Small Business Credit Risk

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Small BusinessCredit Risk

• October 16, 2007

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Seminar Agenda

• About Sum2
• Recent Credit and Market Events
• How Credit Events Effect Lenders
• What Can a Small Business Do

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About Sum2

• Building Sound Practice Foundations for
  Businesses and Industries
• Sum2 is dedicated to the commercialization of
  sound practices that address risk management,
  corporate governance, shareholder communications
  and regulatory compliance
• Founded 2002

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Product Suite

• SMB 360, Small and Mid-Size Business Risk
  Assessment and Management Tools
• PACO, Patriot Act Compliance Officer
• AlphaSource, Portfolio Risk Analysis
• Value Added Distributor

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Some Partners and Clients
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2007 Raging Bulls

• Markets Awash in Liquidly
• Premium Asset Valuations
• Money Chasing Deals / Leverage Buying EBITDA
• Kramer Going Wild
• Kudlow and Goldilocks Americas Cutest Couple
• China and India Driving Demand

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Signs of Froth Appear

• Stephen Schwarzmans Birthday Party
• TXU, Equity Office, First Data, Sallie Mae and
  other Mega PE LBO Deals
• IBs Buying Cash Flow Businesses
• Hedge Funds Go Public
• Dow Crosses 14,000

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What Goes Up
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Submerged Risks
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Against Backdrop Of

• Rising Interest Rates
• Declining / Balance of Trade
• Commodities Rising
• Oil
• Gold
• Geo-Political Risk / War
• Deteriorating Housing Market
• Ballooning Deficit Spending

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CRB Index Monthly Price Chart
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Credit Market Problems

• Sub Prime Mortgage Crisis
• Commercial Paper Market
• Contagion to Hedge Funds
• Securitization Structured Finance / CDOs
• Funding Sources Risk Aversion / Liquidity
• Housing Crisis Housing Bubble or Lending Bubble?
• Change in Valuation Metrics/Psychology
• Credit Default SWAPS / Level 3 Assets

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Banks Assuming Higher Credit Risk
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Kamakura Reports Fourth Consecutive Monthly
Decline in Global Credit Quality
Kamakura Troubled Company Index Rises to 8.0 in
September
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Anecdotal Observations

• Report More Than 300K Ohioans Trapped In Payday
  Lending Debt
• (More than 300,000 Ohioans are trapped in a
  cycle of debt to payday lenders and are paying
  more than 318 million in payday loan fees each
  year)
• Private Student Loan Bubble Could Burst
• New Century Financial Chapter 11 Filing
• Bank Earnings and Write Offs

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Pascack Valley HospitalImpact of a Credit
Default Event

• Systemic Event
• 100mm Debt
• 20mm Outstanding Payables
• 80mm In Bonds Outstanding
• Shut Down Of Services
• Layoff Notices To 700 Employees

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Pascack Valley Hospital Closure

• Pensions
• Local Businesses
• Vendors
• Spouses of EEs
• Housing Inventory
• Mortgage Defaults
• Community Tax Revenue

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Where's Goldilocks?

• Recession
• Inflation
• Deflation
• Stagflation
• Dollar Based Assets
• Corporate Earnings
• Taxes, Deficits, Trade
• Yield Curves and Equities

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Bernanke Goes Greenspan
Federal Funds Rate
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Sources of SMB Funding

• Existing Shareholders And Directors Funds (owner
  financing)
• Overdraft Financing
• Trade Credit
• Equity Finance
• Business Angel Financing
• Venture Capital
• Factoring And Invoice Discounting
• Hire Purchase And Leasing
• Merchant Banks (medium to longer term loans)

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SME Finance Sources

• Self Financing
• Loans
• Bank Loans
• Credit Card Debt
• People to People
• Investment Capital
• Grants

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SME Self Funding

• Existing Cash Flow
• Assumes Strong Cash Management
• Predicable Consistent EBITDA
• Predictive Cost of Sales
• Margins and Pricing Power
• Receivables and Factoring
• Assumes Clients Good Credit Risk
• More Exacting Factoring Standards
• Strong Credit Risk Management Culture

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SME Self Funding

• Personal Capital
• 401K
• Investment Portfolio
• Home Equity

Risk Premium On Collateral Valuation And Market
Risk
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Private Equity

• Angels
• Capital Adequacy
• Private Equity
• Secure Funding Sources
• Credit Risk Premium
• Exacting ROI Discipline

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Banks Response

• More Stringent Credit Guidelines
• Credit Risk Management Response
• Capital Allocation Requirements
• Regulatory Response
• Consolidation and Rationalization
• Market Response

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Small Business Scoring Solution
SBSS 6.0 Fair Isaac
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SBSS 6.0

• Empirically Derived Scores For Startup Businesses
  
• Credit Offer Index
• Size Of Loan Indexed To Industry Experience
• Divergence And Kolmogorov-Smirnoff (K-S)
• Profiling, Identifying And Scoring Bad And Good
  Accounts
• 60 Other Models That Use Application Data,
  Sector, SIC And Other Derived Elements

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Capital Allocation RequirementsRegulatory
Response

• Capital Adequacy
• Define Risk Characteristics Of Business Lines And
  Market Segments
• Allocate Regulatory Capital To Fund That Risk
• SMB 360 Product of Basel II SME Initiative

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FDIC Chart Capital Adequacy Regulatory Capital
to Cover Loan Losses
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Banking Market

• Community Banks Under Pressure
• Competitive Landscape
• SL For Retail
• Bulge Bracket Banks Commercial
• Brokers For Wealth Management
• Private Equity
• Mortgage Brokers

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Market ConsolidationRationalization

• Sum2s NJ Community and Russell 2000 Bank Study
• Acute Competitive Pressure
• Concentrated Regional Risk
• Slowing Earnings Momentum
• Rich Valuations High P/Es (MA)
• Regulatory And Economic Capital Strain

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SBA Study

• Our statistical analysis finds that small
  businesses receive less credit on average in
• regions with a large share of deposits held by
  the largest banks, irrespective of how debt is
  measured.
• Notable details about this primary finding are
  that
• When access to credit is measured by credit
  limits, reductions in lending in response to
• greater market share by large banks is larger
  than when credit access is measured by
• actual credit balances. This means that the
  market for un-accessed lines of credit is
• potentially most affected by banking
  consolidation.
• Credit reductions appear more severe in total
  when access to credit is examined through
• the dichotomous decision to obtain credit, than
  when the amount of debt as a share of
• assets is used as a measure. Thus banking
  consolidation is more likely to affect the
• decision, by either the small business borrower
  or the banking institution, to borrow,
• rather than affect the actual level of debt.
• Credit reductions in areas dominated by large
  banks are found to occur both for firms
• with positive, and with negative, equity. Bank
  credit reductions are found to be more

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SBA Study

• Most importantly, we find that non-bank
  financial institutions are making up part of the
• credit reduction in terms of the level of credit
  conditional on borrowing, but not
• completely in the case of access to credit.
• The activity of the non-bank financial
  institutions appears to be especially important
  for
• firms with negative, rather than with positive,
  equity.
• These findings are essentially mirrored when we
  look at the individual credit instruments
• of lines of credit, and other loans, although
  with some important exceptions. As we find for
  total
• credit limits, non-bank institutions are not able
  to compensate for lines of credit access
• reductions resulting from a greater share of
  large banks. Additionally, non-bank institutions
  are
• not able to make up for shortfalls in credit
  limit levels. In other loans, however, we find
  that
• non-bank institutions do compensate for
  reductions in bank credit, although the finding
  is
• stronger for credit levels than credit access.
• One set of small firms that therefore seems to be
  affected by banking consolidations are
• those that use lines of credit for assurances to
  customers and suppliers, rather than as a source
  of
• loan funds. It is possible, therefore, that these
  small businesses are finding it more difficult to
• conduct their business with a reduced ability to
  access credit. This concern is accentuated

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SBA Study

• The Impact of Bank Consolidation
• on Small Business Credit Availability
• By Steven G. Craig and Pauline Hardee
• Houston, TX
• For SBA
• under contract number SBAHQ-02-M-0459
• Release Date

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SMB 360

• Risk Assessment Management Tools
• Score and Manage Business Threats
• Business Strategy Targets
  
• Business Market Competition
  
• Business Capability
• Business Financial Planning
• Business Risk Management

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360 View of Risk and Opportunities

• Template 1 Market and Competition Assessment
  
• Template 2.1 Product Service Grouping,
  Customers
• Template 2.2 Product Service Grouping,
  Suppliers
• Template 2.3 Product Service Grouping,
  Competition
• Template 2.4 Product Service Grouping, Market
  Dynamics
• Template 3.1 General Management
• Template 3.2 Sales/ Marketing Management
• Template 3.3 Operations and Production
  Management
• Template 3.4 Facilities Management
• Template 3.5 Financial Management
• Template 3.6 Planning and Information
  Management
• Template 3.7 People and Human Resource
  Management
• Template 4 Financial Ratios
• Template 5 Business and Financial Plan
  Assessment
• Template 6 Scoring Specific Critical Success
  Factors
• Template 7 Scoring Generic Critical Success
  Factors
• Template 8 SWOT Analysis
• Template 9 STEEPLE Analysis

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Engagement Tools for Bankers and CPAs

• Why Did You Choose Them?
• Transparency
• Good Risk Management
• Able Management
• Critical Assessment
• Understand Business Process
• Confidence in Product and Strategy
• Risk Factors are Known

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Why Do SMBs Choose You?

• Differentiators
• Communication
• Shared Goals
• Understanding
• Delivering Value Add
• Prescient Tools
• Relevance

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Steeple Analysis
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Steeple Analysis

• Social Risks
• Columbus parade in Lodi and Garfield
• Canceled Because Of Pulaski Conflict

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Steeple Analysis

• Technological Risks
• Lucent Technologies Over Reliance On Central
  Switching Long Lines Business
• VOIP and Wireless
• Offset Printers, Film Developers

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Steeple Analysis

• Economic Risks
• Outsourcing
• Manufacturing
• IC/Barriers to Entry
• Cost of Capital
• Weak Dollar
• Energy Costs
• Recession
• Macro/Micro

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Steeple Analysis

• Environmental Risks
• DEP Releases Ranks Top Risks to New Jersey's
  Environment and Human Health
• Land Use Change Poses a Major Environmental
  Threat to State, indoor and outdoor pollution,
  and invasive species as major threats to New
  Jerseys environment and people.
• United Waters product has high sodium content
  due to salt spreaders
• Climate Change Opportunities Threats

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Steeple Analysis

• Political Risks
• Local Level
• Zoning, Community Standards, Education
• National Level
• Taxes, Infrastructure, Immigration
• International Level
• Trade and Stability

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Steeple Analysis

• Legal Risk
• Sarbanes Oxley, Patriot Act, HIPPA, OSHA, DEP,
  EOE
• Product Liability
• Feds Demand N.J. Tire Importer Pay For Recall
• Chinese Manufacturer Denies Responsibility

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Steeple Analysis

• Emerging Risks
• CAFTA and NAFTA
• Climate Change
• Regime Change
• Laissez-faire / Regulation
• Globalization and Market Stability

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• Sum2 is dedicated to the commercial promotion of
  sound practices. Sum2s objective is to assist
  businesses to implement corporate sound practices
  that add exponential value for shareholders,
  employees, clients and to the communities in
  which they operate and serve.
• Sum2 identifies its core competency to be the
  creative application of sound practice principles
  to the industries and businesses that we serve.
  Sum2s SMB 360 is a clear example of this
  creative application of sound practices to an
  industry need. Sum2 is dedicated to corporate
  responsibility, ethical business practices,
  customer service excellence and delivering to our
  clients a unique and essential value proposition.
  We uphold these values in all our work and
  continually strive to deliver on the commitments
  that we make to our clients.
• All products marketed by Sum2 are focused on
  risk mitigation. We look to creatively package
  and bundle solution suites that address targeted
  client and industry market segment requirements.
  All product marketing activities and business
  development initiatives are guided by and conform
  to a clearly identified industrial application of
  sound practices.
• We appreciate your business and look forward to
  hearing from you about our products and how we
  can improve it.
• PO Box 184
• Little Ferry, New Jersey 07643
• 201.440.1173
• customer.service_at_sum2.us

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Citations

• Dow and Nikkei
• http//www.the-privateer.com/chart/us-jpn98.html
• 300,000 Ohioans
• http//www.starbeacon.com/local/local_story_263024
  729.html
• FDIC
• Key Aspects of the Proposed Rule on Risk-Based
  Capital Standards Advanced Capital Adequacy
  Framework
• http//www.fdic.gov/news/news/financial/2006/fil06
  086a.html
• Yardeni
• http//seekingalpha.com/article/16521-housing-cris
  is-housing-bubble-or-lending-bubble
• Columbus and Pulaski
• http//www.northjersey.com/page.php?qstreXJpcnk3Z
  jczN2Y3dnFlZUVFeXkzNTcmZmdiZWw3Zjd2cWVlRUV5eTcxOTk
  3NDAmeXJpcnk3ZjcxN2Y3dnFlZUVFeXkz
• NJ DEP Study

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