following different roles: Diplomat Detective Salesman Accountant Negotiator Area specialist

BASIC RULES A borrower is always optimistic The credit analyst must defend the Bank, but not the borrower Verify, verify, always verify...

THE SCIENCE vs. THE ART The science consists in: Considering the facts Analyzing the information in order to know the “real story” Preparing the financial analysis The art consists in: Issuing credit judgments based on incomplete data Understanding the borrower’s motivations Building trust IN ALL CASES, WE REPRESENT THE BANK, NOT THE BORROWER

WHAT IS THE MAIN RISK IN TERMS OF GRANTING CREDIT? The main risk is that the borrower is not able to repay and that its guarantees do not fully cover the unpaid amounts However, it is interesting to take the risk if you think that it is profitable for your bank and your analysis concludes that it is a good opportunity to build a partnership with the client Before making the decision, be sure not to have forgotten to analyze all the aspects. Use a checklist called FIVE Cs

WHICH BUSINESS PRESENTS THE MOST RISKS? Printing shop invests in printers already in operation for 5 years creates high-quality graphic presentations for advertising companies, etc. in Kinshasa Water-bottling plant invests in bottling equipment operational for 2 years sells nationwide Tailor invests in 4 sewing machines in activity for 3 months Lubumbashi local market

THE 5Cs The 2 main Cs: Character - the person and the family Capacity/Cash-flow - technical, economic and financial feasibility and past history of the activity The 3 secondary Cs: Capital - funds invested in the business plan Collateral/Guarantees Conditions - the loan terms (amount, rate, repayment terms)

MEANING OF THE 5 Cs CHARACTER: does the borrower WANT to repay? CAPACITY: CAN the borrower repay? “COLLATERAL” or GUARANTEE: are there SUFFICIENT secondary repayment sources? CAPITAL: up to what level does the borrower PARTICIPATE in the risk of the business CONDITIONS: what is the company’s ENVIRONMENT?

CHARACTER Honesty and integrity Family situation Skills for managing an economic activity Family assets (net worth) Reputation in the community Openness and conformity with the market and the community Ability and habit of repaying previous credits

QUESTIONS ABOUT CHARACTER Evaluation of the moral and financial responsibility of the individual requesting a loan may be made by considering questions such as: Are the individual and his family worthy of trust - demonstration of trust, but also honesty, responsibility and work habits? How did the individual and his family arrive at their current economic situation? How did he resolve difficult situations in the past? What do the people and the leaders around him say about him/them? What do the suppliers and the buyers say about him/them? How do (does) his (their) habitual style of life and his (their) habitual expenses compare with his (their) income level? How are the family relationships and family considerations that might affect the activity and the loan?

CAPACITY What does the business plan indicate about the revenue generation and the profitability of the industrial and commercial activity? Can the individual/business produce enough money to honor the loan repayments with interest, including a safety margin? When will the loan be repaid? What are the family needs? What are the consequences of seasonal fluctuations and production variations? How does the entrepreneur/farmer fare compared with others in the same sector or the same activity? Is there a successor?

MANAGERIAL CAPACITY Management questions include: How does he manage his business, farm or structure compared with others? How does he manage his money and his expenses? How have their assets/net worth increased or decreased over time and trends? How do they manage, do they have relationships with people?

HUMAN AND WORK CAPACITY What are the age and the health of the person in question? How does the family cooperate? How does the individual cooperate with other farmers in the community? Is labor available when necessary? How does work capacity influence the economic feasibility of the activity? (This is particularly important when a specific competence or person is required)

TECHNICAL CAPACITY Technical capacity is closely connected with the analysis of feasibility and must be analyzed with other parameters: Equipment Services/maintenance Externalization Land Storage …

LOAN HISTORY Has the client had loans in the past? How were they repaid? How were they managed? Were they late in repayment and, if so, what were the reasons? What is the evaluation of their previous credit managers? Does the client have savings? What is the level of savings compared with the loan? What is the savings history?

CAPITAL How are the assets invested in the business (activity)? What is their value? What is the quality of the assets (are they well maintained)? What are the family contributions to the business (activity)?

COLLATERAL The secondary sources for repayment of the loan: Are they personal guarantees from trustworthy individuals? Are the business’ assets and the personal guarantees enough to cover the repayment of the loan if necessary? But PLEASE NOTE – the guarantee is not a primary source of repayment

CONDITIONS Is there an adequate and stable market to support the business? Are the terms of the loan (duration, interest rate, etc.) well defined in relation to the capacity for repayment? What are the price and production risks? What are the general trends of the sector market? Additional risks such as illness, etc.

CONCLUSION The 5Cs = 5 factors for analyzing the loan risk “The art” is much more than knowing how to calculate! It’s the sense of smell, the intuition and the emotional intelligence! Proper risk management depends on knowing what, when and how to apply the analysis indicators and also how to analyze the borrower’s social and personal factors.