The Annual Credit Review: A Necessary Evil or an Opportunity to Build Relationships and Create Value?

March 19, 2018

Is your company’s annual credit review approaching? Ian BrennerPartner at Farber and former CFO—sheds light on three fundamental shifts in thinking that will yield better results for companies when approaching this seasonal ritual. 

With the seasonal ritual of companies preparing their submissions to their bankers, the CEO, CFO, and their finance team often dread the annual credit review process, approaching it as an activity which absorbs time and resources unnecessarily and makes them feel vulnerable and uncomfortable.

This ought not to be the case. Rather, management should use this opportunity to build (or re-build) a sound, long-term relationship with their banker, raising the level of confidence in the company’s stability and viability, addressing nagging concerns, and enhancing trust and integrity between both groups. Alternatively, it may be an appropriate time to review the arrangement based on fundamental changes to the business and its funding needs.

There are tangible benefits for a company when it has a strong partnership with its bank. A business which provides full transparency to its banker on its strategic and financial position allows the banker to better assess the company’s overall financial health.

Other benefits to the company include a smoother experience in good times and in adverse times. During difficult periods, a sound partnership will allow the company more flexibility and support to potentially maintain or raise capital, waive a breach, manage pricing, or open a suite of financial solutions to manage a particular issue. Like any important professional or personal relationship, you want to keep your partner informed—honesty and transparency are essential and expected from both parties involved. After all, there are only so many banks in Canada; the alternatives are limited.

In our experience, there are three fundamental shifts in thinking that will yield better results for a company from the annual credit review.

1. Put yourself in your banker’s shoes and go beyond the numbers

The primary asset on a bank’s balance sheet is its loan portfolio—so, while banks are in the business of lending, it’s critical to their business that they continuously evaluate the risk of their loans. A lender’s business policy will always be geared towards meeting the needs of its clients, regulators, and shareholders. As a client of a bank, it’s important to remember that while it has an interest in its clients doing well, a banks responsibility to their shareholders is twofold: to ensure the stability of their investment, and to meet their requirements for internal and external audit and Office of the Superintendent of Financial Institutions (OSFI) oversight; ensuring loans are properly risk rated. Albeit mandated by the loan agreement, the annual review is an opportunity for a lender to gather supporting information or to update its insight into its clients’ businesses.

Typically, an annual bank review includes a full overview of where the company has been over the past year and what the company’s plans are for the future. More specifically, a full annual review would typically require the following from the company:

  • annual financial statements with associated Management Discussion & Analysis (MD&A) and variance reports, assessing performance relative to plan
  • detailed budget/forecast (including financial covenant tests)
  • a strategic update (both short-term and longer term), including any indication of significant initiatives under consideration or in process, any pending management changes (i.e., departures, appointments, and status of succession plans), and a discussion on key risks and opportunities

In addition, the bank would value an industry review and it is likely the relationship manager will seek an onsite visit for a discussion with management. (More on this later).

The real opportunity for a business, however, is to go beyond the minimum required. A well thought-out presentation that goes beyond the numbers will:

  • provide a succinct view of the business case or why the company’s strategy is sustainable
  • demonstrate that management understands its industry and is confident in its competitive positioning
  • support and elaborate on the competence of its leadership team and the likelihood of them executing to plan
  • discuss the quality of cash flows and the ability to meet commitments
  • share significant events which have improved the banker’s collateral coverage – giving the bank comfort on its security and collateral position (i.e., Accounts Receivable Insurance is in place, or the value of a secured asset has been enhanced.)
  • review the covenants and their historical and projected compliance, for example, the company may need to explain why non-recurring expenses should be excluded from EBITDA in a ratio of funded debt to EBITDA
  • be clear in its purpose – executives should ask themselves if they are simply requesting a renewal on the same terms, or have circumstances changed and are they seeking to vary the terms in some way?

2. Be candid and credible

As with all relationships, trust and integrity are the building blocks to an enduring, mutually beneficial partnership.

When communicating your historical performance, or your future prospects, share the good news with pride but don’t hype your company—the best way to sell your story is to be factual, incisive, clear, and crisp in your communication, both written and verbal.

Equally important to providing the good news is sharing the bad. Bankers hate surprises, but they understand that all businesses go through difficult periods or have to deal with adversity.

There is no better way to build credibility than by sharing your current or anticipated risks, issues, and challenges. It is critical to provide insights into, and solutions to these issues, together with your plan to alleviate or address these issues going forward.

3. Avoid information overload and hyperbole

Invest the time and effort to develop a quality package of materials for the review. However, don’t go overboard – an Executive Summary with say 15 to 20 pages of supporting detail is far more desirable than a three-inch binder which needs to be read and interpreted.

Do your homework – before you submit your package or meet your banker, ensure you have an understanding of current lending conditions.

  • What is your banker’s tolerance for risk?
  • What is the current rate environment?

Count on the fact that your bank already has a view on your industry. In fact, their risk rating models will automatically compare your historical results to industry rankings. It is therefore important to periodically educate your lender for the nuances of your business. This can be a solid investment of time, as having them understand the fundamentals will reduce your lender’s perception of risk.

Provide insight into areas of sensitivity – if you don’t have a deep understanding of the financial implications of changes in your industry and your business, you will leave your lender with a sense of unease. Keep in mind that most lenders need to distill the information into only a few pages of factual explanation, as part of their internal annual review submission.

Ensure you deliver all the requirements of your lending agreement, including financial statements, covenant tests, and declarations. If you are concerned about meeting your covenants, be transparent and offer solutions. As your business grows and adapts to change, your financing needs change—proactively requesting a revision demonstrates that you understand your business and this is what builds confidence from your banker.

Find the right balance between being informative and information overload; remember that many other companies are also going through the process, so it’s a busy time for your bank.

When was the last time your banker visited your premises? Get your lender to come onsite, tour them through the premises, facilitate introductions to both senior management and key staff, and ensure they gain a deeper insight into your business and its culture. A well-planned and executed site-visit brings the numbers in your review package to life; it’s an opportunity to impart on the lender an enduring image of a sustainable, organized, well-run operation. Also, use the opportunity to ask your banker to provide commentary on trends, new products and services, and market conditions that they see. The bank has access into the insides of hundreds of companies across all industries, and is well-positioned to share these best practices with its clients.

In many cases, form is as important as substance—take the time to stand back and view the package as if you were the reader. Review the details of your submission, ensure it makes sense from a higher-level view, tie the bow, and submit it with the satisfaction that you have approached this process with the professionalism and seriousness it deserves.

A final thought: ensure the credit review package or presentation is delivered on time. Better yet, deliver in advance of the deadline. There are no excuses for missing a deadline. To your banker, tardy delivery begs the questions:

  • Do you have your business under control?
  • Do you take your relationship with your banker seriously?

For many companies, these three fundamental components to the annual credit review are often not easy to achieve and do not come naturally. Perhaps a company does not have the right people in place to ensure a successful review is implemented. Or, the right people are in place but they are simply pre-occupied with a major assignment or initiative. If this is the case, there are interim management solutions available to support your finance function.

An advisor that has experience in dealing with banks, on both sound and stressed situations, may be helpful to your understanding of what a bank is looking for and how they may react in different situations. Also, an advisor may undertake tasks, such as:

  • fine-tuning the approach to your banker andstrategically positioning the company
  • building the financial model for projections, including underlying assumptions and
    sensitivity analyses
  • assembling the final package for submission
  • preparing for the presentation – taking executives through a mock review
  • providing a seasoned voice and support for executives during the review process and particularly in meetings
  • assisting with follow-up questions and ensuring completion or renewal of the term sheet

Once companies start viewing the annual credit review process as an exercise of transparency, the benefits become more obvious. Not only will this provide the bank with a clear view of the overall financial health of your company, it will offer the flexibility and support needed to flourish or help confront adversity head on. When companies shift their thinking and approach this as an opportunity to build a sound partnership, rather than just another ‘to-do’ on the list, the result is trust and the deepening of a valuable relationship.

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Ian Brenner is a Partner and the leader of the Interim Management & Executive Search practice at Farber. Ian can be reached at 416.496.3666 and