Case Study 1- Blue Water Credit Analysis Allie Loken PDF

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Allie Loken APEC3501 Glen Pederson 12 October 2015 Case Study #1 Blue Water Credit Analysis Introduction: Johnny, a recently promoted loan officer, has been given a new case by Charlie Cashman, Chairman of the Credit Committee. Johnny has been given the task to assess a three-year credit evaluation of three independent dairy clients and report back to Charlie and the rest of the Committee with his analysis of the farms and which he deems worthy for loans and which he does not based on their Credit Bureau score, Equity, working capital, debt repayment capacity, and collateral. To find the these scores, he must use the Vermont Credit scorecard to rate their ratios of liquidity, solvency and leverage, repayment capacity, efficiency, and profitability. The weight that he assigned each ratio is used to reflect how important they are in the analysis of the independent farm’s credit worth. He then multiplied to the weights and Vermont Credit scores he assigned to each ratio. This number is used to assess the worth of the farms Anderson, Benson, and Callaway, and whether the Firm sees them as meeting the criteria they have set. Analysis of Current Guidelines: The weights are given based on the importance the Firm sees them as. Johnny knows that the Blue Water Firm puts more weight on the solvency and the repayment capacity of their clients, and allocates some of the remaining weight to the liquidity, profitability, and efficiency of the farms. The weights sum of all the ratios must equal 1, or 100%. Johnny decided to allocate 25% each to solvency and repayment capacity, and split the remaining 50% between the other indicators, giving liquidity a little more because this reflects the quick turnover to cash the farm represents. These weights are multiplied with the independent scores for each specific ratio. The scores are given based on the Vermont Scorecard, which gives each ratio a score of 1, 2, or 3, based on certain percentages or ranges allocated with each ratio. In some specific categories, the independent farms seem to perform better than the others. Such as in the Net Farm Income. Both Benson and Callaway have a 10% Net Farm Income, but Anderson has half of that percentage, at 5%. However, certain categories will have more weight than others, so Net Farm Income has more of an impact on the overall weighted score than Interest Expense, based on how Johnny assigned the weights to each category. Furthermore, since the Solvency and Leverage and the Repayment Capacity has 50% of the weight in the Credit Score, the ratios in those categories

will have more of an impact than, let’s say, Profitability, which only has 16% of the overall weight. Even though all other ratios had a specific scorecard, the Quick ratio and Cash Coverage ratio is not represented on the Vermont Credit scorecard. The Quick ratio measures the client’s ability to pay current liabilities by using the available cash, collecting accounts receivable, or selling assets. Johnny decided that for the Quick ratio, a 0.5 ratio is unacceptable or poor, because this means they only could pay half of their current liabilities. 0.5 to 1 is acceptable, but not desired, and a 1 or higher ratio would be strong and preferred. This would be the same for the Cash Coverage ratio, with less than 2.5 being poor, 2.5-5 being acceptable but not desired, and 5 or greater being strong. For example, if a farm had a Cash Coverage score of 4, they could pay their interest on their loans 4 times over in cash. When analyzing the asset to equity ratio, Johnny had to invert the ratio because the Blue Water Company wants the equity to asset ratio on the spreadsheet. Along with the credit scores, Johnny also must analyze the repayment capacity of the farms. This is important because the Firm needs to know if the farm would be able to repay their loans. In other words, see if they are reliable. This is important because it would give insight to see if the farm is able to repay its debts, and still be able to take on more debt. Farm Creditworthiness Analysis: The credit scores that Anderson, Benson, and Callaway farms have tell Blue Water which farm is a prime borrower, acceptable borrower, and an unacceptable borrower. None of the farms receive a Weighted Credit score higher than 2 in 2013, which is an acceptable range to receive a loan from Blue Water CFA. Because of this, none of the farms would have gotten a loan that year. However, looking at the data, you can see that all the numbers were bad, therefore telling us that an outside force was acting on the numbers, such as a bad market. And since the market greatly affects the dairy industry’s profits, it can be inferred that Johnny did not place much importance on 2013, since all the farms were affected and cannot be considered good data. The Blue Water CFA uses the Vermont Scorecard to score the farm’s ratios, as stated above. They can use those numbers to multiply to the weights Johnny assigned each category, then add up the categories weighted scores to receive the average Weighted Credit Score. The Weighted Credit Score scale is between 1 and 3. A 1-2 is overall poor performance, 2-3 is acceptable, and over 3 is strong performance. Blue Water CFA deems a 2 or greater as acceptable to receive a loan from them. The Anderson farm has a credit score of 680, and therefore would not be seen as a good borrower, because their average score is below the acceptable range 700. The Anderson Farms would get the “Marginal” rating. But the Anderson farm also rated below a Weighted Credit Score of 2 all three years. Even if we took out the 2013 data, Anderson farm had an average of 1.35. This is seen as unacceptable to Blue Water CFA, and therefore they would not give a loan to them.

The Benson farm has a credit score of 700. Since it is right on the range of Marginal and Acceptable, Benson receives an “Acceptable” range. They also received a Weighted Credit Score of 2.05 in 2014, but below a 2 in the previous years. But if we took out the 2013 data, the farm would receive an average of 1.985, bringing them close to the required 2. Blue Water’s criteria require a 2 or higher, so technically they would not receive a loan. However, under special circumstances, they would be able to give them a loan if some aspects were overlooked. The Callaway farm has a 725 score, and although it’s not 750 (prime), the Callaway farm also has a higher Weighted Credit Score, making it a good borrower. This farm received an “Acceptable” Credit Bureau Score. They also had a score of above a 2 two out of the three years (2012 and 2014). They averaged 2.43 for 2012 and 2014, if 2013’s score was ignored. Even if 2013 was added to the average, they would be an acceptable borrower under Blue Water’s Criteria, and therefore they would be given a loan. New Minimum Standards Analysis: Blue Water gave Johnny new minimum standards to grade the farm’s scores to see if they were an acceptable borrower or not. Johnny was supposed to test these new standards and see if the farms would fail any of the new criteria. Looking at the data, each farm failed at least one of the new criteria. Callaway farms, for example, would have passed all previous criteria, but with the new standards in place, they failed the Owner Equity ratio. This ratio standards were to be above 50%, however, Callaway only received a 48% in 2012. Anderson failed multiple standards, deeming them not worthy of credit. And Benson farm did not meet 2 of the requirements, which hurts their chances of receiving a loan despite the fact that they had an overall average score close to 2. When looking at the proposed new criteria, they seem to be too restrictive and may refuse too many farms for loans, even if under the old standards they were credible. With these high standards, it may drive away business and Blue Water will lose profits and borrowers to other financing companies. Recommendations: In the report back to the Committee Chair and Committee about his findings, Johnny should inform them that the new standards would be too strict for new borrowers to qualify for loans. Although they would ensure perfect borrowers, they would also lose too much business, and also prevent good borrowers from receiving loans, when infact they were credible and worthy of the loans. He should recommend that Blue Water assess past loans on the farms, as well as see if they were repaid successfully or not. This data would add more insight to the credit scores of the farms, and possibly create a better set of ratios to determine if the farms have or have not been worthy of credit. This could eliminate the outlier of profitable markets or unsuccessful years of profit, and give a more accurate depiction of the farms worthiness.

Johnny should propose that Blue Water re-examine their standards, and write up a new set of standards to evaluate the farms credit. Since many factors determine if a farm is worthy of loans, Blue Water should include all of these factors into the equation instead of specific standards many farms cannot make. For example, loan history and repayment history is a strong factor that could point to whether the farm would be able to payback their loans or not....