Scott Kiley,
Capital Markets Expert,

You may have chosen a career in sales because you thought credit was boring, but your company expects you to be the “first line of defense” in screening new originations. Having a strong base knowledge of credit analysis and underwriting is the only way you can fulfill this obligation.

Whether you are a direct or indirect originator in this industry, developing strong credit skills will create an easier path to success. I would argue that these skills are more critical for an indirect originator because they see more deals, but every salesperson should have them regardless.

THE BENEFITS OF SOLID CREDIT SKILLS
The benefits of being a salesperson equipped with solid credit skills are significant and will greatly increase your productivity. I hate to break it to you, but you already have a reputation in the eyes of your internal credit staff and senior management — either you “get” credit, or you don’t. If you believe you have no influence on the ultimate credit decision and your common practice is to throw the deal to credit and see what they think, I can assure you, you don’t “get” credit.

No matter the stage of your career, don’t be afraid to ask your sales manager and credit partners for their assessment of your credit skills. If your skills are weak, show a willingness to improve by rolling up your sleeves and spending more time with your credit partner assessing each new opportunity. This will not only improve your credit skills but will also improve their view of you as a respected partner in the deal review process.

Being in sync with your credit partners on what constitutes a “good deal” will result in your team and company operating more efficiently. If your credit partners believe you are weak in credit, every deal you bring in will be scrutinized more closely because they don’t trust that you have met your obligation of being “the first line of defense.” Over the years, I have also found that credit folks find it harder to say ‘no’ to a deal coming from a salesperson who has earned a reputation of possessing strong credit skills.

If you are just starting out, or want to improve your credit skills, how do you go about it? Here are five critical steps:

1. Master the Basics: Take an internal class on financial statement analysis and basic underwriting that your company or the Equipment Lease and Finance Association offers. You must know how to read financial statements and credit spreads and understand the terminology.

2. Learn From Credit People: Ask your senior credit managers and analysts how they read spreads and analyze financials. Have them identify the top three to four financial ratios and non-financial factors they focus on when they first see a deal. You may get different answers from one person to the next, so record that information to use to your advantage in the future.

3. Understand Profitability of Default: Make it a priority to understand what feeds your company’s probability of default (PD) rating modeling and the importance the PD rating plays in the decisioning process. You also must know what constitutes a policy exception within your company in terms of leverage, fixed charge coverage or some other financial or non-financial metric. Too many policy exceptions will kill a deal.

4. Identify the Important Information: You must fully understand how to extract the most important information from the notes to the financial statements. Key notes relate to debt detail, covenants, operating lease obligations, customer concentrations and material litigation.

5. Understand “Unfavorable” Industries and Asset Types: As important as the numbers, you must also have a strong understanding of what industries and asset types your credit folks view as unfavorable. Most shops also have established acceptable deal structures related to term and amortization based on the asset type. You must know if you are dealing with a stretch credit or structure. A poor PD rating (no matter how it is determined in your company) automatically makes it a “stretch” credit.

SEVEN BULLET POINTS ANALYSIS
After mastering these five steps, you are prepared to be an effective first line of defense in assessing new opportunities.

Now I want to introduce you to what I call the “seven bullet points analysis,” as I believe you can break down every credit and deal into seven bullet points. Hopefully, most bullets will be strengths mixed in with some weaknesses (or what are often referred to as risks with mitigating factors).

First, write down the most important strengths of the credit and the deal; they will be different for each opportunity. It may be low leverage, great liquidity or cash flow, strong profit margins, an industry leader, high market cap, alternative sources for debt, strong collateral coverage or upside potential on a fair market value (FMV) lease.

Next, write down the biggest weaknesses of the credit or the deal. Many times, these will be the inverse of the strengths I just listed. The risks must be addressed through mitigating factors, which I will explain later.

Pick the top seven most relevant bullet points. If the top seven include more weaknesses than strengths, move on.

Pro tip: Before passing on a deal, send the confidential information memorandum (CIM) to your credit analyst, but tell them to call you before they dig into the information. When they call, let them know you are thinking “this is probably a pass” for X, Y and Z reasons. My experience is that, 99% of the time, they will quickly agree with your decision, but you just earned a “chip” with credit for meeting your
first line of defense obligations. Build up your chips with credit so you can cash them in later for a stretch deal you strongly support.

Assuming the strengths outnumber the weaknesses, write up your deal pitch and incorporate these seven bullet points. When I was working a deal, I would always keep that list in front of me to easily reference for every phone call, in-person meeting or e-mail with credit. Every transaction will have identified risks, so the question becomes: Can the strengths and mitigating factors overcome the risk level established by credit?

DETERMINE THE MITIGATING FACTORS
Mitigating factors can be strengths of the underlying credit profile, but they can also be a deal-specific strength, such as:
• A rapidly-amortizing deal with strong collateral coverage
• An FMV lease for a highly desirable asset type with great upside potential
• Term of the deal ends a year before material debt maturities
• Financing core production equipment that is essential to the borrower’s operations

Be prepared to hammer home the mitigants every time credit raises one of the identified risks.

FIXED CHARGE COVERAGE RATIO
While I have the megaphone, I want to take a minute to talk about the fixed charge coverage ratio. This is often the most important — and at the same time most manipulated — financial ratio incorporated in the credit underwriting process. I was a persistent proponent of replacing the fixed charge coverage with a debt service coverage ratio as a more relevant ratio. Unfortunately, I lost that
argument with credit over my career because a minimum fixed charge coverage ratio is normally a key policy exception. Fixed charge coverage ratios incorporate the nebulous maintenance capital expenditure (CapEx) deduction as well as a deduction for distributions made to shareholders to determine the cash available to service debt.

Problems with these deductions also lead to the manipulation of this ratio. The maintenance CapEx deduction is an attempt to quantify some level of CapEx that should be covered by operating cash flow. In theory, I don’t disagree with this premise, but determining what that level should be requires unnecessary precision, and you lose the deal to a competitor who approves the deal by establishing a lower cushion.

In addition, most companies can finance 100% of their hard equipment purchases from several institutions, so they don’t need to use their operating cash flow. Deducting distributions is taking the position that senior management and owners put a higher level of importance on pulling money out of the company versus meeting debt service. I vehemently disagree with that premise and don’t believe that is reality.

SUPPORT FOR ADJUSTMENTS
While I know many credit folks will disagree with me, I believe if credit is supportive of a deal, there is more openness to adjusting their standard fixed charge calculation methodology to improve the ratio. Support for adjustments may include incorporating the calculation methodology used in the company’s senior credit facility (if it is known), using maintenance CapEx figure provided by the chief financial officer or calling all or part of a distribution a “one-time” or discretionary event. If there is little support for a deal, credit will be less receptive to adjustments and fall back on the standardized calculation to show a stressed fixed charge coverage ratio.

To conclude, you went into equipment finance sales because you didn’t want to spend your days analyzing financial statements, but your likelihood for great success is directly related to possessing and showing off your strong credit skills. While your tenacity may help you bring in more opportunities, demonstrating to credit that you are a proven “first line of defense” will convert to more opportunities to close deals. •

Scott Kiley recently retired after a 35-year career in the equipment finance industry, including the last 25 years at Fifth Third’s Equipment Finance Capital Markets Group.