BANK CREDIT METHODS AND PRACTICE ■hy THOMAS J.KAVANAUGH mtM lark Hatt QJoUegc of l^griculturc 3Vt CHornell IniuerBttB Ktljaca, N. % ICtbratg >;ieN , Date Due L4lla!Lt^« '" m ' Library Burea Cal. No. 1137 Cornell University Library HG3701.K3 Bank credit methods and practice, 3 1924 013 905 850 The original of tiiis book is in tine Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924013905850 Bank Credit Methods AND Practice By THOMAS J. KAVANAUGH Vice-Preaident Misiiisippi Valley TruHt Company and Lecturer On Crediu, St. Louis University SECOND EDITION NEW YORK BANKERS PUBLISHING CO. 1922 Hq -3701 Copyright 1921 The Bankers Publishing Co. New York aX'^o^ Q^d CONTENTS Chapter I. The Theory of Credit. Credit defined. The introduction of currency. Banking in- separable from credit. Chapter II. The Essentials of a Credit Risk 17 Character, capacity and capital. Wealth created by mutual confidence and trust. Character as applied to credit. Credit extension between nations. Effect of war on world credit. Capacity as affecting credit. Capital last but not least. Chapter III. Foreign Credits 33 Extraordinary economic changes awakening us to the import- ance of opportunities in foreign fields. Unfavorable trade Ijfllances and long credits. Chapter IV. Commercial Paper and Trade Accept- ances 43 Popularity of commercial paper. Methods of handling by brokers. Single-name paper. Renewing of commercial paper notes to be discouraged. Audited statements. Two- name paper. Acceptances. The overdraft system in Eng- land. Chapter V. Bankers' Acceptances 59 Banker's acceptance defined. How created. The trust re- ceipt. Acceptance agreement. Certificate of eligibility of bankers' acceptances. Letters of credit. Chapter VI. Commercial Lines of Credit. Reciprocal Relations 80 Extension of credit based on balances. Seasonal borrowing. Danger of over-extension. Loans on speculative enterprises. Chapter VII. The Federal Reserve System 91 Note issues. Organization of the system. Controlling rates of interest. Rediscount of commercial paper. Financial statement forms. Value of Federal Reserve System proved. Chapter VIII. Theory of Statement Analysis 121 Growth of the statement system. Examples of statements and analyses. Analysis of bank statements. Chapter IX. Importance of Statement Analysis 130 Prosecution in federal courts. Methods of accounting. Sug- gestions for consideration of various items. Chapter X. Analyzing a 'Financial Statement 145 Analyses of statements in various lines of business and with regard to localities served. Chapter XI. Credit Department Methods and Organ- ization ' 1 76 The first bank credit department. Qualifications of the bank credit man. Prompt handling of customers necessary. A central file. Corporation statements. Partnership and personal loans. Form of loan application. The loan com- mittee. Preparedness in handling loans. Chapter XII. Investigation and Compiling Informa- tion 212 Form for investigation. Letters of inquiry. Banking ethics regarding investigations. Mercantile agency reports. A model credit file. The analysis division. The research division. Answering letters of inquiry. Form of guarantee. Loans to banks. Kiting. BANK CREDIT METHODS AND PRACTICE INTRODUCTION Theee has been an insistent demand for a technical book on banking credits. The field is so broad that it has been covered only in a general way. It is a generally accepted fact that one well versed in the handling of bank credits can successfully handle commercial credits. In banking credits the highest order of credit technique and analytical ability is required. In writing this treatise, it has been the author's aim to elucidate in the most simple language what technical authors usually delight in making most complicated by a too classical treatment. It has been his object to make the work of practical value not only to the credit department of the average bank, but also to the student of finance, whether in the college or the home. It has also been his hope that it will be of value to the commercial man, not only in the study of banking, but, what is more im- portant, in enlightening him as to the viewpoint and attitude of the banker in the making of loans, thus bringing him closer to his bank in mutual under- standing. CHAPTER I THE THEORY OF CREDIT Credit is defined simply as the postponement of the payment of a debt. It is the exchange of money or commodities for a promise to pay sometime in the future. The exchange is based upon the faith of the owner of the money or goods in the abihty and good intentions of the borrower or buyer to keep his promise. This promise may be expressed or imphed. When expressed it is usually in the shape of a note, or, perhaps, the equivalent of a note — an accepted draft. An accepted draft provides for payment at some definite future date, and is known as an "acceptance". A note, or, as it is technically termed, a "promissory note," may or may not have a definite calendar maturity. In other words, it may be pay- able on demand made by the holder thereof, or the right to make demand for payment may be post- poned by the terms of the note itself, and its ma- turity fixed at a definite date in the future. The promise to pay may also be in the shape of a written contract signed by both parties, buyer and seller, or borrower and lender; which contract may be either secured or not secured by collateral pledged to 9 BANK CREDIT METHODS AND PRACTICE secure its payment, and which contract may be made either negotiable or non-negotiable. The promise to pay may also be in the shape of long or short-term bonds, either secured or not secured by a mortgage on physical assets, such as real estate, farm lands, plants, machinery, etc. ; also municipals, such as road bonds, drainage bonds, school district bonds and other classes of state and county bonds and Govern- ment bonds. When the promise to pay is implied, it is termed "open credit," or accounts receivable. The use of this form of credit in mercantile and manufacturing business is more general in the United States than the settlement of accounts by notes or acceptances, although in recent years the use of acceptances has been very much encouraged. The open account credit is extended to give the manufacturer time to convert his merchandise, and to help the merchant in effecting his turn-over. The manufacturer must convert his raw material into finished goods, and the merchant his wares into cash. In most lines of busi- ness some period of time must elapse before this con- version is consummated. The account receivable and the note receivable fill their proper places in the incompleted transactions. How was the credit system founded? It was not specifically invented, although some great individual minds have contributed to its advancement. It has rather been the natural outgrowth of a civilization 10 BANK CREDIT METHODS AND PRACTICE seeking to improve its existence ; of society endeavor- ing to facilitate its members in their respective avo- cations; of the progress of ceaseless- working human- ity on its onward march toward a goal set by its Divine Creator — the goal of universal trust and mutual faith. Prehistoric man had little faith in his feUow men. He looked upon his neighbors with suspicion. This was in the day when each man was sufficient unto his own family — ^when he could produce all that was needed for his family, whose needs were then very hmited. But, after a while, as the human family multiplied in numbers and men and women had their first taste of luxury, things changed. The products of the different families became more varied and the things possessed by each family became more sought after by the others. For example, one family de- voted to agricultural pursuits produced more food than was necessary for its requirements. So in like manner did the family engaged in the manufacture of clothing produce a surplus above its needs. This led to a system of barter and exchange, by which the possessor of the surplus clothing exchanged a certain amount of goods with the owner of the surplus food products, the exchange being made in order to sat- isfy their respective requirements. As civilization developed, accentuating the gregarious proclivities of man, there sprang up settlements or villages where these exchanges were facilitated, resulting 11 BANK CREDIT METHODS AND PRACTICE later in mercantile stores and manufactories, where goods were manufactured and sold. As the popxdation of these centers became more dense, it was found that the system of barter and exchange was inadequate to meet the requirements of the inhabitants. The exchange proved unequal because of the fact that the purchaser of one com- modity desired a larger amount of that commodity than was represented by the amount of his posses- sions needed by the party from whom he made his purchases. This left a surplus in the hands of one of the parties to be disposed of to others, and it also made a difference in the amount to be settled be- tween both parties to the transaction. Also over- production left surplus commodities in the hands of the industrious toiler, and he could not use all the commodities received in exchange for the fruits of his labors. This, in time, so compUcated and con- fused all business transactions and made differences so difficult to adjust, that it became necessary to adopt something which could be accepted as a stand- ard of Value between purchaser and buyer, some- thing which would represent intrinsic wealth that could be held and later used in exchange for the necessaries of life. Thus it M'as that money was adopted as a medium of exchange. Since its introduction into the world money has exercised a tremendous influence over the affairs of mankind, causing unhappiness and wars, as well as 12 BANK CREDIT METHODS AND PRACTICE universal comfort and world development. It is magnetic alike to rich and poor, miser and spend- thrift. For thirty pieces of silver Christ was be- trayed, making possible a tragedy unparalleled in the world's history. For it, pirates have roamed the seas, predatory bandits have terrorized countries, and prospectors have braved the wilderness, enduring the hardships that go along with such adventure. There is none immune to its allurements — the illiterate or the scholar, the saint or the unsanctified — and the reason for this is that world economics developed along lines that made money one of the most in- dispensable of human necessities, the meed of the toiler, and the boon of the consumer. Just as stores and factories were the natural consequence of trading in merchandise, so ip turn the growth of communities into large centers of pop- ulation gradually crystallized money trading into a banking system, facihtating the exchange of money. This first started with the individual money changer, who made his profits in exchange. For instance, the merchant of Rome went to Tyre to purchase fabrics and dyestuffs. In order to make his purchases, he was compelled to exchange his Roman coin for the money of Tyre. This was effected by the profes- sional money changer, who charged a commission for the trade, he being the prototype of our modern foreign exchange banker. As this individual grew wealthy and naturally became expert in the handling 13 BANK CREDIT METHODS AND PRACTICE of money, he assumed the role of banker for his community, and in time was allowed a reasonable compensation for the lending of funds, a practice which was at first condemned by the ancients, all interest charges being called usury. Time came when money became insuflScient to supply the needs of gTowing commerce. By money, I mean gold and other metal coins, stamped by Gov- ernments and used as measures of monetary values. It was found that the supply of valuable metals, possessing in themselves intrinsic values, was not large enough to facilitate the purchase and sale of commodities ; and it might be well to mention that in those days coin money had vast purchasing power on account of its scarcity. Then the inventive genius of man was brought into play and the world was given paper money, or currency, which while it was one of the greatest steps taken in the advancement of world commerce, yet was the most vital one in the reduc- tion of the purchasing value of the money unit. Paper money itself is fundamentally credit, mul- tiplying many times the trading power of actual money. Were it not for paper money the business of the world would not have kept pace with the growth in population. The limitations of coin money would have restricted its progress and the march of science would have been retarded by too limited opportunities. Coin money was not elastic. Paper money could be made to expand or contract 14 BANK CREDIT METHODS AND PRACTICE as business demanded. Gold and silver money could be hoarded. It was wealth intrinsically, and when hidden away or lost, its value as a medium of ex- change was gone. Paper currency is based upon wealth — and is not itself wealth, intrinsically. It is merely a representation of the intrinsic value upon which it is based, and its supply can be increased by issue or decreased by withdrawal from circulation, responsive to conditions. Coin money is entirely in- elastic. Its supply is based upon mine production, and it could get into the hands of the few through unequal distribution, thereby causing intense suffer- ing and hardships to the majority. In such an event, an overproduction of gold coupled with unequal distribution of money would cause high prices with no power to check, entailing misery for those possessing little of the world's riches. On the other hand, much evil can accrue from over-issue of paper currency. The prosperity of a whole people or nation may depend upon the wis- dom governing its issue. An over-issue of currency will cause inflation of values, extravagance, and speculation, with consequent labor unrest. It is manifestly unsound, by virtue of the fact that as currency is inflated, the security upon which it is based diminishes in proportionate value. When a country is in the throes of civil war or revolution it usually resorts to its printing press and endeavors to finance itself with unsound currency. This helps 15 BANK CREDIT METHODS AND PRACTICE the demoralization instead of helping the progress of civilization. All big wars, for this reason, are at- tended by currency over-issue, and are followed by periods of extravagance and industrial strife, simply because inflation causes depreciation of the money unit, with resultant high prices of commodities. The subject of banking is inseparable from that of credit. Banking is essentially credit. While a bank is a depository of money, it deals in credit more than it does in money. There is hardly a credit transaction takes place today into which banking. does not enter in some way. Banks are the channels through which credit matters, govern- mental and industrial, national and international, are transacted. It is the author's object to treat almost entir.ely of banking credits in this book. 16 CHAPTER II THE ESSENTIALS OF A CREDIT RISK The extension of credit by one party to another is based upon three essentials, viz.: CHARACTER, CAPACITY and CAPITAL. These are the quahfications that are considered necessary to round out a first-class credit risk. They are so closely inter- woven, so necessary to each other, that the posses- sion of anj"^ one of them without the other two weakens or destroys the risk. This might be further qualified by saying that the man who possesses capital without character and capacity (or the ability to produce) is not a good credit risk. Though he may be possessed of capital now, he may lose his wealth through wasteful and unwise methods or investments, or he may, lacking the very necessary quality of moral strength, seek to defraud his creditors at some future date. A man with character, but without capacity and capital, is a better credit risk, because he possesses the most es- sential qualification of all — ^honesty. But he is not as good a credit risk as the man who possesses character and capacity, without capital, for the lat- ter through liis ability, industry and honesty will create capital if given credit. It goes without saying that the possessor of the three qualifications is the 17 BANK CREDIT METHODS AND PRACTICE best credit risk of all — the ideal risk, whose credit is unquestioned. A large portion of the mercantile credit of the country is based upon the possession of character and ability. In our country's development, the "Village Blacksmith," immortalized by Longfellow, has played no small part. With nothing but an honest, clean mind plus his brawn and tools of trade, he has been trusted — nay, started in trade by the wholesale hardware merchant, and seldom has that confidence been misplaced. Economic changes have made him almost disappear from the highways and b\^-ways, but he was the chrysalis from which emerged the modern garage man, too prosaic for immortalization by any poet. In like manner, the farmer was trusted by merchant and banker in his community, when farming was less profitable than at present and when the farmer was perhaps staked by the banker in his venture, this confidence having been based on two things — ^honesty and ability to make good. A considerable portion of the wealth of our rural districts was created by this mutual confidence and trust — the country banker staking the young pioneer farmer, and receiving his returns from the interest on the farm mortgage. And in many such instances the credit was unse- cured, the banker and the merchant knowing their man, knowing that he possessed the two great es- sentials — honesty and ability. This is more true of 18 BANK CREDIT METHODS AND PRACTICE the artisan and the farmer — i. e., the extension of credit based upon honesty, industry and ability, than it is of the small merchant credit seeker, who is required to carry a stock of merchandise, which good business judgment dictates should be repre- sented by an original investment in money, and which class, experience shows, produces the most numerous failures. But even in the case of small merchants, possessing unblemished records and splendid moral character and ability, often their business foundations have been entirely built upon credit. Possession of these three essentials forms the fundamental of a credit proposition, and is the corner-stone of the whole credit structure, domestic and foreign. A nation is made up of individuals, and what is true of individuals apphes to nations. A modern government is what its individuals make it, stable or unstable. If stable, its credit is good; if unstable, the contrary is true; and either fact affects favorably or unfavorably the credit of its individual subjects or citizens. There are several phases of the question of char- acter as applied to domestic and foreign or to national and international credit. In domestic business each risk is selective as concerns the in- dividual. We take the individual man, firm or corporation and subject each to the searchlight of investigation. We endeavor to learn their past 1^ BANK CREDIT METHODS AND PRACTICE records. Have they failed in business? Have they been dishonest at one time or another? Have they gone through bankruptcy or had a question- able fire? Have they been disagreeable to do busi- ness with? In the case of merchants, have they taken discounts and made other deductions not jus- tified by circumstances? Have they violated con- tracts entered into in good faith? Have they been contentious, litigious and otherwise unreasonable? In the matter of credit extension by the indi- viduals or firms of one nation to the individuals or firms of another nation, the question is larger than one of individual honesty, although this latter is just as carefully investigated in each individual case. Though the individual citizens of a nation, or the corporations doing business within its boun- daries, may have sufficient capital, character and ability, their credit in an international way may be seriously affected by the instability of their govern- ment. The stable and wealthy nations of the world may refuse to extend credit because of lack of con- fidence in their governmental systems. Perhaps the most destructive element mihtating against world credit is war. Before the outbreak of the great world war in 1914, the principal coun- tries of Europe were in strong financial positions. Russia and France especially had accumulated a plenitude of gold reserves. Germany had amassed great stores of gold since the Franco-Prussian war. 20 BANK CREDIT METHODS AND PRACTICE England with her vast dominions and world trade enjoyed distinction as the world's banker, with London as the well-greased axis around which all commerce revolved. Then came the terrific conflict which in a duration of over four years exhausted the man power and financial resources of the combatant nations; which stopped their flow of commerce and turned the plowshare into the sword; which devas- tated the fertile plains of the war-ridden nations and demohshed all of their factories that had not been, converted into agencies of destruction. Their peaceful pursuits stopped by the great cataclysm and their production turned into the destructive, capital-wasting work of war, soon their stores of wealth became practically exhausted, their gold re- serves depleted, and they had to resort to currency inflation, to the creation of enormous external and internal debts pyramided upon decreasing wealth, in order to carry on their wars. Capital is wealth used to produce more wealth. The wealth of the world during the war was used to destroy wealth. So compared to capital, it was working at an inverse ratio, by geometrical retrogression, so to speak. This meant that to take care of war production cur- rency had to be enormously inflated, the proportion in different nations being according to accumulated wealth and the possibilities of internal and external loans. The end of the war found the credit sys- tems of the European nations undermined. America, 21 BANK CREDIT METHODS AND PRACTICE because of her strong economic position, became a creditor nation — not only supplying materials, but also food to the starving people; New York became the financial center and the American dollar the arbiter of world money exchanges. For example: During the year 1919 the exports of the United States to Europe amounted to over $5,187,000,000, while the off -setting imports were about $750,500,000. The inevitable result of this, coupled with enormous loans to some of the Euro- pean governments as a result of the war, was a severe depreciation in foreign exchange measiu*ed with the American dollar. Britain's poimd sterling, normally worth $4.8665, fell in January, 1920, to the tmprecedented low record of $3.19; German marks, normally worth about 23.8 cents, fell as low as 1.05 cents; while French francs, normally worth about 5.18% per $1,00, suffered a sympathetic dechne to the low record of 13.38 and 14 per dollar. It can readily be seen that this condition of the foreign exchange market entails destruction to for- eign commerce and credit; that the only way in which the situation could be soundly remedied would be by the resumption of intensive activity by the nations affected, coupled with acute self-sacrifice on their part in order to restore their economic posi- tions among the producing, trade competing nations of the world. Again the problem of the nation becomes that of the individual. For the individual 22 BANK CREDIT METHODS AND PRACTICE who fails to produce and lives off his more indus- trious and thrifty neighbor, the day of reckoning is bound to come. So it is with the nation that has gone through the destructive horrors of war. Her problem is largely an internal one. The solution rests principally with herself. This is true of past great wars. It will continue to be true of all great wars in the future which may come to upset the equilibrium of the world until man ceases to quarrel with man and commercial nations can peaceably compete for world trade. And those countries that get in the throes of radical misrule — the only way they can get back their credit standing is by the estabhshment of safe, sane governments — ^in fact, by the redeeming of their character. Just as soon as they lose their character, they lose their capacity for production; and losing these two vital essentials of a credit risk, the loss of their capital is inevitable. So, too, with the individuals or corporations that resort to unethical methods in the conduct of their business; they soon lose the confidence of their cred- itors and customers, and no matter how strong they may be entrenched in the world of finance, their credit is bound to be seriously affected. For this reason it is most essential that the bank Credit De- partment should thoroughly investigate the ante- cedents of a prospective borrower. The second of the quahfications — capacity — is no less vital than the first. In former years when 23 BANK CREDIT METHODS AND PRACTICE the United States was in the making and was being developed by pioneers, there was no specialization in education. Men followed their natural bent in a more or less haphazard fashion, and in the splendid fields that were offered by undeveloped territories, found their opportunities to make good. But since the country has passed its embryonic stage, the need for specialization in industrial fields has become more apparent, and the result has been vocational training. This is true of the professions, as well as banking and commercial business. We have the different fields of specialization in law, in medicine, in commerce and in finance. The old-time physician undertook every task, from pulling a tooth to amputation of limbs and ■curing of aches. Lawyers handled all cases from patent law to divorce suits, etc. And so it was in commercial businesses until their very growth got them beyond the limited conception of the unskilled minds. Then came specialization in all fields — and this meant organization — the perfection of which has been keeping pace with the growth of business — in fact, has made that growth possible. A minister of the Gospel could not be expected to run a large packing house with any degree of efficiency, although the theme of his Sunday ser- mons may sometimes be intended to convey ideas as to how the packer could run his business on a better basis. Neither could the packer be expected 24 BANK CREDIT METHODS AND PRACTICE to cure spiritual or physical ills — the natural work of the minister and physician. Each man in his own sphere of activity finds himself best adapted to his particular work, especially in the vocation for which he has been trained. If he is unfitted for such a sphere of activity by his lack of training or natural mental qualifications, he is lacking capacity for the task he has assumed or which has been set before him. He is then out of place, for he belongs to a different sphere of activity and will more than likely make a failure of the business in which he is wrongly placed. In credits we call this capacity. A man emi- nently fitted to conduct the business in which he is engaged inspires that confidence which is necessary to the extension of credit. The only way he can establish the fact that he is so fitted is by actual experience. In a corporation, an aggregation of such individuals make up what is known as a strong personnel. In the case of a corporation where there is an aggregate of individuals, one of whom alone possesses the genius of organization and manage- ment — in other words, high executive abihty — the personnel is weak. And this materially affects its banking credit. Naturally a bank which lends money and depends upon current interest rates for its returns is more scrutinizing in the matter of ex- tending credit than a mercantile institution. The latter usually not only receives a larger percentage 25 BANK CREDIT METHODS AND PRACTICE of return, but it finds through its customers a con- tinuous outlet for its products. Consequently, a bank is not wilUng to loan its funds to organizations of weak personnel. Many men engage in business without a proper conception of the economic soundness upon which their business operations should be conducted. Fore- most among their drawbacks is a failure to realize the importance of proper cost systems. Some op- erate for a full year without knowing whether they are operating at a profit or at a loss. For this reason it is highly important that the bank credit man should possess a fair knowledge of accounting and cost systems, so that he may be able to judge with some degree of intelhgence the merits of a credit proposition. He should also encourage the attaining of this knowledge by his assistants. A competent bank credit man should be able to go through a manufacturing or other industrial unit, and judging from the viewpoint of efficiency, give a reasonably accurate idea as to whether or not the business is being conducted along modem efficient hues. I do not mean to say that he should neces- sarily be or claim to be an efficiency engineer, but his mind should be cultivated along the hnes of in- telligent discrimination in the matter of efficient plant administration. He can considerably increase his value to his bank by being able to investigate the financial management of a business. If neces- 26 BANK CREDIT METHODS AND PRACTICE sary, he should be able to make an audit of such a character as to determine not only the real solvency of the business, but also as to whether its credits are being properly and wisely placed, its collections promptly made, the receivables classed in a proper manner, its cash padded, or whether the merchan- dise or any part of it is obsolete. This is most im- portant, in fact, almost absolutely essential to the intelhgent extension of commercial banking credits. The assistants in the department should be trained in this direction. All the large cities now have schools in commerce and finance, including banking, credits, accounting and economics, and the princi- pal universities have estabhshed night schools where young men and young women are enrolled in the above courses. The large bank that develops its credit depart- ment along lines indicated in this chapter is going to be the successful competitive bank of the future. Some financial institutions have added to their staffs successful certified public accountants for the purpose of investigating questionable statements. Most up-to-date progressive houses welcome intel- ligent investigation of their propositions, as they feel that it is only by this method that the bank will be in position to satisfy their needs with any degree of promptness and justice. Another matter of importance in connection with capacity, but which is also so closely allied to char- 27 BAivK CREDIT METHODS AND PRACTICE acter as to be almost inseparable from it, is that quality of caliber Which enables its possessor to be both cooperative and constructive. An example of how its absence can be destructive to the interests of a business concern could be given in the case of the president of a large corporation who was so arrogant and self-assertive that he refused to join any manufacturers' association and declined to con- form to any rules or regulations made for the bet- terment of his particular industry. He was conten- tious with his creditors, contrary towards his asso- ciates and employees, with the result that he enjoyed no friendships in his own organization and ended his business career in the bankruptcy courts, al- though the possibilities for profit in the business under different management were unUmited. The wise bank in extending its credits will closely investi- gate to see whether there is internal dissension in the executive control of the business under consideration for credit extension, for there is nothing contributes more to the downfall of a business than lack of har- mony in its working forces. It has been said of Andrew Carnegie that the secret of his great success was his faculty of being able to surround himself with executives controlling the various divisions of his business, each of whom in his own particular field knew more than Mr. Carnegie himself. This arrangement makes an ideal organization and makes possible the highest 28 BANK CREDIT METHODS AND PRACTICE degree of success in any business. Consequently, careful credit grantors assiduously avoid the one- man organization, not caring to jeopardize their own wealth by taking unnecessary chances. In many cases, when through unavoidable causes the real success of a business is centered in one man, either on account of his inventive genius or his ability as a producer or organizer, it is usual for banks to require insurance, equal to the line of credit granted, on the Hfe of such principal, made payable either to the bank or to the corporation, and assigned to the bank as additional security. This is a splendid safeguard and should be encour- aged by all banks. Capital, last mentioned, but not the least of the three, now comes up for our consideration. In the chapter on Statement Analysis this will be gone into more fully. What we know technically as capital is that portion of the assets reflected on the liability side of a corporation statement by "capital stock, sur- plus and undivided profits," and on that of an in- dividual or partnership by "capital account." Common-sense business practices decree that this should be furnished by the owners of the business. A business should not be organized or capitahzed based upon quick loans. Credit has played a very important part in the development of the country by the investment of 29 BANK CREDIT METHODS AND PRACTICE capital. In the broad field of investment, the school district bond has made possible the enlightenment of the rural population. Good roads, amongst the most powerful influences for general development, were made possible by road bonds, and it was only tlirough the instrumentality of the irrigation bond and the drainage bond that large arid territories and rich alluvial lands subject to overflow were reclaimed and converted into productive gardens. The financing of railroads, of telephone and of tele- graph systems, and all classes of pubhc utiUties so vitally necessary to our political, social and indus- trial development — all these were made possible by pubhc credit, by the investment of the capital of the individual citizen. So, too, should the commercial business be built on a foundation of private capital furnished by its ownei'S, and in very few instances should credit be asked for to an amount exceeding the invested capital, such few instances, if occurring, being per- haps in connection with highly seasonal businesses, which necessitate the accumulation of heavy stocks at one particular season when all production is ac- complished for the balance of the year. A common pitfall for the unwary credit man is found in the good will and kindred items, such as patents, etc. A man owning what he beheves to be a good patent interests perhaps $10,000 of real money in his venture, then capitalizes for $100,000 30 BANK CREDIT METHODS AND PRACTICE stock, taking $90,000 stock for his patent, and pro- ceeds to do business on a "shoestring." Extreme diHgence should be used by the bank to see that a business is amply financed before credit is extended. The conditions in this respect may vary a little ac- cording to capabihties and character of the credit seeker, but in all cases care should be taken that credit is not extended to the speculative individual, the "rainbow chaser", who is always willing to take a long chance with the bank's money. Temptations may be placed in the way of the bank's better judgment, such as high interest return, special commission payments, etc., but experience has proven that the difference between a low and a high interest return is invariably risk insurance, and that safety even at the sacrifice of high interest re- turns is the golden rule to follow. In order to be safely capitalized, the liabihties of firms or individuals engaged in commercial lines should not exceed the net worth. There are times when this rule might be properly disregarded, such for instance as the "peak" periods of seasonal Unes of business. And, of course, it seldom appHes to the banking business, where invariably the deposit liabilities are many times larger than the net invest- ment. However, concerns that are steady borrowers and whose turn-overs are not seasonal, should not follow the practice of running up their liabilities beyond their net worth, as safe rules of financing 31 BANK CREDIT METHODS AND PRACTICE demand that the creditors should have less involved than the owners. For this reason, the bank should scrutinize statements to see whether excessive divi- dends are paid under unfavorable conditions. Some corporations are addicted to this unhealthy habit, and it not only undermines their finances, but seri- ously affects their banking credit. At the same time, if dividends have been paid within a particular year, they may have been predicated on the earnings of the previous year and distributed in the early months of the year under consideration. Any seri- ous objection made by a bank to the poUcy of its customer must be based upon sound principles and absolute knowledge of the facts. Otherwise the ob- jection should not be entered. . ^^ account and for the payment of any other indebtedness of / . to the Mississippi Valley Trust Company of St. Louis, Missouri. Mississippi Valley Trust Company of St. Louis, Missouri, may at any time cancel this trust and take possession of said goods or of the proceeds of such of the same as may then have been sold, wherever the said goods or proceeds may then be found and in the event of any sus- (my) (our) pension or failure, or assignment for the benefit of creditors, on part or of the nonfulfillment of any obligation, or the non-payment at maturity of any acceptance made by ^™Y under said credit, ot under any other credit issued by the Mississippi Valley Trust Company of St. Louis, Missouri, on /™^^^ account or of any indebtedness on (om-) P"'"^* *" '"^"^ ^^ obligations, acceptances, indebtedness and lia- bilities whatsoever shall thereupon (with or without notice) mature and become due and payable. The said goods while in ,(™y^ hands shall be fully insured against loss by fire. Dated, St. Louis, Missouri 19 (Signed) Exhibit No. 5 — Trust Bbceipt BANK CREDIT METHODS AND PRACTICE The trust receipt, while it may be considered as continuing the banker's title to the goods, permits the customer to take possession of them and convert them, and thus the goods may lose their identity, and in the case of fraudulent transactions a charge of embezzlement is difficult to prove. For this rea- son the use of acceptances based on trust receipts is generally discouraged and the Federal Reserve Banks in their interpretation of Section 13 do not consider a trust receipt which permits the customer to have access to or control over the goods "actual security". A bill of lading draft they consider "actual security" even after svu-render of the docu- ments, provided the draft is accepted by the drawee upon or before the surrender of the documents. Another objection to acceptances based on trust receipts is that the beneficiary of the credit, gaining possession of the materials, is in position to manu- facture them and sell them to his customers and re- ceive therefor trade acceptances which he may be tempted to discount at his bank. This pyramiding of credits would cause inflation, and the original banker's acceptance would lose its self-liquidating features. When a banker accepts a draft he may be se- cured by a bill of lading covering the goods in tran- sit, a warehouse receipt if the goods are in storage, or other shipping documents in the case of imports. Care has to be exercised in the case of warehoused 67 BANK CREDIT METHODS AND PEACTICE merchandise to guard against forged receipts, and in the selection of warehouses, bonded warehouses being highly preferable for such purposes. Bankers' acceptances for financing of commodi- ties such as cotton, etc., pledged as collateral to secure acceptances, are usually covered by an ac- ceptance agreement. (Exhibit No. 6.) As will be seen, this agreement binds the beneficiary of the acceptance credit to furnish additional collateral if desired. It is not the policy of the Federal Reserve Banks to buy unendorsed bank bills. Certain of the Fed- eral Reserve Banks, in order to meet local condi- tions, have discounted direct offerings of acceptances from the accepting bank. A Memphis bank, in order to facilitate move- ments of cotton through marketing or warehousing, will execute an acceptance agreement for its cus- tomer. The customer draws drafts on the accepting bank, and after acceptance the customer sells the drafts to a broker or to another bank. The banker's acceptance should not be used by a bank to increase its loaning power to any one cus- tomer in order to evade the limitations imposed by Section 5200, U. S. R. S. The acceptance is a loan of credit and not a loan of funds. If the accepting bank holds its acceptance in its own portfoho, it is construed as a direct loan to the customer and is subject in the case of a national bank to the 10 68 ACCtiPTAHOtS .Xboi ail tan Jig IV" fmrabi, TW (k ludcnigaed, U cautdertlioa of GducUI BcconiDodalfdb* given ot lo be pvee oi exlca^ to (he nndcnl^cd bf dw Mbtiuippi Vallej' Tnul Compuj. (hereiMfler called (be Tnitl Compaar). by (be aeccpUoM by uid Tnut ConpaBy of ^jr drafl or nay ffon line la lime be required by uid Tnul Company, whether prior lo or el the tiiiK of acceptaiice of laid draft or draf(*, or lo protect it oa oiitiUBdiag agreemcnti lo accepi any draft or draft* for account of the uoderitgned; and b the event the lAaiLel value of any «uch colUleta] ihall dcclioc, while any luch draft or draft* of agreement* lo accept are oulitandug, the undenkgaed protuK* aad agre««a oa deaapd of taid Trull Company, by ordmtry mail or otherwiie, within forty:ei^t hour*, to depoiil add'tiooa) col- lateral IB negotiable form tatiifactoiy lo laid TniU Company, iO that laid TrUil Company ihall at all time* have under pledge lo it and is it* poMesHoa collateral having a ready market value of boI teu than - per cent, in eicau of the anoimt or anountt e( aay •ccq>led draft or draft* outitanding from lime lo lime aod dte amount or amonnli nnder any oaWaadiBg agreemc«t( lo accept. The i*deni^ed furthef agree* dial upon failure lo pay aay drafi or drafb when due, or vpoa die aoa -performance of aay of the -proauae* hcnui coBtaJned, of ia die caie of tatolveocy, bankruptcy or failure in buiioe** of the DDderugned. then and in any *uch cne, any m3 all obligatiou and liabilitic*, direct aad cootinecnl, of the undenigned lo the Tn»t C^mpaoy ^)t fordiwidl brcomc due •nd payable wiihont notice. The widentgtted hereby audwriie* and empower* (he Trait Company at ili option, at any dme, to appropriate and ipply lo ihe paymeBf and ntinguiihrnent of any obligation*, whether now eiitling or hereafter created, and whedier then due or not due, any and •II mcoey*. >,eredili, ptopeitiei aad tecurilie* now or hereafter ia the hand* of (he TivU Conpany, and aay depotit*, balance of de> poMt*, 0* fther MA* «1 any (ime credited by or due from uid Tni*l Company, ihill at all time* be held and treated ai collilEral iccunty for (he poymeal of any obligalioa, indebtedoea or liability of the uaderugned to the Tru«t Company, aitd (aid Tnitl Company may at aay time at it* «ptiaa, tct oS dM ataoual due or to becoiae due hereunder, or any other obligalioa. again*! aay claJD* of |he undei- Mpied aAaiail ib« Tiwl Company. The Tnal Company may immediately, without adverliieraent. aad without n^ice lo the undenigaed, lell any of the lecuritiei held by il a* agaioil any or all liabilitie* of die under*ig&ed, at private *ale or olhsrwiie. and apply die proceed* of Mch *ale, a* far a> Bcoded. toward die paymeol of any and alt of mch liabililiei, l»gediei with inlereil and expenie of **id talc, holding ihe undenigaed re^MDiible far aay de&cicacy lemainiog unpaid after Mich application. If uch «ale be at public auction, the Tnul Company ouy ■belf be a parchaier at lOch tale, free from any right or equity of redenplioa of the uadertigned, luch right and equity being hereby exp?t*ily waived and leleaied. The Baderiigned further agree* dial die TruiC Company ihall not be reiponiible for any loi* ariiiBg from any £8r. Exhibit No. 6a — Certificate Evidencing Eligibility of Banker's Acceptances BANK CREDIT METHODS AND PRACTICE The commercial relations of one country with another would be greatly curtailed without the use of the acceptance form of credit. A merchant in New York desires to purchase a quantity of raw material from a shipper in China. Before the ship- per 4n China would consent to ship the goods, he would require an investigation of the financial re- sponsibihty and standing of the New York mer- chant — ^in other words, a trader in one community could only do business with such foreign merchants with whose financial responsibility and moral stand- ing he was entirely familiar. This would mean that foreign activities of the nations of the world would be curtailed to a very large extent, and foreign trade would be carried on only between the traders who knew each other. A commercial house issues a financial statement but once or twice a year, and then usually at such time as it will appear most favorable. Owing to the distance and the varying conditions existing in the various countries of the globe, this method of credit extension would be very undesirable. It would also necessitate the shipper waiting for his money until the goods were dehv- ered, which, in tvu-n, would hamper his operations by tying up his capital for long periods of time. The elasticity of the acceptance form of credit eliminates this unsatisfactory feature. Without the use of acceptances, the shipper would be compelled to bor- row money from his bank to finance the transactiori 72 BANK CREDIT METHODS AND PRACTICE and carry him over until his draft was paid, and the bank would lend actual cash, and its loans to its customers would depend entirely upon its cash on hand, less its reserves. The effect of this could easily be seen in the case of a bank located in a territory where bank loans are highly seasonal. It would soon be "loaned up". As stated before, the banker who accepts a draft does not lend money — he merely lends his credit. The one for whom the ad- vance is made agrees to have the money in his hands at or before the maturity of the acceptance, and, as previously explained, it is practically self-liqui- dating. In this way the loaning capacity of the banks is increased many fold and the merchants are permitted to "turn" their goods over oftener and at a minimum of expense. When a merchant in New York purchases goods from a foreign shipper, he goes to his bank and obtains a letter of credit. He sends the letter of credit (Exhibit No. 7) to the shipper, who draws a bill of exchange on the New York bank, ships the goods and attaches the shipping documents. The foreign merchant probably knows nothing in regard to the financial responsibility of the New York mer- chant — ^it is not necessary for him to know. He is furnished with a letter of credit from a New York bank in which he has confidence. Owing to the volume of foreign business carried on through Lon- don, it has been the financial center of the world. 78 BANK CREDIT METHODS AND PRACTICE It has correspondents all over the world, and the bulk of the foreign trade is carried on through it. However, since the beginning of the European war New York has made some great strides in this direc- tion, with the result that dollar exchange is being used much more extensively at this time. In the case given above, if the foreign shipper desired ster- ling exchange, the New York buyer would have gone to his New York bankers and requested them to open up a credit in London. ; 1 LETTER OF CREDIT Credit No Mississippi Valley Trust Company- Foreign Department St. Louis, Mo , 19 Gentlemen : We hereby authorize you to value on , for account of up to an aggregate amount of available by your drafts at against shipment of to Insurance Bills of Lading for such shipments must be made out to the order of the Mississippi Valley Trust Company, of St. Louis, unless otherwise specified in this credit. CONSULAR INVOICE AND ONE BILL OF LADING MUSt BE SENT BY THE BANK OR BANKER NEGOTIATING DRAFTS DIRECT TO The remaining documents must accompany the drafts drawn on Mississippi Valley Trust Company, St. Louis, Missouri. The amount of each draft negotiated, together with date of negotia- tion, must be endorsed on back hereof. We hereby agree with bona fide holders that aU drafts drawn bj virtue of this Credit and in accordance with the above stipulated terms shall meet with due honor upon presentation at the Office of , and proceeds wiU be paid at if drawn and negotiated prior to Mississippi Valley Trust Company, N. B. Drafts drawn under this Credit must state that they are "drawn under Letter of Credit No Dated " Exhibit No. 7— Letter of Credit BANK CREDIT METHODS AND PRACTICE Following is a simple example of an acceptance and a letter of credit as used in foreign trade: Mr. Brown is desirous of purchasing a ship- ment of coffee from Smith & Company, coffee growers in Brazil. Smith & Company are probably not acquainted with the financial responsibility of Brown, and even if they were, they would not be willing or able to wait for a remittance from New York for the shipment. Smith & Company ask Brown to arrange for a credit on London in their favor for the amount of the invoice. Brown goes to his New York bank and requests them to open up a credit in London in favor of Smith & Company against ninety-days' bills, with docimients attached. The New York bank instructs its London corre- spondent, the Bank of London, and Brown is fur- nished with a letter of credit to send to Smith & Company, advising him that the credit has been opened in London. When this is received Smith & Company fill the order and place the coffee on board ship, receiving a bill of lading therefor. Smith & Company then draw a draft at ninety days' sight for the amount of the invoice, attaching the bill of lading, invoice, insurance policy, etc. They take this to their bank, the Bank of Brazil, which pur- chases the bill. So far as Smith & Company are concerned they are, for all practical purposes, out of the transaction; they have shipped the coffee and have received their money. The Bank of Brazil for- 76 BANK CREDIT METHODS AND PEACTICE wards the draft and shipping documents to its Lon- don correspondent, the Capital Bank, which imme- diately presents it to the Bank of London for ac- ceptance. The latter bank accepts it and then forwards the shipping documents to the New York City Bank, thereby enabUng it to take possession of the coffee when it arrives, which it will either store for Brown or deliver to him against payment or trust receipt. The draft is now a banker's acceptance, and with the name of the Bank of London on it as acceptor, it is prime paper and finds a ready market in any country in the world. Therefore, the Bank of Brazil will probably instruct its London correspondent to discount the bill in the open market and place the proceeds to its credit. Thus the Bank of Brazil is reimbursed for the advance it made to Smith & Company and is now out of the transaction. The Bank of London depends upon the New York bank to provide the funds to meet the bill at matu- rity, and the New York bank in turn looks to its cus- tomer Brown to meet the bill at maturity. Brown is a merchant of exceptionally high moral and financial standing, and the New York bank dehvers the cofi'ee to him on a "trust receipt". He sells the coffee before the expiration of the usance — ^the time the bill has to run — and uses the money to hquidate the draft. The coffee was shipped and Smith & Company 77 BANK CREDIT METHODS AND PRACTICE were paid as soon as it was placed on board the ship. The Bank of Brazil, which made the advance to Smith & Company, was only out of its money until the bill reached London, where it was dis- counted and placed to its credit. The Capital Bank was merely a correspondent of the Bank of Brazil, and advanced no money. The Bank of London is hable as acceptor, but the New York bank promises to provide the funds to meet the bill at maturity; so the London bank advances no money. The New York bank advances no money either, as it looks to Brown to have the funds in its possession to meet the bill when it is due. During the three months' currency of the bill the coffee was paid for by the firms that purchased the bill in the open discount market of London. In the financing of acceptance credits, there are also formed what are known as "acceptance syndi- cates". For example, a bank acting as syndicate manager will undertake for an agreed commission to "float" an issue of acceptances for a customer where the financing desired runs far beyond the bank's ability to handle it. The bank will then invite a number of other banks to participate in the syndi- cate, each bank agreeing to purchase or subscribe for a portion of the total, and each bank receiving an agreed commission for accepting the drafts. A syndicate agreement usually appoints the syndicate manager as trustee, and the beneficiary of the credit 78 BANK CREDIT METHODS AND PRACTICE deposits with this trustee all collateral under the agreement, which agreement usually provides that the amount of acceptances outstanding at any one time shall never exceed a certain percentage of the value of the collateral deposited, and that in the event the amount of acceptances outstanding should at any time exceed such percentage, the beneficiary of the acceptance credit will either deposit addi- tional collateral or retire sufficient acceptances to reduce the outstanding acceptances to the proper and agreed percentage of collateral deposited. Bankers' acceptances are the highest type of commercial paper, and for this reason they com- mand a lower rate of discount in the market than other classes of short-term paper. As to the future possibihties of the acceptance market in the United States, the surface has been barely scratched. The open market usually absorbs all issuances of bank- ers' acceptances, the added credit of the strong ac- cepting banks making the paper doubly desirable. 79 CHAPTER VI COMMEECIAL LINES OF CREDIT RECIPROCAL RELATIONS A BANK deals in credit, based on the handling of money. Were this money, which constitutes its available loaning power, entirely its own capital, the question might not involve so much delicacy. But there are two main angles to a bank's business — (a) its growth in deposits; (b) its loaning power. Either of these two can be used to the detriment of the other. And especially can its lending facilities be used either to the detriment or betterment of its growth in deposits. The extension of Unes of credit made by a bank to its commercial customers should be based on minimum average balances in deposits to be main- tained by such customers. These are known as compensating balances and form the basis for recip- rocal relations between the bank and its customers. Commercial lines of credit are supposed to be based upon seasonal borrowings. An ideal credit arrangement in commercial banking would be for the bank to be used as a credit clearing house for deposits and loans between the various lines of busi- ness. Take, for example, merchants whose various businesses are highly seasonal. The peak, or high 80 BANK CREDIT METHODS AND PRACTICE producing period, of one class of merchants comes in spring, when their borrowings are greatest. They are extended hnes of credit by their banks for the spring months, agreeing to carry 25 per cent, mini- mum balances, not alone during the existence of their loans, but throughout the entire year. The high production periods of other classes of mer- chants come in the summer, autimtm and winter, respectively, their borrowing arrangements being made to suit their requirements on the above plan, and each class carrying 25 per cent, of their maxi- mum lines on deposit with their banks throughout the four seasons. Through the operations of this plan, it will readily be seen that deposits main- tained by all four seasonal classes of merchants in the banks would be sufficient (with non-borrowing deposits, etc., more than necessary for reserves) to take care of such seasonal requirements. Practical experience, however, shows such ideal banking to be little better than a Utopian dream, never to be reahzed in business hfe. Nevertheless, it pays a banker to keep as close to that ideal as sane banking and proper treatment of customers will permit. If he gets too far from the idea, he may be building his bank on a quagmire; if, on the other hand, he endeavors to adhere too closely to such a rule, he undoubtedly will succeed in impeding the growth of his institution, while his more liberal com- petitors forge ahead. 81 BANK CREDIT METHODS AND PRACTICE Never in the history of the world was there a time when continuous, intensive production was needed more than during the war and the after-the- war periods — one a world fighting period — the other a world-starving period. To encourage the limitation of loans along technical hnes during such period would be both unpatriotic and calamitous. The world needed food beyond the capital ability of the great packing industry to manufacture and ship; the world needed clothing and shoes, and America's great factories had to be almost continuously financed by banking loans. If most of these indus- tries paid off their bank loans once a year, it was through the sale of commercial paper in the open market, and if the principal of hquidation of bank- ing loans at least once a year is intended to show the self-liquidating ability of the borrower's busi- nesses, it takes no keen perception to see that the end was not accomplished through the above means. A bank has to be responsive to the needs of business just as well as the demands of business should be made to fit the bank's abiHty to meet them. A bank, because of its position of money lender, should not expect unreasonable things from its customer; its rules governing its commercial accounts shovdd not be too ironclad and severe. On the other hand, a commercial house should not un- dertake contracts beyond its reasonable capital ability, necessitating continual demands upon the 82 BANK CREDIT METHODS AND PRACTICE bank for capital which should logically be supplied by its stockholders, or owners. Seeing opportunities for large profits, it should not expect nor endeavor to realize on such opportunities at the risk of over- taxing the bank's loaning capacity. Neither shoxild it take offense at the bank's efforts to hold it within proper limitations, but rather should it welcome counsel, made valuable by long experience and con- tact with all Unes of business. There is nothing more dangerous for any line of business than over- extension. It has been the chief cause of commer- cial failures in the past, where natural causes, such as droughts, etc., have not entered. The executives of a modern commercial bank should be men of broad experience and comprehen- sion. They should be competent to size up the situa- tion of a commercial customer and pass with wisdom and justice on his requirements. Many meritorious propositions have at times failed principally because of a lack of proper appreciation of true conditions on the part of the banker handling the account. The bank executive cannot sit constantly at his desk and expect to be able to pass intelligently on all commercial loans brought before him. In the case of the more important loans, he should endeavor to make a personal visit to the customer's establishment and familiarize himself with the business. Where this is not possible, he should have under him men especially trained, who can make thorough investi- 83 BANK CREDIT METHODS AND PRACTICE gations and intelligent reports. The banker owes this as his duty to his commercial customer, and he owes it to himself because it cannot fail to make him a broader, better and more successful banker. It saves him from being too cold and calculating, and will give him a wonderful insight into the various needs of commercial businesses, their stabihty and their weaknesses, and the absolute interdependence of the banking and commercial worlds. Commercial banking usually requires a balance of at least 20 per cent, of the maximvmi line of credit to be carried with the bank. There is a dif- ference of opinion as to whether this should be just a minimum average or a minimimi balance. Having had experience in both banking and commercial credits, the author's views favor the minimum average balance. It is not in keeping with appar- ently sound theory, but it is the result of actual, practical experience, which, after all, is the best teacher, and the best rule to follow. The business of a commercial house fluctuates somewhat daily, and its bank balances should be responsive. For instance, one week large ship- ments of inbound merchandise delayed in transit, or extraordinarily heaA^y for some reason, may arrive with drafts which must be met, and at the same time collections, for some reason, may be slow. It would be unreasonable, in such an event, to expect the house not to draw on its minimum balances in 81. BANK CREDIT METHODS AND PRACTICE bank at the expense of its credit standing, espe- cially when during the following weeks for converse reasons their bank balances may be plethoric. This does not mean, however, that the average balances maintained should be spectacular or mer- curial. Manifestly, it would be equally unfair to the bank for the commercial customer to maintain bal- ances which could not be depended upon for loaning purposes. There should be a happy medium. A num- ber of large banks interviewed on this subject are inclined to be satisfied if the balances average 20 per cent, of the maximum hne of credit on a stretch of twelve months, recognizing the quality of elas- ticity and responsiveness that should characterize the relation between the commercial borrower and his bank. Other banks are satisfied if a 20 per cent, average balance is maintained while the customer is borrowing and 10 per cent, average balance when he is not borrowing. As an offset to the more or less continual de- mands made by borrowers on their banks, the banks have to rely upon non-borrowing deposit accounts. Such accounts usually pay interest to the customer when justified by the possibility of profits. The amounts required to be kept in such checking accounts to entitle them to interest vary in differ- ent centers. Some banks pay no interest on either borrowing or non-borrowing accounts, while still other banks pay interest on both classes. Destruc- 85 BANK CREDIT METHODS AND PRACTICE tive competition is responsible for the latter condi- tion. Deposits having borrowing privileges should not draw interest. There might be reasonable devia- tion from this rule based on the reciprocal relations maintained between bank and customer. For instance, if a commercial customer has es- tabhshed by experience the fact that he is only a highly seasonal borrower, on the bank's books for perhaps only three months each year, yet maintains excellent balances the entire year, he should be en- titled to more privileges than the man who borrows eleven out of twelve months each year, for obvious reasons. His bank has the use of his funds for nine months in the year, and lends such funds to the man who borrows eleven months. Also, if a commercial customer establishes by experience the fact that his balances maintained at the bank are largely out of proportion to the hne of credit granted, he should be entitled to some consideration in the way of in- terest allowed on balances. Especially should it be taken into consideration that non-borrowing accounts, where deposit balances are satisfactory, furnish the bank its most desirable source of discount profit, inasmuch as they make no demands on the bank in return for balances kept. For this reason alone they should be entitled to more consideration than deposit balances carrying bor- rowing privileges. 86 BANK CREDIT METHODS AND PRACTICE It is quite necessary that the credit department and the department of account analysis work closely together. When a commercial customer agrees to carry a 20 per cent, average balance, he should en- deavor to make it a net balance instead of a gross balance. By a net balance is meant the amount available for loaning purposes after deduction of the floating items. In all commercial deposits there are large numbers of items, some drawn on nearby points, some on remote points, that while they are deposited for credit as cash, yet are not available to the bank as cash until returns are made. Many bank customers disregard this condition and draw against such uncollected items. So that while their balances may appear satisfactory, an analysis of some will sometimes show a deficit of loanable funds,, or what fundamentally amounts to an overdrafts Invariably, when such a situation is explained to a customer, he is wilUng to see his error, and it will make him a more satisfactory customer. If he has been wrongfully distributing the items to his banks, where there is more than one bank used, causing difficult collection routing for some, he will remedy the situation readily by rearranging his deposits on a more just and equitable basis. All large banks acquire their parring facilities through their country bank customers. Their territories are usually logically contiguous to the cities in which the banks are located. If a large Chicago customer of a St. 87 BANK CREDIT METHODS AND PRACTICE ]Louis bank deposits in St. Louis items that right- fully belong to its Chicago depositories, and vice versa, it is creating a hardship for its Chicago and St. Louis depositories. By this process a bank cus- tomer may have an apparent deposit of $100,000, when, as a matter of fact, it may have an overdraft, owing to unscientific apportionment of its items deposited. A customer whose deposit account is unsatis- factory should not expect loan accommodations. He is already receiving accommodations through the handling of his unsatisfactory account. A bank should not handle a merchant's unprofitable account. The merchant himself will not handle an order on which the returns are less than the cost. This is the most universally prevailing rule of business; yet banks are expected to and do handle a large amount of unprofitable business. This is done in each case in the hope that some day the relation may become profitable, and also to retain the good will of the smaller customer, who is often instrumental in bringing the more profitable customer. The credit department, if properly organized, can be very ef- fective in building small deposits into profitable ones. This feature will be further explained in the chapter devoted to credit department methods. In order to meet competition on a large scale, a financial institution may be compelled at times to ex- tend lines of credit up to its legal hmit to certain of 88 BANK CREDIT METHODS AND PRACTICE its customers. However, this should be avoided as much as possible not only for the sake of the bank, Ibut also to conserve the best interests of the cus- tomer. It is well for the customer in case of neces- sity to be in a position to borrow additional amounts from its banks, as it may not be able to sell its paper in open market or open new bank lines in tight money situations. A bank should endeavor as much as possible to diversify its loans; in other words, it should avoid having too much money invested in the way of loans in one particular industry at any one time. It is a much wiser plan to have a large num- ber of moderate sized loans proportionate to the net worth of the bank, in various lines of business, than to have a small number of large loans in a few lines of business. Extreme caution should be exercised in the handhng of loans on an unsecured basis to enter- prises that may be to a certain extent speculative. It goes without saying that banks should not make unsecured loans to speculative enterprises. Grain and cotton are highly speculative com- modities, but this does not necessarily mean that an individual or firm in the grain or cotton business in- dulges in market gambling. They may be in either line of business on a fully legitimate basis, and if they indulge at any time in trading in futures, they may be "hedging" to protect themselves against loss on commodities with which they may be caught BANK CREDIT METHODS AND PRACTICE "long" in a declining market. As a general rule, lines of credit granted to concerns in speculative lines of business are on a secured basis, but great care should be exercised as to the value of the mar- gins on account of the fluctuation in the market prices of such commodities. A. bank should refrain as much as possible from lending on the stock of a concern whose direct obli- gations it holds. The line of credit of such a com- pany is not enhanced by the borrowings of its officers or stockholders. 90 CHAPTER VII THE FEDERAL RESERVE SYSTEM The Federal Reserve Act, which was approved on December 23, 1913, is "an act to provide for the estabhshment of Federal Reserve Banks, to furnish an elastic currency, to afford means of rediscount- ing commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes." Prior to November 16, 1914, when the Federal Reserve banks were opened, the national banking system of the United States was operated under the Naitional Bank Act, which was originally passed in 1863. Under this act national banks were required to issue what is known as national bank notes against Government bonds deposited with the Treas- urer of the United States. Under the Federal Re- serve Act of 1913 national banks are no longer re- quired to deposit Government bonds with the United' States Treasurer and take out circulation thereon, but the act does not prohibit the issuing of national bank notes and they are still issued by national banks to some extent. No national bank can have outstanding at any one time more than $25,000 in notes of $1 and $2 denominations, nor a total issue in excess of 91 BANK CREDIT METHODS AND PRACTICE its capital. Such notes must be signed by its presi- dent and its cashier, and it cannot cancel or retire them in sums of less than $9,000 at one time, or more than $9,000,000 in any one month. These notes can be retired by depositing lawful money with the Treasurer of the United States for their redemption. He will return a hke amount of bonds to the bank. Since the Federal Reserve Act was passed national banks can retire their notes by selHng their bonds to the Federal Reserve Banks at par, subject to the discretion of the Federal Reserve Board, and not exceeding $25,000,000 in any one year. The bank notes issued by the Federal Reserve Banks are predicated on bonds deposited with the Treasurer of the United States, and are similar to the notes issued by the national banks, except that thejr are issued under the Federal Reserve Act in- stead of the National Bank Act. Government bonds issued prior to 1917, carrying the circulation privilege, are used to secure national bank notes. Federal Reserve Bank notes can be issued against the same kind of bonds, but in addition can be issued against certain Treasury certificates of indebtedness. Before the Federal Reserve Act went into effect national bank notes constituted a very large pro- portion of the money in circulation. While these issues were secure, they were very inelastic. They did not expand and contract with the demands ■of business. The banks of the United States were 92 BANK CREDIT METHODS AND PRACTICE all independent of each other; there was no con- necting link. National bank notes were issued by numerous institutions. The reserves were cen- tered in the large reserve cities and loaned on call. When the banks throughout the country found it necessary to make use of their reserves, the larger banks were compelled to call these demand loans, which had a very depressing effect on business in gen- eral — money would be tight, with high rates, and financial conditions would become acute. Panics occurred periodically, causing savings depositors to withdraw their money from the banks and hoard it, resulting in a general demorahzation of credits. Under such conditions banks were forced to stop specie payment until the panics subsided, this sus- pension of specie payment having been caused by the inadequacy of the currency system then ex- isting. During the last great panic, in 1907, clear- ing house loan certificates issued by clearing houses, based upon collateral pledged by the member banks were brought into use to reheve the tense money situation. It was the first great remedial step taken at the initiative of the banks towards constructive national financing. It gave impetus to currency reforms which later found crystalHzation in the Aldrich-Vreeland Currency Bill and the Federal Reserve Banking System. "John Doe" checks were also circulated by some banks, based upon the credit of the issuing banks without pledge of collateral. 93 BANK CREDIT METHODS AND PRACTICE The establishment of the Federal Reserve Sys- tem was undoubtedly the most progressive step in constructive banking ever taken by the United States. It has transformed a safe but inelastic monetary system to one equally safe and which wiU respond to the demands of business. The Federal Reserve System differs somewhat from the banking systems of other countries. It includes neither a branch banking organization, as employed in Canada, nor a central bank, as used in the European countries. There are twelve regional banks, all of which are bound together to a certain extent, by the Fed- eral Reserve Board at Washington. The United States is divided into twelve districts, each of which is served by one of these banks. These are located in Boston, New York, Philadelphia, Richmond, Cleveland, Atlanta, Chicago, St. Louis, Minneapo- lis, Kansas City, Dallas and San Francisco. The Federal Reserve banks were authorized to issue two kinds of notes: (a) Federal Reserve Bank notes, of which mention has been previously made, (b) Federal Reserve notes : These are secured by commer- cial paper or gold. They must be backed by a gold reserve of not less than 40% (a part of which must be with the United States Treasury). These notes are obligations of the United States and are a first lien upon the assets of the bank issuing them. They are issued and retired to meet the fluctuating demands of com- merce. The notes are payable on demand in gold at the Treasury 94 BANK CREDIT METHODS AND PRACTICE of the United States in Washington, and in gold or lawful money at the Federal Reserve Bank of issue. No Federal Reserve Bank can issue the notes of another Federal Reserve Bank without pen- alty. They have to be returned to the original bank of issue or to the United States Treasurer for redemption. Federal Reserve notes can be issued against 100% gold reserve. That is, they can issue Federal Reserve notes against gold which is deposited with the Federal Reserve agent, just as in the case of commercial paper ■when it is used as collateral. This gold may be counted as a part of the reserve bank's required reserve against its reserve notes out- standing. In other words, a Federal Reserve Bank with $1,000,- 000 in gold can issue $1,000,000 in reserve notes against it and then, counting it as legal reserve, issue additional notes against commercial paper until the total issue reaches $2,500,000 (40% being the reserve requirement). The theory of the Federal Reserve System might be illustrated as follows: John Smith goes to his bank and makes a ninety- day loan of $1,000 to purchase raw materials. The bank credits his account with $1,000, less the dis- count. This means that the deposits of the bank were increased by the amount of the proceeds of Smith's note, and its reserve must be increased accordingly. The bank takes the note to the Federal Reserve Bank, where it is rediscounted. The Federal Re- serve Bank places the $1,000 commercial paper with the reserve agent, who issues $1,000 Federal Reserve notes to the Federal Reserve Bank, it in turn paying the proceeds to the member bank. The Federal Reserve Bank pays the proceeds of the re- discounted note in Federal Reserve notes. It will be 95 BANK CREDIT METHODS AND PRACTICE seen that what really happens is this. The $1,00& Federal Reserve notes issued in the above ease are really Smith's note in another form; that is, in- stead of loaning $1,000 on Smith's note and holding it till maturity, thereby tying up so much capital, this note, being the obligation of a merchant of ac- cepted standing, to be used by him to purchase raw materials, which he will manufacture and liquidate, and also being ehgible for rediscount, is theoretically transformed into an elastic form of currency in con- venient denominations which can be circulated dur- ing the hfe of Smith's note. The Federal Reserve notes are secured by Smith's note and are backed by a gold reserve of 40 per cent., and are a debt of the United States and a first lien upon the assets of the issuing bank. Smith pays his bank, and the bank in turn pays the Federal Reserve Bank, which hands the Federal Reserve agent $1,000 in Fed- eral Reserve notes, for which it receives Smith's note and its gold reserve. Thus the $1,000 Fed- eral Reserve notes are taken out of circulation. When money is in demand and rediscounts are heavy, the issue of Federal Reserve notes increases; likewise, to meet the conditions when money is abun- dant, the circulation of Federal Reserve notes is automatically reduced. The same notes that were originally issued may not be returned and most likely will not be, but Smith's note will be re- leased by the Federal Reserve agent upon the sur- 96 BANK CREDIT METHODS AND PRACTICE render of gold or other collateral. In other words, if the Federal Reserve Bank has outstanding $1,000,000 notes against which there is deposited $1,000,000 commercial paper, if this commercial paper is paid and the Federal Reserve Bank has no more commercial paper or notes, it has to surrender to the Federal Reserve agent $1,000,000 gold to redeem the notes. About two-thirds of the gold in the United States is deposited in the Federal Re- serve Banks. Each Federal Reserve Bank origi- nallj'^ acquired its gold by requiring at its inception the capital subscriptions to be paid in gold, and later by requesting all banks to deposit their gold with it. The Federal Reserve Banks have two ways of influencing or controlling rates of interest: (1) ad- justing the rates of rediscount, (2) buying or sell- ing bankers' acceptances or other paper eligible for purchase vmder the open market privileges of the Federal Reserve Act, Section 14. Before commercial paper can be rediscounted at a Federal Reserve Bank it must come under the re- quirements governing rediscounts. Following are the requirements of the Federal Reserve Bank of St. Louis, as indicated by circular No. 3, series of 1920: 1. There must be on file with the Federal Re- serve Bank a resolution of the board of directors of the ofl'ering bank authorizing its officers to borrow. 97 BANK CREDIT METHODS AND PRACTICE 2. The paper must be eligible for rediscount. The Federal Reserve Board is given the right to determine the character of paper eligible for redis- count and with a view of interpreting the provisions of the Act itself, it has made the following regula- tions : A Federal Reserve Bank may discount for any of its mem- ber banks any note, draft, or bill of exchange, provided — (a) It has a maturity at the time of discount of not more than ninety days, exclusive of days of grace; but if drawn or issued for agricultural purpjoses or based on live stock, it may have a maturity at the time of discount of not more than six months, exclusive of days of grace. (b) It arose out of actual commercial transactions ; that is, it must be a note, draft, or bill of exchange which has been issued or drawn for agricultural purposes, or the proceeds of which have been used or are to be used for such purposes. (c) It was not used for carrying or trading in stocks, bonds or other investment securities, except bonds and notes of the Government of the United States. (d) The aggregate of notes, drafts, and bills bearing the signature of endorsement of any one borrower, whether a person, company, firm, or corporation, rediscounted for any one member bank shall at no time exceed 10% of the unimpaired capital and surplus of each bank; but this restriction shall not apply to the discount of bills of exchange drawn in good faith against actually existing values. (e) It is endorsed by a member bank. (f) It conforms to all applicable provisions of this regula- tion. 98 BANK CREDIT METHODS AND PRACTICE General Character of Notes^ Drafts, and Bills of Exchange Eligible The Federal Reserve Board exercising its statutory right to define the character of a note, draft or bill of exchange eligible for rediscount at a Federal Reserve Bank, has determined that: (a) It must be a note, draft or bill of exchange, the pro- ceeds of which have been used or are to be used in producing, pur- chasing, carrying, or marketing goods in one or more of the steps of the process of production, manufacture, or distribution. (b) It must not be a note, draft, or bill of exchange, the proceeds of which have been used or are to be used for perma- nent or fixed investments of any kind, such as land, buildings, or machinery. (c) It must not be a note, draft or bill of exchange, the proceeds of which have been used or are to be used for invest- ments of a purely speculative character. (d) It may be secured by the pledge of goods or collateral, provided it is otherwise eligible. A promissory note is defined as an unconditional promise, in writing, signed by the maker, to pay, in the United St«tes, at a fixed or determinable future time, a sum certain in dollars to order or to bearer. Before a Federal Reserve Bank will redis- count a promissory note, it must be satisfied by reference to the note or otherwise that it is eligible. The offering bank should certify in its application whether the note has been discounted for a depositor or another member bank, or whethei^ it has beet) purchased from a depositor. Drafts, Bills of Exchange and Trade Acceptances (a) A draft or bill of exchange is defined as an uncondi- tional order in writing, addressed by one person to another other than a banker, signed by the person giving it, requiring the person to whom it is addressed to pay, in the United States, at a fixed or determinable future time, a sum certain in dollars to the order of a specified person ; and a trad* acceptance is defined 99 BANK CREDIT METHODS AND PRACTICE as a draft or bill of exchange drawn by the seller on the pur- chaser of the goods sold and accepted by such purchaser. (b) A Federal Reserve Bank can take such steps as it deems necessary to satisfy itself as to the eligibility of the draft or bill offered for rediscount, unless it presents prima facie evi- dence thereof, or bears a stamp or certificate affixed by the acceptor or drawer showing that it is a trade acceptance. Six Months' Agriculturai, Paper (a) Six months' agricultural paper is defined as a note, draft, bill of exchange, or trade acceptance drawn or issued for agricultural purposes, or based' on live stock, that is, a note, draft, biU of exchange, or trade acceptance, the proceeds of which have been used, or are to be used, for agricultural pur- poses, including the breeding, raising, fattening or marketing of live stock, and which has a maturity at the time of discount of not more than six months. (b) To be eligible for rediscounting six months' agri- cultural paper, whether a note, draft, bill of exchange, or trade acceptance, must comply with the respective sections of those regulations which would apply to it if its maturity were ninety days or less. Bill op Lading Drafts Drafts with bills of lading attached, executed according to requirements of Federal Reserve Bank, are eligible for rediscount. Paper Secured by War Saving Stamps Notes, drafts and bills of exchange which are secured by War Saving Stamps and the proceeds of which were used to pur- chase War Saving Stamps are ineligible for rediscount with tlu Federal Reserve Bank. 3. The paper is secure. The financial state- ment should show an adequate excess of quick asset.s over current liabilities. Conservative bankers en- 100 BANK CREDIT METHODS AND PRACTICE deavor to confine their commercial loans and their investments in commercial paper to borrowers whose financial statements show an excess of liquid assets over current liabilities somewhat nearly in the pro- portion of two for one. The Federal Reserve bank is permitted to waive the requirements of a state- ment with respect to any note discounted by a mem- ber bank for a depositor as for another member bank. (1) If it is secured by a warehouse, terminal, or other simi- lar receipt covering goods in storage. Warehouse receipts offered as security for bills discounted must be issued by warehouses which are independent of the borrower. (2) If the aggregate of obligations of the borrower redis- counted and offered for rediscount at the Federal Reserve Bank is less than a sum equal to 10% of the paid-in capital of the member bank and does not exceed $5,000. If the note is secured by warehouse receipts for readily marketable commodities, the receipts to be acceptable must be issued by a warehouse which has been approved by the Federal Reserve Bank. If the note is secured by a chattel mortgage, it must be accompanied by a copy of the mortgage with evidence that the original has been recorded or filed. 4. The notes are properly endorsed by a mem- ber bank. 5. The statements of the makers are attached, or have been filed with this bank. Forms of finan- cial statements recommended by the Federal Re- serve Bank of St. Louis are shown in Exhibits 8, 9, 10 and 11. 101 Cub on htnd-. C»b .in K-n-IT-IOU-S-M F'uwacUl Sutcment for use by { To the or Nunc . ™— Location ..i — ViMrmclirm. -Bank tDwertt* ckancin ol IiuImh tBllj} For the piirpoie of procnring credit from time to lime, tbe ondenigned hereby malces to yon ibe following statement of the cod- .. . . - ^. J „-»„.j -- tk. ^_____„ d» «i>g -; and the undersigned hSSby latnuSr. SS^*r«teS that >M statement is in .11 «"specin;;;nrd correct; and yon may consider said statement as to the p^S"w7ponsibUi^o( the nndenigned aa contioning to be tme and correct unUl written noUce of a change is givtn to yon by the oadersigned. ... Fill all blanks, writiav "no" or "^ne" wbcre neeeaMnr to compleie information. , .Bank Bios Recdvable, from Customers, good (Hot toMtttni M picdfcdl Accounts Receivable, from Customers, good on giveo arc, in evtry mpcct, iroc and ia accordance with the facts. Dafc Signed... Ej - - Exhibit No. 8 — Reverse Side rWANCUl. 3T4TiEMF^T-5T0CKM£N. (Nkma of BHk) O-'OcMtMj tor the purpoae o( |)rocuring credit from time to time, the undersigned hereby maLes to you the following statement of the coadititSQ of the undersigned on (he day of 19 : aoiJ the undersigned hereby maintains and guarantees tfi«t said stateiMnt u in all respects true and correct; and you may consider said statement as to the pecuniary responsibility of the uadersigoed H continuing to be trub and correct until >Titten notice of a change is given to you by the undersigned. MC*ibe ud t)n t»Tdc ol vaj olher prtipcrtj) TOTAL PROPERTY. ACCOUNTS PAYABLE by me._ NOTES PAYABLE by me MORTGAGE on land. NOTES due by me secured by chattel mortgage- All other debts.- I have endorsed or guaranteed notes ' for others amounting to $ TOTAL DEBTS. QUESTIONS TO BE ANSWERED RBQARDING PARU LAND: Pkno b slmted in Connty ot— .. .Sute ol ... Deterjbcd M toUo^ Range, Section, Township, Etc » < TaM mmabtt of «crcs7-. -J^elTa onder cnliiTatlon?.... .^cres «o6l for aill!nttos?». Any waaeaablc year, Utia land'wiO iirodocc per acrcx. ~-balcB cotton; bushels of wheats. _; boshels of com— (OVER) Exhibit No. 10— Credit Statement b bod sBbject to everihmi' How long have you «wn«d (his bnd?- 1» lay part rcolcd; bow anc^ uid lor whit rent?-..- ^_, Dfrtucc from acwest lowa to yoar finn?— milet from _. ... IKatttcc Irani narttt railroad itatioo to brm?.. Al whtf price per acre^ Iutc bnprovcd bnns ia your neiKhtwrbood told duins the past year?. Al what price per acre has rongh bod fa jrev eeighborbood sold fai paat year? b tbcrc any-nortgagc on your bad? AmooDl . — due... k die tide to Ihe bad ia ywr oanic? _ Par vtel b tUa bad assessed lor taxatka?— I kcrebr •dernabr declare atid certify thai the above ia a Irvc sutemcot of my 6iuncial coDditioa. (SifBcd). Paie,— ,..—., ——..,. .■,,.. ——.■■..,— —..■■..,- Addrcta.. Exhibit No. 10 — Reverse Side riWAWCIAL STATEMEHT— MEKCHANTS CoipontioQ hitocrship. ...BlUebM... (Oooibe load d bwbai hilly and >tate whether vhoUuk or rouU.) For ttw (Huposa of pncwiag credit fiwa tiaa to Oom^ the tmUmised hoelty makm to ym ths CoOoiriai itoteneat of the coaditioa of the undw- d oo thft..» .- _ jd»y. ^ 19...-..-; ud the undenicDed hereh/ nuiatuiu [wnatca thU Mid atatcoxBt U ia all nspecta tnw and eomct; and yea may cOadder eaid BtatciMat a* to the pecuniary RBpouibili^ ol the under* intd writtca.aatice of a dunca i« i ivia'ta ynu br tha undmiciud. ABUTM UABIUTlEg CASH on hand TRADE ACCEPTANCES UBBKTY BONDS BILLS PAYABLE _uiAlu.muk ACCOUNTS PAYABLE DEPOSITS OP MONEY WITB US MORTGAGE ON REAL ESTATE CHATTEL MORTGAGE DEBT OTHER UABIUTIE8 ■•■ N0TB3 BSCBtVABLB of oogtonun (M( krMirfwnd « *Meitf> -— (M% MMtamI « vM^O unfinialml (h"* -Klufd ) INVESTMENTS, ttcida >ed bomU: REAI, ESTATE aHd is tnuMa CDCTORES lud in baam CXTHEK ASSETS: TOTAL UABIUTIES NET WORTH, TOTAL .. .- .. . ~ SURPLUS *PROnTS t TOTAL TOTAL Or. PBonr AMD LOSS AccontT, naoAL t«as on >zHa . . . , It Cr Actual eipense at comductittg bunoess - _...». GROSS PROMTS Witbdrawslt or Dividends Paid - - * - - Nat Piofite ..-.„ _. _.._ - . » Prom Othw Soufcee _.._ 1 TOTAL , « TOTAL -...„ „.«..„ _ diaoounted or aold - - 1 - — Date of last annual statcnieats SfCcedM tborm iMiipuif* DO BuikUngt. $-. — Mrfrh*»d>T* •*» ♦'■"d ""I 'h-** -tat* ». Amount of cnerchaodiae bou^ bom that date to date of abovv atatement. « Total aala of mcnihandm m tht aane period. S. On abak aoseta ara mortgacea a lien?... Is etatenent baaed on aetuat iovenUtry?. What anoont c4 mcRhaadiae has bc«n on hand orcr one yearf ,. Whnt amount of acoooota and bills receivable are pi£t due sod extoidedf t ... UmiI tanna oo which you buy' — - - — -■■ Usual tcfou on which you tolO ~ - - — - — Total oalea Cor past twelve moBtha S ...~ ..... _.., ...It eo, gnra data .of isTeatory— Exhibit No. 11 — Financial Statement M MKb BSU Paytblc «b4 bow iccured _ _„__ _..„ b wy psrt of itenu, "Noto Reoovable of Cnstomas" «r "Aoeotsits Receivable ot Cuctomen." doe troa tQted oMnpuka or finns a whidi yon an U CBi, |sn amoiata, 1 Notes Receivable. I... Vatt ham beta ia busiaev. And «iwfD flBccMded ^ -^...^ ...Acconnts Recdva^ Slate tut date of taldac trial balance of your books .... Repilu' time of baUscinc yow books.-. » ,. Bank aocoimts, where kept? Where is merchaiuSse loeatedF. — If • Onporation, fin oat foUowinc schedule: omens Aim dzbxctobs NAME IN PULL NoofaiamRcVl V ft I^rt a mhl p. en oat foQowinc tc h eJnIe: rUTMKU. NAME IN PULL 'fi^^tL- LUbiUty' liwtod to '•s-- ADDRESS Iboi^catity tbat, to the betf of toy kiKy«MKe asd bdHl the Gtuni lad olonBAtiDD ctrcn ife, fat every iBpect. tnie a^ (Sen Qapantioo «r Tifm Natoe Here.) Exhibit No. 1 1 — Reverse Side BANK CREDIT METHODS AND PRACTICE 6. The notes have a final maturity. 7. The maturity of the notes comes within the provisions of the Act. 8. The application for rediscount be made in dupKcate on proper form. The rate of interest or discount charged by the offering bank should be noted on the application after the name of the maker of each note offered, as the Federal Reserve Board requires this information on all notes accepted for rediscount. Following are examples of the forms used for rediscount: rbl* pom t« Im Q»ed for Redisoonals secured br Government ObliA«iion« ONLY. FEDERAL. RESERVE BANK ST Louis, mo Centttaien We eneroM herewith, ani] offer (or redUcouni at the going trank nit. the item* li*ted berow. ind lUlhoriM that they be charged than a tike face amount of bonds or notes of the United States issued since April 24, 1917, or cerliticalet ot mdebtedness of the United Stales, without regard to the amount the borrow- ing bank may have already loaned lo its borrower under his regular line ol credit: provided, how- ever, that the aggregate ol all rediscounts must in no case exceed twemy per centum of the capital and *urplus of the member bank." (Name of ofTcVing Bank or Trust Company) Authoriied Oflio atat* Whtthw Ptpai Mpoiltari' PapI>UCATION FOR SEDISCOUNT. THIS TORM TO BE USED UNTIL DECEMBER II, ItWi AND BV NATIONAL BANKS ONLY. - = - 19..-.- TO TM« FEDERAL RESERVE BANK St. Louis, Mo. Ceollanca- We,«KlOK herewith, and offer for rediscoanl at the goinr bank rate, the items Hated below. and aaOnrizc thai they be charged to our account at maturity. To the best of our knowledge and belief the proceeds of these obligations have been used, or are 10 be used, in producing, purchasing, carrying or marketing goods in one or more of the steps of the process of production, manufacture or distribution as provided in the Federal Reserve Act and in the Regulations of the Federal Reserve ' Board. (Nime of olItriBg Bank) Auihorized Office tnoenoin om OKawM WPM«f* Exhibit No. 13 — Application for Rediscount Exhibit No. 13 — To be used by National banks only, when applying for all rediscounts other than those secured by obliga- tions of the Government. Exhibit No. 14 — To be used by State member banks or trust companies only, when applying for all rediscounts other than those secured by obligations of the Government. 9. The condensed statement of the offering bank accompanying each offering. 10. Revenue stamps are attached to the notes. Ill BANK CREDIT METHODS AND PRACTICE SFntCACiON FOn REDISCOUNT THIS FORM TO SE USED UNTIL DECEMSER 31, !«« . 191.. FEDERAL RESERVE BANK St. Louis. Mo W« enclose herewith, and offer (or rediscount at the goin? bank rate, ihc items listed below, md aslhorizf that Ibej be charged to our iccouiit at inMurit^. To the bc.ni of our knowledge anil iKncI fhe proceeds of these obligations have been used, or are 10 be used, in producing, purchaeing, CRrTTine or marketing good^ in one or more of the steps of the process of production, manufacture or cnsirtboilon aa provided in the Federni Reserve Act and in the Regulations of the Federal Reserve Board. -^W« berebj certify thai none of the borrowers whose paper is herewith offered (or rediscount is IraWc to vs lor borrowed money; other than secured by obligations o( the United States Covernmenl Issued sltKe April 24, 1917; in an amount in excess of 10% of our Capital and Surplus; and we hereby guranlec that no such borrower shall be permitted to betoinc liable to us in excess of such amount, tuecpt as herein stated, while its notes, drafts or Litis of excliange are under rediscount by us. or •I* htU k9 collateral to obr ohlit;alioiis, to the Federal Reserve Bank of St L.oui»- t «f oUttmg Bank or Trull Companjil Auihonitd OfT'ct ■tato Wb«(Mr Pa^mr H PaW >•«#••««' Mr-" Exhibit No. 14 — Application for Rediscount A customer's bill or note, the proceeds of which have been used or are to be used, for the purpose of carrying or trading in bonds or notes of the United States, may be rediscounted by a member bank with the Federal Reserve Bank, provided the same has a maturity at the time of discount of not more than ninety days. Such notes need not be drawn for a commercial purpose other than for the purpose of carrying or trading in Government securities. The privilege of borrowing money on its own promissory notes was not granted to the member bank under the Federal Reserve Act as it was 112 BANK CREDIT METHODS AND PRACTICE originally passed, but is a feature that has since been added for the purpose of facilitating discouni operations where funds are needed for a very short period of time only, and is as follows: Any Federal Reserve Bank may make advances to its mem ber banks on their promissory notes for a period not exceeding fifteen days at rates to be established by such Federal Reserve Banks, subject to the review and determination of the Federal Reserve Board, provided such promissory notes are secured bj such notes, drafts, bills of exchange or bankers' acceptances as are eligible for rediscount or for purchase by Federal Reserve Banks under the provisions of this Act, or by the deposit oi pledge of bonds or notes of the United States. ^^"here advances are desired for a time not ex- ceeding that period, it is considered expedient, as a matter of convenience, to allow member banks to borrow on their own obligations rather than to re- quire them to rediscount items running for a longer time. Promissory notes offered for discount may be secured by the deposit or pledge (1) of Govern- ment securities or (2) of bills receivable that are eligible for rediscount or purchase by the Federal Reserve Bank. Bills receivable so pledged should have a maturity of not less than the period of the obligation they secure, of not more than ninety days in the case of commercial paper, and six months in the case of agricultural or live stock paper. Except as provided above, it is not the intent of the Federal Reserve Act that the promissory note 113 BANK CREDIT METHODS AND PRACTICE shall take the place of rediscount. The counsel for the Federal Reserve Board has rendered an opinion to the effect that, while it is lawful for the Federal Reser\^e Bank to permit a member bank to renew its fifteen-day promissory note, it should not enter into any agreement at the time of discount for subsequent renewals, since that, in effect, would extend the ma- turity of the fifteen-day note. Under the provisions of Section 13 of the Fed- eral Reserce Act, any Federal Reserve Bank may rediscount for any member bank, whether State or National, the obligations of any one borrower to the extent of ten per cent, of the member bank's capital and surplus, but it is expressly provided that "bills of exchange drawn against actually existing values" shall not be included in determining that ten per cent, limit. In the opinion of the Federal Reserve Board this phrase "bills of exchange drawn against ac- tually existing values" includes "drafts or bills of exchange secured by shipping documents conveying or securing title to goods shipped" and "bankers' acceptances of the kind described in Section 13 of the Federal Reserve Act", even though Section 13 does not expressly state that the two classes of paper are bills of exchange drawn against actually existing values. In the opinion of the board, how- ever» accepted demand bills on which the drawer is released from liabiHty are not "bills of exchange" 114 BANK CREDIT METHODS AND PRACTICE within the meaning of Section 13 and must, there- fore, be included in determining the limits of the amount of paper of any one borrower which a Fed- eral Reserve Bank may rediscount for any member bank. As amended by the Act of March 3, 1919, any Federal Reserve Bank may, until December 31, 1920, rediscount for any member bank, whether State or National, the obhgations of any one bor- rower to the extent of twenty per cent, of the mem- ber bank's capital and surplus, provided, however, that the excess over and above ten per cent, unse- cured must be secured by bonds or notes of the United States issued since April 24, 1917, or by certificates of indebtedness of the United States. By the act of February 27, 1921, the time within wliich Federal Reserve Banks may rediscount such paper was extended to October 31, 1921. If the regular line of credit of the borrower from a member state bank is not more than the ten per cent, limit fixed by Section 9 of the Federal Reserve Act, Federal Reserve Banks may redis- count for State member banks to the same extent that they may for member National banks. If, however, the regular line of credit of the borrower from the member state bank is more than that ten per cent, limit, then the Federal Reserve Bank can- not rediscount any of that regular line of credit, but may rediscount that paper which is secured by 115 BANK CREDIT METHODS AND PRACTICE Government obligations of the kind specified, up to the limits described above. (See ruling of the Fed- eral Reserve Board printed on pages 361 and 362 of the April, 1919, Federal Reserve Bulletin.) All bankers' acceptances and other eligible two- name paper taken at special rediscount rates arc included in the borrowings of a member bank. All such paper purchased by the Federal Reserve Bank at open market rates is not included in the member bank's borrowings. Following are statements of resources and lia- bilities of the Federal Reserve Banks of the United States as of December 31, 1914, a month and a half after they opened, and as of December 31, 1920. A comparison of these will give the reader an idea of the enormous growth and development since their inception. I in BANK CREDIT METHODS AND PRACTICE STATEMENT OF RESOURCES AND LIABILITIES OF THE FEDERAL RESERVE BANKS OF THE UNITED STATES OF AMERICA ASSETS Dec. 31, 1914 Dec. 31, 1920 Gold coin and certiacates $329,069,000 ^,059,333,000 Legal tender notes, silver certificaites and subsidiary coin 36,578,000 189,830,000 Total $255,647,000 $i,24«,163,000 Bills discounted and bought 10,593,000 2,974,836,000 Investments 255,000 288,191,000 Banl£ premises ...... 18,450,000 Uncollectible items and other deductions from gross deposits 717,227,000 5% Redemption Fund against Federal Reserve Bank notes 12,752,000 All other resources 11,349,000 8,898,000 Total resources $277,844,000 $6,369,517,000 LIABILITIES Capital paid in $18,051,000 $99,770,000 Surplus 164,745,000 Reserve deposits 256,018,000 1,748,979,000 Government deposits 27,639,000 Deferred availaJbility items 522,638,000 Other deposits, including ft)reign govern- ment credits 23,161,000 Federal Reserve notes in actual circulation 3,775,000 3,344,686,000 Federal Reserve Bank notes in circulation — net liability 316,960,000 All other liabilities 131,939,000 Total liabilities $277,844,000 $6,369,517,000 Federal Reserve Banks aim to prevent member banks from using them to over-expand their own businesses. The Federal Reserve System was founded upon sound and sane principles for the good of all, and not for the special privilege of a few, and if safeguards against its exploitation by over-ambitious institutions were not provided, it 117 BANK CREDIT METHODS AND PRACTICE would lead to not only specific, but general abuses of the system, which would destroy its functioning and make it ineffective in serving the purpose for which it was created. For instance, if in times when money should be normally easy, the Federal Reserve Banks allow their reserve ratio to fall to the forty per cent, fixed by the Federal Reserve Act, without discouraging inflation by limiting their rediscount privileges to member banks, and carry such a condition into the moving period when money is normally "tight", then the Federal Reserve Banks would not function properly and a panic might ensue, thus making futile the remedial features of the Act itself. When the Federal Reserve System was first in- augurated, there was evidenced among some mem- bers of the banldng fraternity a lack of cooperation, which in some cases amounted to opposition to the system, this being particularly true in the Eastern banking field. As the war progressed, the Federal Reserve System became an extremely important factor in the financial business of the United States and later, in fact, its influence reached many other countries. In 1919 an eminent financial authority said that the world war was won by the Federal Reserve System which, through its financial ramifi- cations, made possible the marshaling, not only of our man-power, but particularly of the country's resources. 118 BANK CREDIT METHODS AND PRACTICE It was not, however, until 1920 that the power for good exerted by the Federal Resei"ve System proved its great value to the country and to the business world in general. In 1919, immediately following the signing of the armistice, the purse strings of the country were cut loose, speculation in stocks and bonds and in foodstuffs and other com- modities was rampant; profiteering became the pass- word in commerce. The gold reserves of the country were being severely taxed to meet the persistent demands of constantly over-expanding business, re- sulting in the depreciation of the money unit value and consequent extremely high cost of living. Other Government agencies had tried in vain by prosecu- tions, investigations and rules to abolish profiteering and decrease the cost of hving. Deflation became necessary in order to avert a financial disaster of unprecedented magnitude. The Federal Reserve Board saw that by deflation only could the proper remedial steps be taken. They raised the discount rate to figures that made the continuance of market speculations undesirable and unprofitable, and ulti- mately effected a reasonable deflation of currency and reduction of living costs. This process of defla- tion is still in operation at the time of writing this book. The illustration is given in order to show the wonderful influence for good possessed by the Fed- eral Reserve System, especially in view of the fact that the Federal Resen^e Bank is a corporation 119 BANK CREDIT METHODS AND PRACTICE whose charter can be perpetuated, thus preserving for future crises an agency that can exert its influ- ence and exercise its powers, based upon the invalu- able experience of the past, to avert financial calami- ties under similar circumstances. 120 CHAPTER VIII THEORY OF STATEMENT ANALYSIS One of the most important features of the work of the modern credit department of a bank is the analysis of bank and commercial statements. In former years, when most banks were small and had no regularly organized credit department, it was very seldom that the bank asked its commer- cial customer to furnish a statement showing its assets and liabilities, and in very few cases was the customer wilhng to comply with such a request, while the matter of profits and losses made by mer- cantile corporations or firms was entirely sacred to the management of such concerns and not to be given to even its banking creditors. However, with the march of progress and the growing complexity of business relations, this pohcy of secretiveness in business matters gradually van- ished, and the commercial customer of a bank real- ized that in order to get to the bank's pocketbook in a manner that would meet his growing financial needs, he had to lay his cards upon the table, so tu speak, and make the banker his confidant. The country town soon became the large city, and with that development the village banker grew into the large city banker with the more modern idea 121 BANK CREDIT METHODS AND PRACTICE and more extended vision. In this transformation it became an impossibility for the city banker to continue extending credit based upon his personal acquaintance with the customer, coupled with his very vague knowledge of the customer's net worth. One of the most corrective influences in bringing about the requirement for detailed statements was the institution of Federal, State and clearing house bank examinations. To inteihgently pass upon the value of the bank's assets and the soundness and wisdom of its investments, it became necessary for the examiners to have placed in their hands, at the time of examination, detailed figures concerning the bank's assets. This was followed by a new science in banking, namely, the ability to analyze and effi- ciently judge a financial statement. In the handling of this subject it is the author's aim to sufficiently go into the matter to enable the student of credits to have a fairly comprehensive idea as to the proper way in which a business state- ment should be analyzed, and in that connection point out the salient features of the statement which should influence the judgment of the credit man either favorably or unfavorably. The conditions governing the analysis of state- ments vary according to the territorial location of the particular business under consideration, and also the different lines of business involved. The idea of discriminating analysis in connection with bank 122 BANK CREDIT METHODS AND PRACTICE credits is getting more widespread in this connection and the banking world is gradually entering a new era, in which no rigid rules of analysis will be applied to all businesses alike. At one time it was the set rule among a great many bankers to require a state- ment showing a ratio of quick assets to current lia- bilities of 200 per cent., regardless of the nature of the business under scrutiny, but in late years while the maintenance of business concerns at least on this basis is considered highly desirable, the tendency has been to deviate so as to make banks' demands elastic enough to suit the different lines of business, the quality of the assets, the frequency or infre- quency of the "turn-overs" and the economic condi- tions governing the different locations. For instance, the statement of a packer's business in which the turn-overs are bi-monthly or oftener, all the sales being nearly on a cash basis, may show a ratio of 150 per cent, and yet be desirable, whereas the statement of the business of a time-payment music house, whose sales are made on a basis of monthly install- ments, extending sometimes over one year, may show a ratio of 350 per cent, and not be as desirable for credit extension. The same is true in connection with the nature of the assets that go to make up each statement, neces- sitating the closest analysis and investigation that can possibly be given in each case. The Robert Morris Club, organized in Salt Lake 123 BANK CREDIT METHODS AND PRACTICE City in 1915, and comprising the credit men of the principal banks of the United States, has recently foi-med a research organization whose prime pur- pose is to investigate economic conditions governing the different lines of business and furnish service to its members along the lines of constructive research work. The Federal Reserve Bank of St. Louis in 1919 compiled the following set of figures, showing the ratio of quick assets to current habilities, and of debts to net worth in nine different lines of business. In their analysis they did not take into consideration the five biggest packers: Independent packers j Wholesale grocers . . . j ( 191 Wholesale dry goods . •< Wholesale drugs .... < Shoe manufacturing. . Wholesale lumber . . . Wholesale hardware . Rubber goods and tire Cotton oil Quick Debts No. of to to state- current net worth ments 7 1.60 .73 16 8 1.57 .96 22 917 2.21 .91 136 1918 2.07 .70 218 917 2.30 .66 46 2.17 .76 58 1917 2.9 .24. 12 1918 2.7 .32 26 1917 2.2 .58 33 1918 2.3 .58 49 1917 2.28 .32 SH 1918 2.14 .40 121 1917 2.82 .56 38 1918 2.71 .60 51 1917 2.38 .73 13 1918 3.2 .44 20 \ 1917 3. .49 16 ( 1918 2.35 .39 21 124 1 BANK CREDIT METHODS AND PRACTICE This research work is commendable and should, if possible, be followed by the credit departments of banks whose volumes of credit lines and commercial paper purchases are considerable. In order to arrive at a figure which could be reasonably accepted as a basis for the anah'sis of statements in the comparison between any two years, it would be best to take the statements of the same companies for each year under consideration without the addition of other companies and also to allocate the companies by territorial division. By this means, the banking credit man could gauge the individual statement by the conditions that obtained in the credit seeker's territory. For example: In the Southern states, wholesale grocers and other large merchants usually carry their customers into the harvesting season, thus accumulating large receivables and making their turn-overs infrequent, unless they should increase their borrowings. In other words, if they did not borrow their ratios would be favorable but their turn-overs less fre- quent, while if they did borrow to make possible more frequent turn-overs, their ratios would be less favorable but their profits probably much greater, provided that through this latter practice they did not get over-extended. In the Xorth, the wholesale grocer usually sells on short terms, much after the fashion of the packer. His turn-overs are more frequent, his borrowings 125 BANK CREDIT METHODS AND PRACTICE more permanent; his ratio of quick assets to current liabilities may not be entirely favorable, and his profits may be small, but his condition may be much more liquid than the Southern wholesale grocer. The character of the trade served by the North- ern wholesale grocer is more diversified on account of the great variety of crops produced in the North, while in the past the South has produced a prepon- derance of one or two crops, which narrowed the field of the Southern merchant in his collection pos- sibilities. However, the figures in the above table are extremely valuable in that they can be used with reasonable qualifications, as set forth in the fore- going paragraphs. As a guide in the analysis of each individual statement, this research work can be carried further by the bank credit man, who can make his own se- lection of statements, taking into consideration the varying conditions governing different lines of busi- ness in the different parts of the country. It is well in order to facilitate the quick analysis of a statement to have a printed form for such pur- poses, using ordinary paper, as the first analysis is not a permanent record. As an example of how a statement is analyzed in this manner, we give, first, a statement as present- ed by the commercial paper broker before analysis: 126 BANK CREDIT METHODS AND PRACTICE JOHN SMITH & CO. St. Louis, Mo. We request you to retain in confidence the following information; STATEMENT of JOHN DOE COMPANY (Wholesale) NEW YORK CITY ASSETS Dec. 31, 1918. Land, bldgs., plant, machinery & equipment $6,054,159.00 Sundry investments 170,973.00 Current assets: Inventories of manufactured and process stoclts, materials and supplies as cer- tified to by the responsible officials and valued at cost $7,833,4.54.00 Bills receivable (less reserves) 3,551,573.00 Accounts receivable (less reserves) 2,331,015.00 Liberty Bonds 331,672.00 Cash in banks and on hand 750,941.00 ■■ 14,787,655.00 Deferred charges: Unexpired insurance premiums, prepaid interest and expenses, catalogues, etc 254,366.00 .■g-Jl, 367,063.00 LIABILITIES Capital stock: 7% cumulative preferred $5,000,000.00 Less — ^purchased for retirement 1,100,000.00 — $3,900,000.00 Common 7,000,000.00 Current liabilities: BUls payable— Bank 3,555,000.00 ' Accounts payable 784,591.00 Reserve for Federal taxes 300,000.00 Dividends payable 1-15-19 77,003.00 4,676,593.00 Surplus 5,690,460.00 $31,267,053.00 (Signed) JOHN DOE COMPANY By — John Doe, Pres. Statement : Quick assets $14,787,655.00 Current liabilities 4,676,593.00 Above statement prepared and certified to by Jones & Co., Certified public accountants. 127 BANK CREDIT METHODS AND PRACTICE Sales and profits: Sales for year ending 12-31-18 $33,261,9] 3.00 Net profits for year ending 12-31-18 l,962,562.0t> Banks aocts.: Peoples Banlc, Monetary, N. Y. Third National Bank, New York City And then as it appears after analysis by the credit department, and compared with the previous year's statement : Dvin's rating — Ch'er 1 million — high Bradstreet's rating — Over 1 million — 1st Name — The John Doe Co. Address — New York City Business — Phonographs, etc. Increase -|- Decrease — Qxiick assets: Dec. 31, 1917 Dec. 31, 1918 Cash $480,327 $750,941 Accounts receivable — less reserve 2,127,233 Bills receivable 3,S53,80i9 Merchandise 7,190,332 Liberty Bonds Total $13,351,701 Current liabilities: Bills payable — ^Merchandise. Bills payable— Bank 2,750,000 Accounts payable 884,592 Reserve for taxes 97,810 Dividends paid 79,709 Sundry reserves 60,000 Total $3,872,111 Working capital $9,479,590 Ratio 3.44 Other assets: Real estate — Bldgs. & equip. $5,948,051 Furniture and fixtures Machinery and equipment . . Due by officers Stocks — Investments 184,399 Deferred charges 244,224 2,321,015 3,551,573 7,832,454 + 331,672 $14,787,655 $1,435,9.54 ,3,555,000 784,591 200,000 77,002 60,000 + ^,676,593 $804,482 $10,111 063 3.18 + $631,472 $6,054,159 170,973 254,266 Total $6,376,674 $6,479,398 + $102,724 128 BANK CREDIT METHODS AND PRACTICE Net worth $15,856,364 $16,590,460 Capital— Preferred 3,900,000 3,900,000 Oommon 7,000,000 7,000,000 Surplus 4,956,264 5,690,460 Sales 24,562,331 33,261,913 Earnings 1,003,054 1,962,562 Dividends 321,260 428,366 + $734,196 A suggested form to be used for analysis of bank statements is shown below: THE NATIONAL BANK OF BANKVILLE, WIS. QUICK ASSETS 1 Cash and Exchange $204,774.89 2 Loans and Discounts 565,585.05 3 Overdrafts 367.83 4 Cust. Accept. Liab 5 U. S. Bonds & C. Ind 56,908.01 6 Liberty Bonds 7 Bonds and Securities 8 Ttrtal Quick 827,635.78 LIABILITIES 9 Circulation 10 Due to Banks 11 Ind. Dep. Demand 623,075.81 12 Ind. Dep. Time 129,264.11 13 Bonds Borrowed 14 BiUs Payable 15 Accept. Liabilities 16 Rediscounts 17 Other Liabilities 54.72 18 Total Lialbilities 752,394.64 19 Margin in Quick 75,241.14 FIXED ASSETS 20 Banking House 14,000.00 21 Furniture & Fixt 4,486.50 22 Other Real Estate 434.55 23 Other Assets 24 Total 04,162.19 25 Capital 70,000.00 26 Surplus & Profits 24,162.19 27 Total Capital and Surplus. 94,162.19 129 Dec. 3, 1919 CHAPTER IX IMPORTANCE OF STATEMENT ANALYSIS The necessity for a close analysis of financial state- ments becomes evident when one stops to consider the difficulties that may be encountered in the mat- ter of establishing a case in the courts against a cor- poration, firm or individual charged with having made a false statement for the purpose of obtaining credit. This charge may be made in either or both of two ways — ^in the federal courts and (or) state courts. In the federal court criminal suit may be entered in case the statement came through the mails, under the federal statute prohibiting the use of the mails for fraudulent purposes; in the state courts, under the false statement act. In either event, the burden of proof rests with the com- plainant. This point should never be forgotten. If it is ever present in the mind of the credit analyst, he will be extremely careful, cautious and foreseeing in the handling of the statement. For prosecution in the federal courts it is vitally necessary that all statements coming through the mails have the envelopes in which they were enclosed attached thereto and made part thereof, with the sig- natures of two witnesses placed on the envelopes, under the receiving stamp, with date of receipt. One 130 BANK CREDIT METHODS AND PRACTICE of these signatures should be that of the party who opened the mail. For prosecution under criminal statutes in any court, it is necessary |;hat the statement should be made conforming to certain rules; otherwise the ends of justice may be defeated. For example: The cash item may read "Cash, $10,000". The bankrupt may claim he had that amount of cash on hand with a small portion in bank, and it rests with the prosecutor to prove that he had not. This may be impossible. For this rea- son, it should be insisted that a reasonably full ex- planation of the cash item be given; in what banks carried, how much in each bank at the date of state- ment, and how much on hand. Also whether the cash contained due bills, etc., carried as cash items. The same is true as to the merchandise account. Let us take, for instance, the case of a man whose statement reads "Merchandise, $50,000". Some time subsequent to making the statement he fails, and there are grounds for believing that he has made a false statement. The nature of his business re- quired the conduct of branches located in different parts of the country. It will be impossible in such an event to prove that he really did make a false statement, i. e., the proof will more than likely be insufficient to convict him, considering the strict technicalities of the law and the fact that he will most probably employ competent and clever coun- 131 BANK CREDIT METHODS AND PRACTICE sel to defend him. The statement, for this and divers other reasons, should show where the merchandise was located at the date of the statement; how much on hand at the home store or factory; how much in each branch, the name of the branch and the town in which the branch is located; the amoimt of goods in transit, and if the merchandise contained any goods on consignment, i. e., goods on hand belonging to others for which he has to account when sold. The real estate and buildings items should read: "Belonging to me (us) and in my (our) name(s)." This for obvious reasons. Apart from the legal reasons involved, sane busi- ness judgment requires that all the safeguards pos- sible be placed around the extension of credit. In connection with the handling of the paper of, or the making of loans to, large companies or firms, espe- cially those whose statements are audited, the veri- fication of cash items is not usually necessary. But all deahngs of a bank are not with large, respon- sible firms. A considerable number of its loans are made to smaller firms and individuals, in the han- dling of which loans the closest scrutiny should be practiced. In some instances, however, the large banks of the country have been deceived by size. This was notably so in the colossal failure of an East- ern concern, guilty of grossly dishonest methods. Prior to the failure the banks could not get all they wanted of its "prime" two-name paper, which wa» 1S3 BANK CREDIT METHODS AND PRACTICE nothing more than "manufactured" receivables. A false endless chain of reciprocal checking, through the workings of which each one of forty checking banks receives its inspiration of confidence from the ©pinions of the thirty-nine others, usually does the damage. In the case referred to, the statements were not audited. The insistence by the banks upon audited statements would have disclosed true condi- tions in time to have averted the calamity. Accounts receivable item should explain what proportion is collectible, and from the accounts i^hould be deducted the reserve for doubtful accounts. The uncollectible accounts should be charged off before the statement is made. Sometimes a statement may include in its ac- counts receivable, cash advanced to subsidiary com- panies, or other items not legitimate accounts receiv- able. In handling the customer individually, this question should be settled to the satisfaction of the bank. It should be ascertained also how much of the accounts are past due and how long past due. If the statement contains "Trade Acceptances," it should be ascertained whether or not any have been discounted at bank, and if so, whether or not a contingent liability has been set up against their non- payment at maturity; also whether the trade accept- ances were given in settlement of current shipments or past due accounts. 133 BANK CREDIT METHODS AND PRACTICE In analyzing the merchandise account, the real difficulty is experienced. No really satisfactory method has yet been found practicable for the prop- er checking of this most important item — for it is the one pivotal item in the entire statement. In the past it has been nourished, pampered and fattened for the payment of dividends and the obtaining of credit ; yet at times trimmed and starved to "needle's- eye" proportions for the squeezing out of minority stockholders. However, with more truth than face- tiousness, it might be said that since the inaugura- tion of the income and war excess profits taxes, few nursery methods have been applied. In fact, the contrary has been the case, and the "inquisitive" bank credit man invariably gets no nearer actual conditions than a "knowing" wink; but much of the bank's worries about padded merchandise have been eliminated. How long the business man could con- tinue these practices without becoming entangled in a maze of silent reserves is a problem that could be solved only by the reduction or abolishment of some of the governmental taxes or a drastic fall in commodity values. It would be folly, however, for the statement analyst to take it for granted that such conditions governed all statements pre- sented to him for analysis. The merchant may be in narrow straits and seek in the padding of his state- ment a channel through which he may stretch his credit. 134 BANK CREDIT METHODS AND PRACTICE Some accountants in making audits attempt also to take an inventory, and have on their staff for that purpose men experienced in the appraising of mer- chandise. In taking inventory, they attach tags of different colors to the wares; for example, first class or highly salable, blue tag; second class or slow sales, red tag; obsolete, yellow tag, etc. Other accountants — and these are in the ma- jority — do not attempt to take an inventory, but do check the extensions of prices and quantities on the inventory sheets, and take the statement, sometimes sworn, of an officer of the company as to the cor- rectness of the prices and quantities. All financial statements of manufacturers should show the merchandise account properly classified in amounts as to raw materials, finished materials, work in process and goods in transit, and it should be ascertained whether the indebtedness represent- ing such goods in transit is included in the habilities. Inquiry should be made as to the salability under certain conditions of all of its merchandise. For example, in the depression of 1913-14, an automobile company of some importance failed. A considerable part of its merchandise account consisted of parts that could not be used for any other car and which were later sold as junk, although very valuable to the business in prosperous times. Again, a merchant through overbuying may get stocked up with a large amount of merchandise which he may be compelled 135 BANK CREDIT METHODS AND PRACTICE to carry over into a season of changing styles or lower prices, or both, making his stock liquidable only with disastrous consequences. Sometimes over- stocking inures to the benefit of the merchant who overbuys. The author personally knew a small shoe dealer, who, in 1917, accumulated a stock of shoes valued, at cost prices, at $45,000, predicated on sales of $75 per day, or nearly two years' sales, and he was then preparing to make further purchases. In the subsequent market of prohibitive shoe prices, he increased his sales by underselling his competi- tors, and made enormous profits. Such arguments are used with the banker to encourage loans for such purposes, but they should be swept aside. Similar incidents occur in connection with all speculative transactions, but like the roulette gambler, the spec- ulator in the long run gets ruined more often than benefited. In times of great prosperity, the ten- dency always is to overbuy in anticipation of higher prices; but if the tide of prices should turn down- ward, the merchants become heavily involved and the banks are called upon to pay for their folly. In times of high prices, the careful merchant and manu- facturer set up reserves against periods of depres- sion. This is entirely correct and should be encovu'- aged by the bank. Joseph's interpretation of Pharaoh's dream holds good as to modem business conditions. Another question that should be fully answered 136 BANK CREDIT METHODS AND PRACTICE is as to whether the merchandise account is fully covered by insurance. In some cases this is a diffi- cult matter to check on account of the character of the business. A large part of the merchandise ac- count of a typewriter or adding machine company may consist of machines rented or on trial or in branch offices all over the country, and it would be next to impossible to check them not only as to their coverage by insurance, but also as to their market- ability. Good will account sometimes covers a multitude of sins. The question of its value does not at first glance seem to affect the bank creditor, because the bank is primarily concerned with the quick assets. On the other hand, a large good will account is very often created to furnish an excuse for the payment of large dividends, and such large dividends cannot be paid without affecting the quick assets. The ethical ground of a corporation for cre- ating a large good will account is a much mooted question. Where one corporation buys the business and assets of another corporation or individual, and pays an amount in excess of the appraised value of the acquired assets, its right to create a good will account representing that excess amount does not seem to be questioned. But where a corporation arbitrarily creates a good will asset upon which to base further stock issues for the payment in divi- dends of excess earnings, its ethical grounds for 137 BANK CREDIT METHODS AND PRACTICE doing so are very often questioned. The system leads to abuses, especially in connection with public utility corporations. It is commonly referred to as "watered" stock. Where the comotnon stock is orig- inally represented by good will, it is considered good business pohcy to accumulate a surplus in tangible assets to represent the common stock and gradually write off the good will item. Patents are often carried at exaggerated values on balance sheets. Sometimes these patents have ex- pired, but the carrying of them under such circum- stances is not always a subject for criticism, as their value may be changed into good will through ad- vertising and sale of the products to such an extent that the sale of the products based upon the patents may not be affected by the expiration of the patents. But in such an event both good will and patents should not be carried. Trade-marks and brands have no tangible value, but they may have very great value in connection with the sale of commodities. In the case of a company doing a large foreign business inquiry should be made as to whether their trade- marks are registered in the coimtries where their products are sold, as in many countries a resident business concern may adopt for its own use, without penalty, the trade-mark of a foreign importer. Investments, bonds, etc. This item in most cases carries perhaps a small amount of salable bonds and a large amount of stock in other corporations, i. e., 188 BANK CREDIT METHODS AND PRACTICE subsidiaries. Careful investigation should be made, as this item of the balance sheet will in many in- stances furnish an insight into the policy of the man- agement. The credit man should differentiate be- tween the concern with natural subsidiaries for the handling of its products and the concern whose owners branch oflf into other lines of business and use the funds of the company for such pm*poses. The latter practice has been the cause of many failures. Plant property: real estate, bmldings, machin- ery, etc. It is seldom that this item can be judged correctly at the desk of the banker. The more mod- ern practice in connection with the extension of bank credits has been to personally visit the plant, exam- ine the machinery, buildings and real estate, and see the business in operation. To successfully do this, the credit man should possess a strong character and not be awed bj^ conditions he meets or allow his better judgment to be influenced by excessive courtesies, as sometimes happens. After he becomes experienced through having visited several plants of the same kind in each case, he should be able to make mental comparisons, and arrive at a reasonably in- telligent conclusion as to whether the business is being conducted along proper lines, the real estate strategically located, the plant operated on an efii- dency plan, and as to whether proper switching facilities, labor markets, etc., are available. 139 BANK CREDIT METHODS AND PRACTICE If a personal inspection cannot be made, the credit department should by personal interview with one or more of the owners, satisfy itself about the foregoing points. It should also find out what, if any depreciation method is being used; on what basis repairs and replacements are being taken care of, etc. The bank credit man should famiharize himself with the various methods of depreciation used and satisfy himself that a correct one is being used in each case. Depreciation is not governed by any strict or ironclad rule and varies in the differ- ent lines of business. The machinery of one class of business may last for a number of years and re- quire only its worn-out parts to be replaced, while the machinery of another class of business may be subject to obsolescense due to swiftly changing condi- tions or new inventions or improvements. The judg- ment of the bank credit man must be elastic and responsive to all these different situations, but in no ease should he allow himself to appear too technical. Rather should he use the knowledge acquired by ex- perience in a constructive and helpful way, never giving the impression that he thinks himself endowed with superior judgment to that of the borrower, or that he knows more about running the borrower's business than does the borrower himself. His in- quiries should be diplomatic, and his advice entirely modestly suggestive, and he should never project himself into the issues at stake. 140 BANK CREDIT METHODS AND PRACTICE Now, as to the liabilities: When the bills or notes payable contain an odd amount, such as "$105,639.23," it raises the question as to whether the borrower is giving notes for his merchan- dise accounts payable. This has been considered bad practice. It is not considered sound financial policy to give notes for merchandise accounts and at the same time borrow from bank and sell notes in the open market. Where it is the borrower's own bank that is concerned, they know the nature of the business and such items probably could be explained to their satisfaction, but where open-market opera- tions are predicated upon the statement, it affects the salabiKty of the paper. Bills and accounts pay- able should not be shown as one item any more than should notes and accounts receivable be shown to- gether in the assets. Comparison of accounts payable should be made with probable purchases and actual sales. This item should not be large if the borrowings through bank are large. If the accounts payable appear large,, they should be investigated to see whether the bor- rower is getting extended, or whether he is taking advantage of discounts with the money borrowed. If the borrower is giving trade acceptances at the same time that he borrows from bank, he i* frowned upon; particularly so if he allows his ac- counts payable to become large. A practice that is very much condemned among mercantile credit men 141 BANK CREDIT METHODS AND PRACTICE is the secret pledging of accounts receivable. It is claimed that under such circumstances preference is given to some creditors over others, and that the ac- counts transferred are invariably the best. The writer of this book once had a statement submitted to him in connection with the purchase of a commer- cial paper note. The statement had attached to it a copy of the certificate of a responsible public ac- countant and made a very clean showing. How- ever, investigation made during the ten days' option allowed disclosed the fact that from the copy made of the original audited statement, there was ehm- inated from the assets and liabihties a large amount of accounts pledged with a commercial credit com- pany, the president of the manufacturing company claiming that he innocently did so, as he did not see any harm in ehminating offsetting items, inasmuch as one took care of the other. As a matter of fact, his company was in a precarious credit position at the time he made his statement. Large bond issues appearing on the statement as a general rule hurt the sale of a note in the open market. There are many exceptions to this rule, of course; but while a company which owes a large amount of bonds may be in the highest credit stand- ing with its own banks and mercantile creditors, paper buyers very often look askance at such state- ments, the theory being that the borrower should not resort to too many methods of financing. If the 142 BANK CREDIT METHODS AND PRACTICE statement should be considered as a basis for credit, it should be ascertained what portion of the bonds is maturing at such dates as to class them as quick lia- bilities. The provisions of the mortgage should be investigated where the mortgagor is arranging for a permanent bank line, so as to find out if there are any clauses that affect the quick assets in case of foreclosure. A discriminating legal mind should pass upon this feature. In some cases, the personal property, although apparently free from the mort- gage, has been known to be affected by a seemingly trivial clause in the mortgage when it came to fore- closure. The credit of a company is Hable to be seriously affected by dissension between preferred and com- mon stockholders. One instance is given of a cor- poration which enjoyed the rare distinction of hav- ing two sets of officers over a period of two years. Naturally the credit of an otherwise splendid busi- ness was hurt. This happened because of the error of giving the preferred and common stockholders equal voting power. While sometimes permissible and perhaps advisable, it is not always good policy. Of course, preferred stock usually acquires the right to vote upon non-payment of preferred divi- dends. A company that is in the mercantile and manu- facturing business should confine all its efforts to the promotion of its legitimate business. Its stockhold- 143 BANK CREDIT METHODS AND PRACTICE ers should not engage in trafficking in its stock. This is mentioned because we frequently hear it said of a company that it is in the stock- jobbing business in- stead of the mercantile or manufacturing business, the criticism being caused by the tendency on the part of the owners of such concerns to "juggle" their stock at the expense of pubhc investors. In the analysis of the statement, careful consid- eration should be given to the capitahzation in the case of a corporation, and the capital investment in the case of a firm or individual, with a view to see- ing whether the business is properly capitahzed for the volume transacted. If there is a tendency toward over-expansion, it should be healthfully checked by the banking creditor, and if a commercial paper name, it would probably be tabooed by the paper buyer, unless other circumstances warranted the setting aside of such objections. If all these rules are apphed to the analysis of credit statements, together with the practical exam- ples given in the analyses that follow, the student of credits will soon become familiar with the funda- mental principles that govern the extension of bank- ing credits. The foregoing suggestions merely give the line of thought to be followed in general. Each case, however, will develop its own peculiar situa- tions, but the fundamental principles are the same. In the variations will occur the degrees to which the credit grantor's judgment will become expansive or contractive as circumstances in each case warrant. 144 CHAPTER X ANAJLYZING A FINANCIAI, STATEMENT In the following set of analyzed statements the author's endeavor has been to select for analysis one statement of each of different hnes of business lo- cated throughout the United States. Some of these analyses are made with special regard to the locali- ties served, other factors entering into the analyses being given special consideration in each individual case: STATEMENT NO. 1 H. C. L. BOOT & SHOE COMPANY BROCKTON, MASS. Quick assets: Dec. 31, 1918 Dec. 31, 1919 Changes Cash $31,762.00 $81,473.00 Accounts receivable. 460,372.00 491,188.00 BiUs receivajble 12,871.00 26,708.00 Merchandise 456,318.00 427,168.00 $961,333.00 $1,026,537.00 + $65,214.00 Current Ijalbilities : Accounts payable. . . $78,250.00 $136,750.00 Bills payable 322,500.00 437,353.00 H. C. Lewis 76,000.00 Stockholders 23,050.00 $499,800.00 $574,103.00 + $74,303.00 Working capital 461,523.00 452,434.00 — 9,089.00 Ratio 1.92 1.78 Other assets: Real estate $2,067.00 $1,795.00 Fixtures 8,738.00 8,238.00 Machy., last & pat- terns 54,276.00 64,749.00 Deferred charges . . 34,500.00 36,993.00 Interest 2,033.00 2,922.00 $101,614.00 $114,697.00 + $13,083.00 145 BANK CREDIT METHODS AND PRACTICE Net worth 563,137.00 567,131.00 + 3,994.00 Capital 550,000.00 550,000.00 Surplus 13,137.00 17,131.00 + 3,994.00 Comparison of these statements would seem to indicate that the H. C. L. Boot & Shoe Company is not in as good condition for credit purposes as it was the previous year. While the quick assets show an increase of $65,214.00, this was more than offset by the increase in current liabilities of $74,303.00, resulting in a decrease in working capital of $9,089.00 and in ratio of quick assets to current liabilities of from 1.92 to 1.78 to 1, causing its liabil- ities to exceed its net worth in the new statement. BiUs payable show an increase of $115,000.00 and in the absence of further information relative to this difference and the absence of items to "H. C. Lewis" and "Stockhglders" in the 1919 statement, one would be justified in assuming that the company borrowed money to pay these two items. Another feature worthy of comment is, that, while their net worth increased $3,994.00, it was brought about entirely by an increase of $13,083.00 in other assets, which means that the quick margin of safety for creditors was less on Dec. 31, 1919, than it was on the year previous. In connection with the above statement, it would be necessary to have more detailed information with reference to the "machinery, last and patterns" item^ the "other assets" providing a very small reserve in the event of liquidation. 146 BANK CREDIT METHODS AND PRACTICE For purchase of its paper in the open market, the showing of the company is somewhat "insipid," and for this reason it would be necessary to have a profit and loss statement in order to arrive at a correct conclusion. STATEMENT NO. 2 CONTINENTAL WHOLESALE GROCERY COMPANY OMAHA, NEB. Comparison of statements shows; Quick assets: Dec. 31, 1918 Cash $19,820.35 Liberty Loan Bonds 30,851.45 Accounts receivable. 550,333.80 Notes receivable . . . 2,100.64 Mdse. inventory 875,857.33 $1,469,963.57 Current liabilities: Notes payable $590,800.00 Accounts payable.. . 138,496.00 Reserve for dividend 50,000.00 Due ofScers & em- ployees 19,031.33 Reserve for taxes . . $788,317.33 Working capital 680,646.34 Ratio 1.86 for 1 Other assets: Fixtures & equipt... $30,811.30 Good will 300,000.00 Deferred charges . . Investments $330,811.30 Net worth 1,011,457.64 Capital 750,000.00 Surplus 261,517.64 Sales 5,170,803.00 Profits 100,000.00 Dividends 50,000.00 147 Increai !e + Decrease — Dec. 31, 1919 Changes $16,371.28 47,450.00 630,440.10 1,500.75 1,002,171.62 $1,697,933.75 + $228,970.18 $785,000.00 139,347.33 40,000.00 5,100.10 13,100.35 $983,547.67 + $194,330.44 715,386.08 + 34,739.74 1.73 for 1 $B7,311.40 300,000.00 3,250.19 3,000.00 $333,561.59 1,048,947.67 750,000.00 298,947.67 6,334,510.00 113,943.00 60,000.00 + + + $2,750.29 37,490.03 37,430.03 BANK CREDIT METHODS AND PRACTICE It will be noted in the foregoing statement of the Continental Wholesale Grocery Company that the great outstanding feature is the vast amount of mer- chandise accimiulated, which would give the impres- sion of overstocking and, perhaps, food-market spec- ulation. However, a relief from the impression is found in the figures of sales for the year, amount- ing to $6,324,510.00, showing approximately six turn-overs of the merchandise account and showing the stock of merchandise to represent about two months' sales. Also it must be remembered that the excess merchandise is largely represented in price rather than in quantity. The sales in this, as in most cases, is the index figure. For instance: The accounts receivable show $630,440.10, which represents approximately one-tenth of the sales, or about five weeks' accumulated receivables, indicating quick collections and careful credit extension. While, at first glance, the debt appears large, showing same to be slightly more than the merchandise inventory, yet they show, at first glance, a somewhat favorable ratio compared with net worth, but on further analysis we find that there is represented in this net worth $300,000.00 of good will, reducing the tangible net worth to $748,000.00 and showing the surplus to be really represented by good will. The company has in cash, Liberty bonds and ac- counts receivable nearly $700,000.00, and consid- ering the fact that a grocery stock properly kept 148 BANK CREDIT METHODS AND PRACTICE and turned over as often as this stock has been should liquidate 90 cents on the dollar, the indebt- edness seems to be well secured and quickly hquid- able. The large volume of sales is in itself an assur- ance that the merchandise on hand can be disposed of within a very short time and the proceeds used, if necessary, to take care of current obligations. The dividends paid are in proportion to the earnings and the amount allowed to remain in the business as ad- ditional capital. Considering the large amount of notes payable, cash from the banker's standpoint is too small, but this seems to be characteristic of the wholesale gro- cery trade, and is due to the activity used in pur- chases for quick sales. All in all, the paper of this company should receive favorable consideration from the buying bank, so far as the statement is con- cerned. STATEMENT NO. 3 SOUTHERN GROCERY COMPANY COTTONVILIyE, TEXAS Comparison of statements shows: Increase + Decrease — Quick assets: Nov. 30, 1919 Feb. 38, 1920 Changes Cash $5,868 $25,100 Accovmts receivable 383,099 81,634 Notes receivable 31,766 18,230 Merchandise inventory 14.5,857 115,321 _ , ,. , .,.^. $566,590 $240,285 — $326,305 Current Labilities: t~ < -r , -^ , Notes payable— Banks $357,020 $74,100 Accounts payable 51,265 22,400 Reserve for taxes 11,200 11,200 Reserve for dividend 8,000 $427,485 $107,700 — $319,785 149 BANK CREDIT METHODS AND PRACTICE Working capital 139,105 132,585 — 6,530 Ratio (1.61) (3.46) Other assets: Real estate & bldgs $15,838 $25,838 Autos, wagons, etc 5,670 5,670 Furniture & fixtures 10,300 10,300 Total otlier assets $31,808 $tl,808 + $10,000 Xet wortii $170,913 $174,393 + $3,480 Capital 150,000 150,000 Surplus 30,913 34,393 + S,480 One year One year Sales $1,250,600 $1,331,400 Net profits 74,240 79,765 The comparative statements of the Southern Grocery Company show quite a contrast when com- pared with the statements of the Continental Gro- cery Company. The Southern Grocery Company's statements are purposely shown as of Nov. 30, 1919, and Feb. 28, 1920, the statement of Nov. 30th having been probably made around the time when they had accu- mulated the highest amount of receivables that they had to carry for their cotton customers. In the November statement the cash item is small and the receivables are heavy, compared with the merchan- dise on hand, and the large amount of debts neces- sarily show a more unfavorable ratio of quick assets to current liabilities than was shown in the statement of Feb. 28th. It will be noted that their debts con- siderably exceed their net worth, this condition being allowed to exist on account of the nature of their business. \^'^hile their assets are undoubtedly liquid and more than sufficient to take care of their liabili- 150 BANK CREDIT METHODS AND PRACTICE ties, their statement of Nov. 30th taken alone would make a decidedly unfavorable impression and they would more than likely be rejected by the conserva- tive bank as a basis for credit extension without a close knowledge of their real condition. However, the statement of Feb. 28th helps to reinstate confi- dence, as it shows a liquid condition as compared with that of Nov. 30th, the cash and accounts receiv- able being sufficient to liquidate their debts. A notable fact is, that outside of their quick assets, they have little other assets to realize upon in case of over-extension at a time of depreciated values of commodities. Their sales are rather out of proportion to their net worth, indicating a tendency to operate too much on borrowed capital, and a con- clusion would naturally be drawn from a casual ob- servation of their statement, that they were rather permanent borrowers, the statement of Feb. 28th, taken in their unusual liquidation period, still show- ing somewhat heavy liabilities. The accounts receiv- able in Nov. 30th statement represent about four months' sales, a marked contrast when compared with the statement of the Continental Grocery Company. It is usual, and, in fact, most wise in such cases to require that the paper be indorsed by the OAvners of the company, as they should be willing to back their credit judgment with their personal worth. 151 BANK CREDIT METHODS AND PRACTICE STATEMENT NO. 4 THE SCRAP IRON AND METALS CORPORATION Comparison of statements shows: Increase + Decrease — Quids: assets': May 31, 1918 May 31,1919 Changes Cash $13,720.19 $83,754.32 Mdse. inventories . . . 119,983.40 325,927.48 Aocts. receivable 402,936.83 367,737.27 Liberty Loan Bonds & W. S. S 5,211.37 84,254.25 Adv. on purchases . . 18,112.21 89,467.89 $559,963.99 $951,141.21 + $391,177.22 Current liabilities : Bills payable banks. $160,752.19 $450,000.00 BiUs payable others 55,021.14 3,841.70 Trade acceptances. . 18,080.23 150,945.15 Accounts payable. . . 46,237.11' 70,793.22 Due to officers & employees 17,675.41 1,817.90 Accrued accounts. . . 7,328.53 10,854.66 Customers' advances on purchases . . 35,410.31 $305,094.66 $723,662.94 + $418,568.28 Working capital 254,869.33 227,478.27 — 27,391.06 Ratio 1.83 for 1 1.31 for 1 Other assets: Real estate, bldgs. & yards $60,910.50 $101,437.62 Mchy. & equipt 7,414.29 39,749.78 Automobiles 1,870.23 2,684.10 Furn. & fixtures 1,250.35 4,119.81 S. I. &M. R. R 28,850.42 Less res. for deprec. . . . Deferred charges Due from officers & em- ployees Sundry accts. receivable. $71,445.37 870.17 540.13 Less real estate mtge. . . $72,855,617 $176,841.73 11,520.16 $165,321.57 3,887.63 18,574.60 3,153.49 190,937.29 15,000.00 $72,855.67 162 $175,937.29 + $103,081.1 BANK CREDIT METHODS AND PRACTICE Net worth 327,725.00 403,415.56 + 75,690.56 Capital 250,000.00 250,000.00 Surplus 71,545.00 147,674.32 + 76,129.32 Reserves 6,180.00 5,741.24 — 438.76 Statement No. 4, presented by the Scrap Iron Metal Corporation of Blank, Calif., furnishes the student of credits considerable food for thought. One of the most important things to consider in connection with this statement is the absence of sales figures, and these figures would be absolutely neces- sary in order to form mature judgment as to the merits of the proposition. The statement of May 31, 1919, compared with that of May 31, 1918, shows such decidedly unfavorable results that an ap- phcation for credit would be immediately rejected by the bank not already interested. While the cash was increased approximately $70,000.00, the receiv- ables were decreased $35,000.00, which would seem at first glance to indicate that the increase in cash came from better collections; but we find that the merchandise inventory was increased $206,000.00, which, coupled with an increase in the item of "ad- vance on purchases" amounting to $71,000.00, made the total merchandise account approximately $449,- 000.00, with nothing to indicate whether or not the company had increased sales. In order to accumulate this large amoimt of merchandise, their liabilities to their banks were in- creased $290,000.00 and their trade acceptances 163 BANK CREDIT METHODS AND PRACTICE were increased from $18,080.00 to $150,945.00; their accounts payable from $46,237.00 to $70,793.00. While they M^ere vastly increasing these liabili- ties to outside creditors, they reduced their liabilities to their officers and employees from $17,675.00 to $1,817.00. The only favorable item of their state- ments of assets by comparison was the increase of Liberty bonds and war savings stamps from $5,- 211.00 to $84,254.00. A very unfavorable feature of their liability items is shown by their various kinds of borrowings, showing a greatly over-extended credit condition. The statement of quick assets and current habilities for the year ending July 31st shows a highly speculative tendency, the company evidently desiring to do the major portion of its business on borrowed capital. The ratio of quick assets to current liabilities suffered a reduction from 1.83 for 1 to 1.31 for 1, their current liabilities having been increased $418,568.28 compared to an increase in quick assets of $391,177.00, resulting in a decrease in working capital of $27,391.00. While their net worth shows an apparent increase of $75,690.00, it is interesting to note that they have increased their fixed assets from $71,445.00 to $176,841.73, and there is nothing to indicate whether or not this in- crease was by acquisition of additional property or by reappraisement in order to save their surplus. The same is true of "machinery and equipment," which was increased from $7,414.00 to $39,749.00. 154 BANK CREDIT METHODS AND PRACTICE Also their liabilities are nearly double their net worth. It is also interesting to note that, while they have practically paid off their liabilities to their officers and employees, the latter now owe the cor- poration $18,574.00; and they have also placed a mortgage on their real property amounting to $15,000.00. In the statement of their current habil- ities, they show bills payable to others reduced from $55,021.00 to $3,841.70, causing the suspicion that they had not only overpaid themselves, as previously explained, in the period between the two statements, but that thej'' had also taken care of some friends. In their habilities, they have adopted every known method to save themselves from submerging in a sea of financial distress except, perhaps, the pledging of their accounts receivable, of which the statement bears no evidence. There was no auditor's certifi- cate attached to this statement. It is useless to comment further on the unfavor- able features of the foregoing statement, except to say that the only remedy that could be applied for the salvation of the company would be the cessation of purchases and a quick liquidation to the point of safety. ]55 BANK CREDIT METHODS AND PRACTICE STATEMENT NO. 5 THE PACKERS LEATHER (X)MPANY WHOLESALE LEATHER & TANNERS BALTIMORE, MD. Comparison of statements shows: Increase + Decrease — Quick assets: Jan. 1, 1918 Jan. 1, 1919 Changes Cash $590,118.30 $611,902.64, Accts. receivable . . . 2,072,317.14 2,253,583.17 Notes receivable ... 168,061.45 50,854.30 Inventories 6,119,538.91 6,001,966.19 Liberty Loan Bonds 100,500.00 10,554.10 Adv. on raw mat'l. . 5,343.66 22,175.43 $9,055,879.45 $8,951,035.83 — $104,843.62 Current liabUties: Bills payable $2,751,300.00 $2,586,310.00 Accts. payable trade 1,686,009.75 1,233,637.21 Deposits — Officers & emp'loyees 728,584.37 1,061,530.36 Acer, accts. payable 311,316.81 217,334.61 $5,377,110.93 $5,097,813.18 — $279,298.75 Working capital 3,678,768.53 3,853,323.65 + 174,455.13 Ratio 1.68 for 1 1.75 for 1 Other assets: Real estate, bldgs., mchy. & equip.. $1,300,584.19 $3,485,284.96 Furn. & fixtures.... 3,984.37 5,131.20 Rolling stock 16,872.41 13,998.76 Deferred charges .. 85,110.33 68,521.37 Investments — Stocks, etc 830,190.40 17,527.71 $2,225,741.60 $2,590,464.00 + $364,722.38 Net worth 5,904,510.13 6,443,687.65 + 539,177.53 Capital 3,000,000.00 2,000,000.00 Surplus 3,719,010.85 4,328,269.55 + 509,258.70 Reserves 185,499.37 316,418.10 + 39,918.83 Sales 18,378,190.00 31,996,000.00 Profits (before taxes).. 1,760,000.00 1,640,000.00 Dividend None None In statement No. 5 of the Packers Leather Com- pany of Baltimore, Md., Avill be found some inter- esting figures. 156 BANK CREDIT METHODS AND PRACTICE This company, in the period between Jan. 1, 1918, and Jan. 1, 1919, showed a decrease in quick assets of $104,843.62 and a decrease in liabilities of $279,298,75, resulting in an increase in working cap- ital of $174,455.13, and in ratio of from 1.68 for 1 to 1.75 for 1. To reach this condition, they hqui- dated $893,000.00 of their investments, including Liberty bonds, while for plant expansion they ex- pended approximately $1,184,700.75, which wlas practically taken care of by the liquidation of in- vestments and the increase in deposits by officers and employees, indicating that none of the bank or commercial paper borrowings were used for plant expansion. There is a serious objection by many to the prac- tice of using borrowings from officers, employees, stockholders or friends for plant expansion, it being contended that such financing should rather be based upon capital accretions or bond issues. This theory is entirely correct, as permanent improvements should not be based on quick or semi-quick liabili- ties. Under no circumstances should the proceeds of sales of commercial paper or direct bank loans be used for such purposes. The company in both statements shows ample cash reserves and highly hquid condition, inasmuch as their merchandise inventory of $6,000,000.00 should in ordinary times be readily marketable, 157 BANK CREDIT METHODS AND PRACTICE leather being one of the most quickly liquidable commodities known. Aside from showing advances to officers and em- ployees in the asset figures, they showed deposits by officers and employees amounting to $1,061,530.36, an increase from the previous year of $332,945.99, indicating a highly perfected, loyal organization whose utter confidence the company enjoys. The ratio of debts to net worth is 89 per cent., which is not much out of proportion for the line of business. Their merchandise account of $6,001,- 996.19 is, perhaps, a little large compared with sales of $21,995,000.00, taking the profits on sales into consideration, and, another sUghtly unfavorable fea- ture in the fact that on smaller sales for the year ending Jan. 31, 1918, they showed profits of nine and one-half per cent., while on the larger sales of $21,995,000.00 for the year ending Jan. 1, 1919, they showed profits of seven and one-half per cent., but this slightly unfavorable feature was more than offset by the fact that in neither year did they pay any dividends to stockholders, allowing the accumu- lated earnings to remain in the business. All things considered, the statements make a strong showing, entithng the paper of the company to favorable consideration under ordinary conditions in the leather market. I 58 BANK CREDIT METHODS AND PRACTICE STATEMENT NO. 6 DEALERS HARDWARE & SUPPLY COMPANY WHOLESALE HARDWARE Comparison of statements shows: Increase -f- Decrease — Quick assets: June 1, 1918 June 1, 1919 Changes Cash $48,975.35 $189,765.31 Liberty Loan Bonds & W. S. S 53,140.76 150,854.33 Accts. receivable .. 440,113.89 401,993.17 Notes receivable ... 4,210.30 2,670.56 Mdse. inventories .. 756,119.52 651,212.14 $1,301,559.82 Current liabilities: Notes payable $300,000.00 Accts. payable, incl. officers and em- ployees 73,815.18 Accrued taxes, incl. res. for income & war profit taxes 190,330.45 $564,145.63 Working capital 737,414.19 Ratio 2.30 for 1 Other AS'Scts I Real, est & bldgs.. . $195,000.00 Furn. & fixt. & equip., less depr. 10,511.73 Miscl. accts. rec. (incl. employees) 26,510.19 Deferred charges . . 3,906.51 $234,928.43 Less real estate mtge. notes due 10-30-30 80,000.00 $154,928.43 $163,785.20 + Net worth 892,342.62 885,021.05 — Capital: 6% cum. preferred. 275,000.00 275,000.00 common. . 235,000.00 225,000.00 Surplus 392,342.62 385,031.05 — Sales 3,500,000.00 2,600,000.00 159 $1,396,4«5.40 + $94,935.58 $410,330.00 44,819.32 220,110.23 + $675,359.55 $111,113.93 731,235.85 2.00 for 1 16,178.34 $189,981.70 18,950.78 29,987.03 4,865.69 ^43,785.20 80,000.00 $8,856.77 7,321.57 7,321.57 BANK CREDIT METHODS AND PRACTICE Statement No. 6 — Dealers Hardware & Supply Company: Cash shows large compared with the pre- vious year, but this might have been caused by bor- rowings in the open market, as the notes payable have been increased over $110,000.00. While there has been an increase of quick assets of $94,935.58, the current liabilities were increased $111,113.92, causing a reduction in working capital of $16,178.34. The merchandise inventory has been reduced by $105,000.00, and the net worth decreased $7,321.57, although there has been an increase in sales of $100,- 000.00. This would indicate unfavorable partial hquidation of the merchandise inventory or the sell- ing of some of their merchandise at a loss. How- ever, in this connection, a very pecuhar feature of the statement is that it shows accrued taxes, includ- ing reserv'^e for income and war profit taxes, amount- ing to $220,110.23, as against $190,330.45 for the previous year. The question arises, if they have made such large profits as to warrant the payment of such an amount of taxes, what became of the profits, considering the decrease in their net worth? In order to competently pass upon a loan based on this statement, it would be necessary to have not only figures for the profits made, but a statement of the profit and loss account. There are no figures given for profits or dividends. The accounts receiv- able are not excessive, considering the amount of sales and the line of business, and if their receivables 160 BANK CREDIT METHODS AND PRACTICE are good and can be considered as practically cash in connection with the large amount of cash balances and increased amount of government securities, the company should be in a highly hquidable position so far as the creditors are concerned. But the state- ment itself does not show correct proportions, and the causes for these seeming inconsistencies should be investigated before finally passing upon the loan or purchasing the paper of the company. Kil BANK CREDIT METHODS AND PRACTICE STATEMENT NO. 7 INTERNATIONAL TIRE & RUBBER COMPANY Comparison of statements shows: Increase + Decrease — Quick assets: Dec. 31, 1917 Dec. 31, 1918 Changes Cash $1,557,687.15 $1,897,198.41 Accts. receiv. less reserve 5,993,854.03 5,311,430.70 Mdse. inventories .. 18,759,433.18 15,107,642.19 Liberty Loan Bonds 215,590.68 $26,310,974.36 $22,431,861.90 — $3,879,1 12.4<> Current liabilities: Bills payalble $10,870,410.70 $8,940,900.00 Accts. payable 3,751,211.18 760,513.80 Accrued payroll . . . 28,290.23 15,050.22 Dividends unpaid... 10,510.00 5,170.00 Federal tax reserve est 1,300,437.83 $14,660,422.11 $11,022,071.84 — $3,638,350.37 Working capital 11,650,552.25 11,409,790.06 — 240,762.19 Ratio 1.78 for 1 2.03 for 1 Other assets: Real estate, bldgs., mchy., equipt., less depreciation $6,987,391.30 $7,550,418.90 Investments 305,137.83 218,001.30 Deferred charges . . 380,746.20 410,326.18 Due from officers & employees for stock subscrip- tions 470,815.50 418,991.32 Tires used on mile- age contract . . . 60,290.17 65,300.80 Good wUl 7,000,000.00 7,000,000.00 $15,204,381.00 $15,663,038.50 -|- $458,657.50 Net worth 26,854,933.25 27,072,828.56 -|- 217,895.31 Capital preferred 13,500,000.00 13,300,000.00 — 200,000.00 common 7,000,000.00 7,000,000.00 Surplus 6,354,933.25 6,772,828.56 + 417,895.31 Sales 55,000,000.00 61,000,000.00 Statement No. 7 — International Tire & Rubber Company: While the quick assets show a decrease 162 BANK CREDIT METHODS AND PRACTICE of $3,879,112.46 compared with the decrease of $3,- 638,350.27 in the current liabilities, the examination of the statement itself shows the company in a more favorable credit position at the end of Dec. 31, 1918, than it was the previous year, the ratio of quick assets to current liabihties being 2.03 as against 1.78 for the previous year. They have increased their cash from $1,557,687.15 to $1,897,498.41, and de- creased their accounts receivable from $5,993,854.03 to $5,211,430.70, and their merchandise from $18,- 759,433.18 to $15,107,642.19. This indicates a con- servative policy in a period of increasing prices. Their sales were increased from $55,000,000.00 to $61,000,000.00, but their bills payable were decreased from $10,870,410.70 to $8,940,900.00, and their ac- counts payable were reduced from $3,751,211.18 to $760,513.80, while their net worth shows only an in- crease of $217,895.31; still they show reserve for federal taxes estimated at $1,300,437.82, indicating a large amount of profits. The question again arises in connection with this statement as to what became of the profits made. Their other assets include an item of $7,000,000.00 good wiU, representing common stock, but the sur- plus item of $6,772,828.56 shows the common stock to be almost entirely backed by tangible assets. An examination of this statement, as illustrated above, again emphasizes the necessity for detailed figures showing profits and dividends paid. 163 BANK CREDIT METHODS AND PRACTICE STATEMENT NO. 8 CONSUMERS PACKING COMPANY SOUTH BEND, IND. Comparison of statements shows: Quick assets: Nov. 2, 1918 Cash in bank and on hand $580,938.50 Accts. rec., less res.. 810,0*1.70 Notes receivable 1,000.00 Inventories 3,800,057.39 Liberty Loan Bonds & W. S. S 51,200.00 $5,243,247.59 Current liaibilities :* Notes pajable $3,985,141.70 Accts. payable 204,512.04 Due officers & em- ployees , 13,001.50 Accrued int., taxes, etc 68,469.59 Res. for Federal taxes. . 170,000.00 Res. for divs. declared. . Res. for insurance Decrease — Increase + Dec. 31, 1919 Changes $290,740.80 666,880.30 6,000.00 3,065,837.35 48,510.22 54,077,968.67 — $1,165,278.93 $1,610,300.00 297,090.37 12,323.34 70,786.86 6,800.00 25,000.00 5,000.00 $3,441,124.83 $2,027,300.57 — $1,413,834.26 Working capital 1,802,122.76 2,050,668.10 + 248,545.34 Ratio Other assets: Property, plant & equip., less res. for deprec Deferred charges . . R. R. claims less res. Miscl. accts. receiv.. Investments 1.52 for 1 $2,509,318.71 51,036.16 $2,560,354.87 Net worth 4,362,477.63 Capital 2,500,000.00 Surplus 1,862,477.63 Reserves $2,094,053.08 176,908.72 17,137.50 5,881.46 8,000.00 $2,301,980.76 4,352,648.86 2,500,000.00 1,84.3,378.60 10,270.26 + $258,'!74.11 s,s:s.77 30,'n0.03 10,270.26 ^Cnntine-ent liability with respect to endorsement of notes receivable discounted $40,815.90. Statement No. 8 — Consumers Packing Com- 164 BANK CREDIT METHODS AND PRACTICE pany — makes a favorable showing as to quick assets and current liabilities, although no figures are given for sales, profits and dividends paid. There are many points in the statement, however, that would need further explanation. An analysis shows that the decrease in quick assets came about through a reduction in the principal items, i. e., cash, accounts receivable, inventories and Liberty bonds, the latter being probably through decrease in market prices. It shows favorable partial liquidation, inasmuch as concurrent with this decrease there took place a de- crease of $1,374,841.70 in the bills payable. How- ever, an indication that they had an unfavorable year is shown by the reserve for federal taxes, the amount of reserve for 1918 being $170,000.00, while that for 1919 was $6,800.00. The reserve for divi- dends can be hghtly passed over, considering the size of the company, the amount being only one per cent, on their capitalization, but if the amount of reserve for dividends were larger, then in view of the un- favorable showing of profits indicated and the fact that net worth was reduced $9,828.77, their right to pay dividends under such circumstances would be seriously questioned. Their real estate, plant, etc., shows a reduction of approximately a half million dollars. An explanation should be added as to how this reduction took place. While the statement, as stated before, shows a favorable credit position as to proportion of quick assets to current liabilities, still 165 BANK CREDIT METHODS AND PRACTICE the above points should be explained to the satis- faction of the bank. STATEMENT NO. 9 THE TEXTILE DISTRIBUTING COMPANY WHOLESALE AND RETAIL DRY GOODS Comparison e of tinitnfn od iTw.... —day- ,19 . and of all facts beteioafter sel fortb. mads to THE CHASE NATIONAl. BANK Ot thk tin. tat tlio parpOM of procoriog credit and any other accommodations or booeCts which may ba reqnenwj. Par aoch parpoaea, any lline assame that the condjtioa and aflain of (be corporation have cootinued •nbtuolially aa good as herein set fortlT DBtCl notiftad by the corporatioD to the oootrvry. llie corporation agree* lo immediately adviie the bank of any Hbatanlial change ia iti coodition or KBaJr& cmr OF Hsi* ibe book loay KILL ALL BLANKS WRITING NO" OR "NONe: VhERE necessary ASSETS LIAUILltlES ■ rii.t. In hnnln. for paper lold through Due from cuiiomers: "■' o- t to otheril^ Accoaots payable for merchatdiie ■• lo orhi-r. Dne from controlled or allied coocerns: Trade acceptaocn pavable Duelaafficcn. directon, employe-i, Deoosila of moaey with company Merchandise. tinrlfsurr, dpht When due IntereiL race Land (valued al CMt. -mortgages. Lifiii on »h.-.t MHtli if nny, in l.ahilJtIMi Mchy. A Equip. (preseni value, -mortgage*. When due Other liabaiiie* (xemiie) 1 1 [ 1 alli-l .-MirATT..- r-.«vt will Uiher osaeta (itetniie) Reaervei r b«aefil of biM Lj(« in name of -OTHER BANK ACCOUNTS laoanMmted uader lawi o( Sial« o{_ Autbotixed ciptui, Prefeireii t Common • _Dai* of Ckart«r_ ^Inoed capita), Pretarrcd |_ _Eipiratia« at chaRor^ Total Uaaiaam lodebiadncH lait je»t t_ Winimmn iadabtedoeu lait ^ear t _Dat«_ _Daio_ Exhibit No. 19 (Page 2) U th«* aartbiag io by-lasrs or ehinar of corpottxiaa limillog U* borrowing capscitr? Wh*l i Oaos COTporatioa bortow oo collateral? What kind of ™ll>tara]> il sa owiBg OD flatoRieal daleF |_ Ara thaca 407 ODseltled claim*, or Mill peodiDg, agaiair carparalion not appoariog oa books u liabilities? _ Citw amoiiot i , .._-..■_.-. Oa what ba»i* is depreciatioo cfaar|ed on bu!tdiDgi?_ Wbal il appraised value of bnildlDgi' • Are booln regularly aodiied by public accouaUDH>_ Civa oaiae* of aeeouatants who made last audit Oq machiiiBrj and equiptoeoi'_ Ot machiDery aade0B1 Firm Name .-. Home Office (PARTNERSHin Tbe folbwiog is a irne ot tbe fiouicial coodiiioa of this partoership at the close of baainesi od the day ._ -...Ifl. and of all (acts hereinalter set forth, made to the THE CHASE NATIONAL BANK orTUcmoPNEw voDKrfor the porpose ot procuriag credit and aoy oth-r acconunodKiiou or bencGts which itu; b« requested. For tacb porposes. the book maj at an; lime asanme that tbe cooditioo aod aSairs of ihe firm have coniiaaed substaotlally as good r» bereia set forth ODtil tMXified b; the ^nn to tbe contrary, Tlie firm agrees to iiDmcdiaielf advise ibe baok of nay snbsiaotial cbaDge ■□ it* coadiiioo or aflain. HLL ALL BLANKS WRITING "NO" OR "NONE" WHERE NECESSARY ASSETS LIABILITIES 1 ruhnrihanit for paper told through -—•-I On n7*n arrnnnt* V Depooite of mooer with firm , Hafchaodae- TiwiL nr •^rrn— >|te df Give amoaol o( cocb reserve on ■tatemeol date S , REAL ESTATE Oo what haws -do' y> rtnag»dt]pi*«o foo borrow oftceUUanBz TBha* Mod d «^fa*«»W Ciw onxtoni >o owios <» wawnwovAwe' _ An (bare iiiiji iiaiiiWilT rtMiiKi of-3ni^ i p«!ndk»ft apmsl yoor firm bM appearing oo poor boota ^ liabUif^B i ^ Oive amouii f^j , , Xn foui liiii*nmmii> — dfte^by paWp aBOoaausuf Giw dair ol lad andh _ *1[ yoD seH c uuBd w m lrty j pO'ffiaoiigb bnte*#vr itfhars. ghw (BBki of aoch braken (or ocbers>_ Tlile dam on wttTclr yOD ragtflavV '■^ ExHiRiT No. 20 (Page 3) M6M0ERS OF WiRU PI«Me BSD bne^ {k Bcmbar at Ibe &<- EsHHiiT No. 20 (Page 4) To the MISSISSIPPI VALLEY TRUST COMPANY SAINT I/3UIS. MISSOyft! For Uw patpom« af procorloB crefii bom dm! to dnie (ram joa lot nj aif odable paper m oiben*tie, I fUnUb yam with Aa lollawlac ■UtcnCDl. wbich tally aad inlj ■c|» Ijinb 07 QovpefaJ caadJtIon on ibc— _.-.. iMf 9I — --, — .iw— — . ■bleb autcmeDt 700 emn conaldcr u contlDalaK to be tiill aiid accurate uDleca wriiien qoi1c« of chingo !• (I*ea yo^ I eSTea Is nottfy you pfonplly ofaoj cbange tbat mateilallj rcdueea my BoancUl reapopilbillir or JeopnrdUealn aur way ibe value of the ((cq/hy twck of 017 a)>UgatioD to 70a. Assets I Own Debts I Owe CASH rw "*,"*- CaSB ON HAND » AC CB rrqs PAYABLE X^OUNTS PAVABLE 1 HOTBS SacnRBD BV ■MDORSBMENT AND CON3ID KKED COO D ATTBL MORTCACBS _ BOTES SBCDRBDBV RBAE, ESTATE noCES AND BONDS rSR SCHEDULE 8 1 K nrCACES AND LIENS ON KIAL BSTATE ; RKAI, ESTATE IK My NAME PER SCEtEDDLE LIVRSTOCE lUCHINXEV £ s' s ■ JTAL ASSETS • TAL DEB1% ET WOETB TOTAL ASSSn TOTAL debts Exhibit No. 21 — Financial Statement (Personal) I ■ ■ ■ i! Met tileck bkI lot muntiei SCHEDULE OP STOCKS, BONDS AND SECURITIBS Pab Valdx •PtHDCKD llARKBT VaLOB - - :::: -- «- -•- - ....,..„ ^ — -'■■■- -•- •9uMti(Mdaai»N Exhibit No. 21 (Page 2) rnvmAiKjie^iiiuiDON hv-^psS uvz STOCK ccwmrs ow •>«» nncKAHCB AND TORMADO INSDRARCI tums oijrsTAKDiwc. payable to Moras SNDORssa. for wuou CHATtBL UORTOAOBS. IN FAVOR OF Exhibit No. 21 (Page 3) BANK CREDIT METHODS AND PRACTICE If a firm, the f onn to use would be as shown in Exhibit No. 20. If a personal loan, based upon his credit stand- ing and wealth, he should be asked to fill in and sign Exhibit No. 21. As explained in the preceding chapter on state- ment analysis, the credit man should then obtain a full explanation of aU items on the statement. The loan application should be written up as given on form below, and if authorized by the executive of- ficer who first handled the customer, the latter's note shoidd be discounted, the money placed to his credit, and then the loan should be submitted for final ap- proval of the finance committee. If the customer is not in a hurry, the loan proposition should be first submitted to the executive conrniittee or finance committee for their approval. The custom varies in different banks. In some large banks the executive officers pass on all loans, granting or dechning ap- plications according to their relative merits, and then submit the loans granted for approval of the executive or finance committee two or three times a week; while in other institutions, the granting of loans is almost exclusively the function of the finance or executive committee. The following is suggested as a form of loan ap- plication : 199 BANK CREDIT METHODS AND PRACTICE FORM OF LOAN APPLICATION THE IRON MANUFACTURING COMPANY (Iron & Steel Castings). CHICAGO, ILL. Application: — ^The Iron Manufacturing Company, line of credit not to exceed $50,000; commensurate balances to be maintained. CAPITALIZATION— JAN. 1, 1919: Capital $150,000 Surplus 215,26T SYNOPSIS OF STATEMENT-hJAN. 1, 1919: Quick assets $239,511 Current liabilities 107,930 Working capital $131,581 Ratio (2.12) Other assets 233,686 Net worth P65,367 SALES— 1919: $545,000. NET EARNINGS— 1919: $110,000. DIVIDENDS— 1919: $9,000. ANTECEDENTS & PERSONNTEL: This is a close corporation owned by John R. and Clifford S. Stacy, who organized the company in 1896. In 1898 it was incorporated imder the laws of the State of Illinois with an authorized capital of $50,000, which was increased in 1915 to $100,000, and in 1917 to $150,000, all of which is issued and fuUy paid. The Stacy Brothers are both middle aged, of excellent reputation and high personal standing. They are considered very capable in their line and from a small beginning have built up a large and prosperous business. Their business records are clear. MAXIMUM PERIOD— March to August. MAXIMUM BORROWINGS— $100,000. MINIMUM PERIOD— October to February. MINIMUM BORROWINGS— $10,000. COMPARISON OF SALES & NET WORTH: Sales Net worth 1915 $215,450.80 $186,500 1916 398,261.44 199,100 1917 532,261.35 246,921 1918 545,000.00 365,266 TRADE INFORMATION: Current supply bills reported promptly paid by Dun's and Brad- street's reports "Company is in high standing in the trade and meeting its obligations promptly." 200 BANK CREDIT METHODS AND PRACTICE Dun states "Concern last fall purchased a part of the equipment, stock, etc., of the Miller Manufacturing Compaiiy of Toledo, Ohio, and amount owing in that direction is payable in monthly installments." DETAILED STATEMENT AS OF JAN. 1, 1919 QUICK ASSETS: Cash $3,400 Merchandise 173,763 Liberty Bonds 1,663 Accounts receivable 61,686 $339,511 CURRENT LIABILITIES: Bills payable — personal $11,990 Bills payaible bank 40,000 Accounts payable 41,354 Deposits 5,300 The Miller Mfg. Co 9,486 $107,930 Working capital $131,581 Ration (3.12) OTHER ASSETS: Real estate $199,833 Machinery & fixtures 31,063 Autos, wagons, etc 3,300 Patents 9,500 $333,686 Net worth $365,367 Capital $150,000 Surplus 315,367 BANK & TRADE INVESTIGATION: Bank No. 1, Chicago, 111., 3-10-19. We consider the Iron Manu- facturing Company among the very best of our customers and their record for payment and financial responsibilty is excellent. Bank No. 3, Chicago, 111., 3-10-19. The statement of this concern shows that they have a capital of $150,000.00 and a surplus of $315,367.00, doing a large and successful business, well and ably managed; and the company is owned by the Stacy Bros., both of whom have been associ- ated with the business a number of years and stand high locally. Bank No. 3, Chicago, 111., 3-10-19. These people are considered one of the best companies in our city. They have been residents of Chicago for yeaw. They are excellent men m,orally, and are worthy of a line of credit. Brown & Company, Springfield, 111., 3-10-19. We have bad business dealings with the Iron Mfg. Company of Chicago, covering a period of about twenty-five years, and we regard their account as entirely satis^ factory. Their Mr. John R. Stacy, President, is a man of exceptionally 201 BANK CREDIT METHODS AND PRACTICE high character and ability and we have entire confidence in bis word. Our accounts with this company range from $2,000 to $10,000. Terms are 30 days and payments are prompt without exception. Miller, Weidle & Co., St. Louis, Mo., 3-11-19. We have been seUing the above company for a consideraible time on a 30-day basis without discount privilege. They have not always paid promptly in SO days. Sometimes their accownt has gone 60 days. It has run as high as $5,000, but usually averaging around $3,000. They are well rated and we are not in position to say just why they are slow at times, as the statement which they furnished us makes a good showing. Landis Mfg. Co., Detroit, Mich., 3-11-19. Sold several years. High credit $1,900, past due $1,600. Terms 30 days. Payments SO to 60 days slow. GENERAL REMARKS: The company has a modern plant, erected last year on their real estate in Chicago. They own eighteen acres of land in the busi- ness section. It is adjacent to all the railroad stations and has splendid switching facilities. Their shipments are not only domestic, but quite a percentage of them are to foreign countries. Their foreign shipments are all paid for in advance and are sold f . o. b. Chicago. They have a very conservative policy, both as to their accounting system and credit system, and secure themselves against loss on every shipment by either demanding cash in advance where a. company is inclined to be slow and shipping on credit only to those absolutely good. They carry their real estate at a very low figure and their merchandise account of $173,000 has advanced considerably in price since purchased. Their record of growth has been steady and satisfactory, their net worth having increased from a deficit in 1894 to $365,000 in 1919, and their sales from $5,000 in 1894 to $545,000 in 1919. The company banks at the Bank of Chicago, where it owes $30,000. It also owes $5,000 to the Bank of St. Louis and $5,000 to the Milwaukee Trust Company. RECOMMENDATION : This company seems to have had a very good record in the way of sales and increased earnings. The personnel seems to be first-class, and the only criticism is the two trade references reporting tjie company slow at times. In view of the company's progress and apparent liquid condition- the line is recommended as desirable. Respectfully, MANAGER CREDIT DEPARTMENT. The policy of the loaning organization of the bank should be one of preparedness. The bank should not wait until the day the loan matures and 202 BANK CREDIT METHODS AND PRACTICE the customer requests a renewal before deciding what to do. There should be a loan committee, consisting of three officers of the bank, whose duty it would be to examine carefully all loans about ten days in advance of their maturity, keep in touch with the security of the loans; that is, not only the securities hypothecated as collateral with the secured loans, but also the condition of individuals, firms and corporations that have loans not secured by col- lateral. The Credit Department should prepare for this committee a record of each maturity on a form as illustrated in Exhibit No. 22. r«» ,A. © » tA^n-v- InJ. U below Um ObtkHl SuK uUiiad. PidcUk ■tNoW- GCai>TERAL Exhibit No. 22 — Record of Maturities 203 BANK CREDIT METHODS AND PRACTICE There should also appear at the bottom of this form the approval or disapproval of the loan com- mittee, together with recommendations as to rate or possible partial payment advised. On the hne "O K'd by" should be shown the initials or names of the executive officer who originally authorized the loan. In addition to the description of the col- lateral pledged to secure the maturing loan, which description is given on the body of the sheet, there should also be a list of other indebtedness, with a description of the maturity of each note and of the collateral security. The credit department should total the entire indebtedness and value of total col- lateral and show the current account and other re- lations of the borrower. This is best accompHshed by attaching a "sticker" to the sheet, as shown by Exhibit No. 22a. Attached to this sheet should be the card record of the customer and affili- ated customers, showing all average balances and loans carried (Exhibit No. 17). Inasmuch as this card is especially adapted to the use of trust com- panies with several departments, the form used by the Union & Commerce National Bank of Cleve- land (Exhibit No. 23) and which conforms to the requirements of a national bank, which is not a highly departmental organization, is suggested as a substitute for National and State banks. 204 ■I pa Ek bdow. SbMiWcW. Sme'a Vhen IiOBji Hade_ Hl^eafc AEUjunb qf Iioan_ Recomoenda bion: Committee on Loftn3_ Total Indebtedness C/A Bal. . OA Bal Average C/A fialanoeai 1319 « 1920 t 1921 i Affiliations »lth Otlier Departments Borrowings of Affiliated Aooounts TOM. Conoittee on ManageTiient_ Exhibit No. 22a — ^Loan Renewal Sheet Hi "'•"'■""•"" O K b a <» o> 2 -■ « III ft « -I •^ a a •^ o « J 4 .1 o < J D o a a 4 a a « .1 » a « a«^a«-t»«ijo«>ea.ta'€ja«ja«jaajfi«^Q«ja a«ja«.ts«.40«wB«.*a«.«o«^a«jla«.ieitJa4ja 111 B«-a*-a«..o..,a,jfe«.,o«..D»-fl.^a,..J,^ BANK CREDIT METHODS AND PRACTICE This card has some excellent features which recommend its use to any institution, one of the most important being its separation of loans, discounts and acceptances, with separate columns showing the maximimi and minimum amount of each. The reverse side of this card. Exhibit No. 24, shows a simple record which takes care of the requirements of a national bank. Account cloieJ Othaf Bank Aceowrt. Exhibit No. 24 — Reverse Side of No. 23 Where it is desired that the record of average balances and loans be filed in the credit file itself, a form used by the Guaranty Trust Company of New York is suggested (Exhibit No. 25). When the loan is passed upon by the loan com- mittee, the records described above should go to the 207 GDuapty Tnut Company of New Yorir CREDIT DEPASnSIEKr 00 Omitted Liberty LAum not Inclnded * Indicate* ProportioD o( Balances to Loana 19 IS s.™-'^"%.»..,« BalMCeB * ^ ■..^--l.™, Baluicea » S«nrft) UoHCBitd Balinces « Jan. Jan. Peb. Uar. - Uar Uay May Jane June Jdy July Sep. Sep. 1 0«- Nov, Stn. Dec. Dec. bold 1«KI ■' 1 " 19 i«.,.d"'*''l.«.™i I B.l.n=M| » i„»i"'"%~™. 1 ?•■""• 1 » LOANS 3«n»d UiHKQnKt Balances » Ju. Foto. Feb. Mar. Mar. Apr. 1 Apr. M.7 1 1 Jan. 1 Jme i Jul7 , 1 .£fijt. Sen. Ott. Mot, Kov. ..' Dec. .■SS . »!S -^' •1 nai nns ■ POI OFl nctn *■" ■«■ °' MB. ... Bfl VINO uc TC Exhibit No. 25 — Average Balance and Loan Card BANK CREDIT METHODS AND PRACTICE Discount Department, which is thus advised of the proper action to be taken when the borrower visits the institution with reference to the maturing loan. The average balance cards, however, should go back to the Credit Department at once. The entire rec- ords in each case will finally go to the executive committee for its approval. In no event should the loaning organization of the bank be guilty of unpreparedness in the handhng of a customer's loan. There is nothing more pleas- ing to a good customer than the freedom and ease with which a bank facilitates his transactions, and there is, on the other hand, nothing so unpleasant to him as experiencing difficulty in getting action on the part of the bank. In all banks in which there is a credit manager, he should be a member of the loan committee; or, if not a member, he should be called into all its councils on account of his familiarity with the details of the loans. The handling of collateral loans based upon stocks and bonds hsted in the different prominent exchanges is not difficult because of the readily available quotation hsts at the command of all bank- ing institutions, but in many cases the loans desired by customers carrying good accounts with the bank will not be based upon such collateral and their ap- proval will, therefore, be more difficult. In such an event the credit manager should always handle the 209 BANK CREDIT METHODS AND PRACTICE loan and question the borrower closely as to the valuation he places upon the collateral offered, get- ting a minute description of same and then have the valuation verified by independent investigation. It is not well to pass upon such loans hurriedly unless the known wealth of the customer and his relations with the bank justify doing so without question. It is with this latter class of loans that banks usually get burdened and find the greatest difficulty in hquidating. There is no set form in use for getting such information from a borrower, as the descrip- tion generally varies in each case. The credit man- ager should have the facts dictated in as well clas- sified and systematic manner as possible at the time of the interview. In connection with hnes of credit granted to bank and commercial customers an important point to be considered is the danger of the bank getting over-extended by reason of the fact that all lines of credit are not used simultaneously, and if the bank gauges its commitments by the actual loans out- standing it may get into serious difficulty at a time of great demand for money when most of its cus- tomers may simultaneously call for their lines. For this reason the Credit Department should keep a record constantly up to date showing each hne of credit granted, the amount taken, and the balance available to each customer. In the same record 210 BANK CREDIT METHODS AND PRACTICE should be shown against the lines of credit granted the average balances maintained by such commer- cial and banking customers. In some instances a progressive bank wiU grant a line of credit to a pro- spective commercial customer without definite assur- ance that it is going to be used. Such lines of credit should be tentative and should not be included in the record until definite assurance is given by the pro- spective customer that he intends to open relations with the bank. 211 CHAPTER XII INVESTIGATION AND COMPILING INFORMATION If the organization of the Credit Department has grown to respectable dimensions and a considerable volume of credit transactions passes through the de- partment, the clerical forces should be divided into subdivisions; for example, filing, stenographic, in- vestigation, research, analysis and ansv^ering of in- quiries. Outside of the fihng division, which has to be as nearly perfect as human ingenuity can make it in order to conserve the interests of the bank, the next most important subdivision is the investigation divi- sion, which should be up-to-date and alert in all its activities. A prospective borrower likes best that bank which gives him the most prompt action. And, also in the assimilation of information bearing on a commercial paper note purchase within the ten-days' option allowed by the broker, it is vitally necessary that the greatest promptness should be observed by the investigation division in securing adequate infor- mation. In order to systematize the work, we will give a description of how we think this should be handled in a modern Credit Department. The credit manager should use a form similar to 91? BANK CREDIT METHODS AND PRACTICE Exhibit No. 26, patterned after that used by the National City Bank of New York: INVESTIGATION Name Business Address Write — Banks Write — Trade Interview Local Trade — General Special Have sent for — Bradstreet's report Dun's report Reason for Investigation — Revision New Account Commercial Paper Foreign Exchange New Business Domestic Foreign Exhibit No. 26 — ^Credit Investigation When filled out, this form should be handed to the investigation division. In writing letters of inquiry to banks, especially on commercial paper names, some banks, in the past, 213 BANK CREDIT METHODS AND PRACTICE have followed the practice of writing to nearly every bank in a particular city. This, in nearly all in- stances, resulted in the one or two banks carrying the account of the name inquired about receiving numerous telephone inquiries from the other banks written to, causing irritation, confusion and unneces- sary duplication. If more than two banks are writ- ten to, it should be stated in the letter of inquiry that inquiry is being made of several other banks in that city. Or, if a bank not having the account of the name inquired about is written to, mention should be made of the fact that the inquiring bank knows that the bank inquired of is nuv directly inter- ested, but would, perhaps, be able to give informa- tion of value from its files. Following are suggested forms of inquiry letters suitable to each case men- tioned : Simms National Bank, Chicago, 111. Gentlemen : We have occasion to inquire in regard to the financial re- sponsibility and standing of John Doe & Company, 33 LaSalle St., and having been referred to you, shall be pleased if you will kindly furnish us any information jou may have or can readily obtain in this connection. Thanking you in advance, and assuring you of our readiness to reciprocate the favor, I am Yours very truly, 214 BANK CREDIT METHODS AND PRACTICE LaSalle National Bank, Chicago, 111. Gentlemen; We have occasion to inquire in regard to the financial re- sponsibility and standing of John Doe & Company, 33 LaSalle St., and having been referred to you, shall be pleased if you will kindly furnish us any information you may have or can readily obtain in this connection. The above company is contemplating relations with us, and we would like to have the benefit of your experience. Thanking you in advance, and assuring you of our readiness to reciprocate the favor, I am Yours very truly, Jameson Trust Company, Chicago, 111. Gentlemen : We are revising our files, and write to inquire as to the pres- ent financial responsibility, standing and prospects of John Doe & Company, 33 LaSalle St., and shall be pleased if you will kindly furnish us any informa- tion you may have or can readily obtain in this connection. We are writing also to those banks who have the account, Lat would like to have the benefit of your knowledge concerning the same. Thanking you in advance, and assuring you of our readiness to reciprocate the favor, we are Yours very truly. In cases where the banks are located in the same city as the inquiring bank, the information should be gathered by personal interview rather than by 216 BANK CREDIT METHODS AND PRACTICE correspondence or telephone. (The telephone should not be resorted to except in cases of extreme urgency, as most banks object to giving information over the telephone.) The investigator should, upon his return to the office, make a condensed report of the result of his interviews, and hand the same to the division of analysis, where the information is being systematically compiled. The same is true as to the compilation of trade information, which should be conducted personally instead of through correspond- ence, if possible. In many instances, however, the mercantile or manufacturing concerns may be lo- cated in such remote parts of the city as to render this impracticable, and then the investigation divi- sion should resort to correspondence. A feature of trade information that detracts much from its value is the frequency with which the bank credit department receives meagre answers from mercantile concerns. Some of these concerns, instead of going fuUj'^ into the facts in each case, giving a narrated history of the account and the quaUfication of the customer, merely stamp a ledger record on the back of the letter and return it to the bank. Sometimes this record wiU read: "Purchased ten bills; highest credit $500; prompt pay". It might be contended, however, that this information is valuable in that it shows the manner in which the bank's customer takes care of his trade obligations, '»ut the bank has to rely upon other bank and also 216 BANK CREDIT METHODS AND PRACTICE mercantile agency information for the antecedents and general qualifications of the borrower. The in- quiring bank is always better satisfied when a nar- rative history of the paying record and quahfications of the customer is furnished by the trade, as well as by banks, in letter form and signed by an officer of the concern of which the inquiry is made. Many mercantile letters, both of inquiry and answer to in- quiries, are signed only by the typewritten or stamped name of the company. A suggested letter of inquiry to the trade is given as follows: Johnson & Sons, Brooklyn, N. Y. Gentlemen : We have occasion to inquire in regard to the financial re- sponsibility and standing of James Roe & Company 178 Broadway, New York, and, understanding they are known to you, shall be pleased if you will kindly furnish us any information you may have or can readily obtain in this connection, particularly with regard to their standing in the trade. Thanking you in advance, and assuring you of our readiness to reciprocate the favor, I am Yours very truly. In writing to banks for information on any name, it is well to state, in most cases, the reason for the desired information. Banking ethics demand that in a case where one bank is endeavoring to 217 BANK CREDIT METHODS AND PRACTICE secure a portion or all of a commercial accomit car- ried by another bank in writing or approaching the other bank the reason for desiring the information should be frankly stated even though it means fail- ure to secure the business. At a meeting of the Robert Morris Club, held in Detroit, the following resolutions were passed pertaining to banking ethics: Resolved, that it is the sense of this conference that the continued observance of high ethical principles in the conduct of credit departments of banks and banking institutions insures the best results and cooperation in safeguarding banking credits. Resolved, that it is not permissible nor the part of good faith in soliciting accounts from a competitor to seek information from the competitor without frankly stating the object of the inquiry. Resolved, that it is the sense of this meeting that in answer- ing inquiries the source of the information should not be dis- closed without permission and that letters written in answer to inquiries should be held inviolable by the recipients. Resolved, that in seeking information the name of the in- quirer in whose behalf the reference is made should not be dis- closed without permission. Resolved, that in answering inquires it is advisable to dis- close all material facts bearing on the credit of the borrower to the end that paper offered in the open market be of the same de- scription as that held by the borrower's own bank. The following resolutions were also adopted: The first and cardinal principle of credit investigation is the sacredness of the replies and any violation of this principle places the violator beyond the pale of consideration of the honest credit man. Every letter of inquiry should indicate in some definite and conspicuous manner the object of that inquiry. 218 BANK CREDIT METHODS AND PRACTICE When more than one inquiry on the same subject is simul- taneously sent to the banks in the same city, the fact should be plainly set forth in the inquiries. Individual consideration by the recipient of a credit inquiry of the distinguishing marks therein will increase the efficiency of credit investigation. Indiscriminate revision of files regardless of the presence of the note in the market is unnecessary, wasteful and unde- sirable. Mercantile agencies, such as Bradstreet's and Dun's, cover the field of credits with an intensive organization. They have been established for a great many years, during which time they have suc- ceeded in building up information files of vast pro- portions. These reports are extremely valuable in their antecedent records. They are practically the only medium of information available to the bank credit department in securing the history of a bor- rower or prospective borrower or commercial paper name dating back to the inception of the business tmder consideration. When an agency report is furnished, which, in the judgment of the credit manager or the investi- gation division, is too old, or is a duplicate of a re- port furnished on the occasion of a previous investi- gation, it should be returned to the agency and an up-to-date report requested. The reports of the agencies should be carefully scrutinized for any in- formation in them which would tend to show dehn- quency on the part of the borrower. If the bor- 219 BANK CREDIT METHODS AND PRACTICE rower has gone through bankruptcy at any time in his history, it should be a danger signal to the com- mercial paper buyer and a warning for the exercise of extreme caution on the part of the lending bank. In most cases where individuals or concerns have failed and gone through bankruptcy, it casts a cloud upon their credit. There are some exceptions, how- ever, to this rule. Careful investigation should be made of the circimistances surrounding the failure, as there are many cases on record where business men have taken advantage of the bankruptcy courts to relieve them of too heavy obhgations and en- able them to make a fresh start, but after having succeeded in their new ventures they have taken care of the old obligations removed by the bankruptcy court. Such business men should be entitled to the highest consideration as credit risks. It should be the function of the mercantile agency to supply in- formation of this character in each individual case. To be really effective, a mercantile agency re- port, properly written, should be classified or sub- divided in something like the following manner: History of concern Capitalization Personnel Antecedents of personnel Financial Statement Verification of cash statements at banks Banking record Trade information and paying record 220 BANK CREDIT METHODS AND PRACTICE Record of growth with comparative figures of net worth, sales and earnings Conclusion Rating In any agency report there will sometimes ap- pear inconsistencies which, when explained, are justi- fied by circumstances. For instance, a new concern with a capitalization of over $1,000,000, which has recently started in business with apparently ample capital and a good paying record, and about whose personnel no question is raised, will sometimes be rated AAA 1%, which indicates second-class rating for the capital invested. The reason given for this second-class rating is that the company being new has yet to demonstrate its success, although all other features may be highly in its favor. There may be other features entering into the report causing such rating which will be apparent to the investigator after he has become experienced in his work. When the investigation division is satisfied with the fullness of the answers received to inquiries made, these reports should be handed in condensed form to the credit manager. In the meantime the analysis division has had the statements analyzed, and these analyses are also handed to the credit nanager, who has before him all other facts neces- sary to the compilation of the credit file. A credit file, with a loose-leaf feature in which this information can be arranged as desired, is un- 221 BANK CREDIT METHODS AND PRACTICE doubtedly the niost satisfactory form of file, as it permits the rearrangement and insertion of new re- ports and additional credit information, and, at the same time, presents the credit information in a con- densed form which can be quickly grasped, in addi- tion to safeguarding the loss of the various records which go to make up the file. There are many forms of credit files in use in the various banking in- stitutions, some of the features being developed to meet the requirements of each particular bank or trust company. For the purpose of illustration, we will describe a model credit file (Exhibit No. 28) recommended for use by an up-to-date Credit De- partment. The information contained therein is sep- arated by index sheets as follows: "agencies," "statements," "correspondence," "special information" and "investigation" The folder itself is made of stiff pasteboard. All the records and statements in each file are securely fastened to the folder by means of metal clips. On the left side of the folder before the index "Agen- cies," the reports from Dun's and Bradstreet's, as well as any local agencies, are placed. This keeps all the agency reports in one place, affording ready reference to which revised reports can be added from time to time. Next comes the "Analysis" sheet, on which is shown a comparative analysis of statements for a 222 BANK CREDIT METHODS AND PRACTICE number of years. An analysis of the latest state- ment on file, as compared with the previous year, is prepared on the typewriter, showing increase and decrease for the period, as well as comments on the statement, and this is also filed with the compara- tive statements under the index sheet, marked "Statements". On the right side of the folder ap- pears a "History" sheet, a sample of which is given in Exhibit No. 27. This sheet contains in condensed form a brief history of the subject company, showing the date the relationship was established, the character of the business, who introduced the account, the names of the officers or partners, other affiliated accounts, the broker handhng the company's paper, as well as its banking connections and the line of credit granted, if any, and when granted. Under the index sheet "Investigation" is placed the condensed report of the investigation division. Then the correspondence is filed under the proper index sheet. This means that the information com- piled by the investigation and analysis divisions, as well as all the information secured from the various sources, including personal calls on local commercial houses and banks, is now incorporated in convenient form in a folder from which the credit manager can secure information which will enable him to handle the proposition intelligently and with dispatch. Ex- 223 OPFKUS 01 rMnEKS ouTsiDt iimMsn UOKO ■AMI Actoinm AFFIUATED ACCOUms unor cmMTCXAno Exhibit No. 27 — History Sheet BANK CREDIT METHODS AND PRACTICE hibit No. 28 is an illustration of this folder as it appears when open, which will undoubtedly give the reader a clear idea of its form and construction. Concurrent with this file there is used a similar pasteboard folder without index sheets for the flh'ng of letters and miscellaneous other memoranda, this being done to keep the real credit file in concrete condition and also from getting too voluminous. In a great many banks all commercial paper purchases for the banks' own investments are made by an executive. He passes on the paper and then submits his purchases in bulk for the approval of the finance committee. In other banks all purchases are required to be authorized by the finance committee. The latter plan is obviously not as good as the former. Through the first mentioned method the bank is enabled to get the benefit of desirable paper by quickly taking advantage of choice offerings. It can in this way successfully compete with other banks similarly operated. If the second plan is fol- lowed, the officer charged with the duty of selecting the paper is compelled to await the action of the finance committee before he can make his purchases, and in this way the best and most desirable paper gets beyond his grasp. In either case, the Credit Department should use a printed form for presen- tation to the finance committee. It can be changed to suit each individual bank. These forms, when 225 /COSRESPONOENCEYsPKIAllNFORMATIONy INVESTIGATION ^ m^M& ^m SlN3UJ31ViS( — - BANK CREDIT METHODS AND. PRACTICE filled out, presented to, and passed upon, by the ex- ecutive committee should be retained in the credit file of the Credit Department for future reference after the cashier or secretary has made his minute therefrom. After commercial paper purchases are finally ap- proved, the Credit Department should notify all makers and endorsers or guarantors of the purchases made, giving dates, numbers, amounts and maturi- ties of the notes, together with name of the broker from whom purchase was made. In addition to the paper that a large city bank purchases for its own investments, it is also called upon almost continually to make purchases of paper for its country bank correspondents. These purchases are usually handled by the Credit Department with- out being passed upon by the finance committee, this custom varying in different banks. In any event the same amount of care, diligence and watch- fulness should be followed as is observed in the pur- chase of the bank's own investments. A large bank should for this purpose keep several hundred first- class commercial paper names regularly checked, with the files kept in an up-to-date condition. Although a great many fiscal statements are issued under dates of December 31 and July 1, each year, the inventory dates vary with the differ- ent companies. The Credit Department should keep a chronologically arranged tickler record for 227 BANK CREDIT METHODS AND PRACTICE such statement dates, and after a reasonable time has elapsed to allow a company to complete its state- ments after inventory, an effort should be made to obtain a copy of the statement. When these statements are received, they are analyzed by the analysis division of the Credit De- partment, as explained in the chapter on Statement Analysis, and are brought up for review and con- sideration of the executive officers and finance com- mittee if the bank is interested. In large institu- tions, where a considerable number of these state- ments have to be analyzed daily, the system used by the Federal Reserve Bank of St. Louis is recom- mended. (Exhibit No. 29.) This system saves a great deal of time and labor, and is operated in the following manner: An ex- pert in the analysis division takes the statement as it comes, and, commencing with the first item, desig- nates by number in pencil markings how each item should be classed. For instance, if the statement as presented shows merchandise in the first place, in- vestments in the second place, buildings in the third place, cash in the fourth place, accounts receivable in the fifth place, etc., they are marked up by him, as follows: 5 Merchandise 20 Investments 15 Buildings 1 Cash 4 Accounts receivable 228 LOCATIOH ACCOUKTANTS DATE 1 Ci>h 4 AccounUReeeivible S Merchuidi»njtYcar 58 MditNot [nclu-l^d in Inveniory or Alcli- Payable M> Endorierj Worth OulJ^i Thu Bunnell , 64 65 Exhibit No. 29 — Statement Analysis BANK CEEDIT METHODS AND PRACTICE When marking is completed, the statement is handed to a machine operator, who is thus enabled to make a rapid and automatic analysis. In the research division information should be compiled in connection with all securities that are held by the bank as collateral and are not hsted on the principal stock exchanges. Many institutions are not satisfied with the stock exchange figures and go deeply into intrinsic values represented by stocks and bonds. The necessity for this will be apparent when it is remembered that some stocks may be sub- ject to speculative influences, either "bulls" or "bears". Especially is this investigation necessary in the management of securities of trust estates handled by a trust company. This research work is sometimes done in the Credit and Analytical De- partments and sometimes in a division of the Trust Department. The duties of the research department of the Credit Department of a large institution should be the compilation of information with reference to crop and trade conditions in the particular territo- ries served by the institution, and also, in connection with its commercial paper purchases. It should in- vestigate general agricultural and trade conditions throughout the United States, classifying each in- vestigation according to the different lines in which the bank is interested. It should for this purpose keep a book record of all commercial paper pur- 230 BANK CREDIT METHODS AND PRACTICE chased; first, according to territories, and Second, according to lines of business. There is no particu- lar form recommended for this purpose, as each institution can devise one to suit its own purpose. The sheets should be kept in a loose-leaf binder. The best method of compiling such information is through the correspondent banks and also through the large merchants situated throughout the differ- ent sections. It is well also that the Credit Depart- ment should subscribe to the service of some reliable statistical and research organizations. In either the analysis division or the research division of the Credit Department records should be kept of the comparative ratios shown by the state- ments of different companies in which the bank is interested. A suggested form for such a purpose is shown in Exhibit No. 30. Name COMPARATIVE RATIOS Date 1 A. Assets to Cur. Liabilities Accts. and Notes Rec. to Mdst. Net Worth to Fixed Assets Sales to Accts. and Notes Rec. Sales lo Merchandise Sales to Net Worth Total Debt to Net Worth Exhibit No. 30 — Comparative Ratio Card 231 BANK CREDIT METHODS AND PRACTICE In the large financial institutions situated in the principal cities of the country, the answering of let- ters of inquiry involves a considerable amount of work in the Credit Department. Sometimes several hundred inquiries are received daily in such institu- tions, bearing on their customers and also commer- cial paper names in their files. Considering this from the viewpoint of such banks, the demand should be made as light as possible by the use of discretion on the part of the inquiring bank, as here- tofore mentioned. In answering such inquiries, a financial institution should use a form of letterhead bearing the following notice to its correspondents: All persons are informed that any statement on the part of this bank or any of its officers, as to the responsibility or stand- ing of any person, firm or corporation, or as to the value of any property or securities, is a mere matter of opinion, given as such and solely as a matter of courtesy, for which no responsi- bility, in any way, is to attach to this bank or any of its officers. This is made necessary by reason of the fact that in many instances bank and commercial correspond- ents carelessly violate the confidence placed in them by disclosing facts contained in such answers. This is a Very serious abuse of confidence that a bank or commercial house should never be guilty of, for it very often leads to damage suits being brought against the bank furnishing the information. Neither the Credit Department of a bank nor any officers or directors of the bank should give out 232 BANK CREDIT METHODS AND PRACTICE information about customers' balances to a third party without the written authority of the customer himself. Sometimes a request of this nature will be inspired by the desire on the part of the inquirer to get the information for garnishment purposes, and regardless of the merits of the matter at issue, the bank should protect its customer. For this reason, an answer to an inquiry concerning a customer's credit should never contain the amount of his bal- ance. It may be advisable in some instances to state the amount of his borrowings for the purpose of comparing notes, but this is a matter left to the dis- cretion of the bank. The answers to inquiries should be clear, concise and to the point and should not tend in any way to conceal unfavorable facts be- cause of the fear that any damage done to an un- worthy debtor may hurt the bank's assets. Cut- throat competition should be entirely ehminated and "dumping" of undesirable customers by one bank onto its competitor bank should not be practiced. These letters of inquiry, with carbon copies of answers attached, should be filed in a separate folder in the Credit Department, bearing the same number as the real credit file, but indexed "A" or "B," as the case may be. For instance, if the mmiber of the real credit folder is 220, the number of the subsidi- ary folders for the fihng of miscellaneous data and letters of inquiry should be numbered 220- A, 220-B, 233 BANK CREDIT METHODS AND PRACTICE etc. In the real credit folder there should be kept a sheet containing a list of names of parties inquiring, with dates of inquiries and answers. In some Credit Departments, the folders are filed alphabetically, and the system can be changed accordingly, using 1, 2, 3, etc., as the adjunct index number. In cases where inquiries are made on names on which the Credit Department has little, if any, information, a card index is kept of such inquiries and answers. It often happens that the information the Credit Department has on a name will not justify the use of a credit file, as illustrated in Exhibit No. 28. In this event, this information can be kept in a miscel- laneous file. This file will have one number, say, 320, and will be divided into 26 divisions, which, in turn, would be numbered from 320- A to 320-Z. This miscellaneous file could be incorporated in the same system with the regular credit files, and when filled to capacity, another miscellaneous file could be created by using the next file number available in the files. For example, if when miscellaneous file 320-A to 320-Z i§ filled to capacity, the special filing has progressed to 550, which was the last file used, the file clerk would in such event use 551-A to 551-Z for the next miscellaneous subdivision. In indexing this miscellaneous file, information on John Smith & Company would appear in 320- S, which would mean that the information on this company would be filed in miscellaneous file 320, in the S folder. 234 BANK CREDIT METHODS AND PRACTICE In some large institutions the credit files cover- ing country bank relations are kept by the Depart- ment of Correspondent Banks. It is best wherever possible that such files be kept in the Credit Depart- ment in order to have all of the credit records of the bank unified so as to prevent confusion and dupUca- tion of labor. The loan application of a correspondent bank could be handled in much the same fashion as that of a commercial customer. The country banks have various ways of borrowing, the common custom being loans based upon notes of customers pledged as collateral. Where the credit standing of a bank is unques- tioned, it matters little as to the form of collateral security. In fact, loans are most often made to such banks on an unsecured basis. However, in the case of a large city bank having considerable of its de- posits from country correspondents, a large number of these correspondents do not find themselves in po- sition to command unsecured credit hues. If such banks do not borrow on their bills receivable, they are required to furnish a guarantee signed by their directors. A suggested form of guarantee for this purpose is shown in Exhibit No. 31 as follows: 235 Wl^tTSBBt Th« uderalgned have herMotora teqoaited. and hereby requeat, (fea UUallUppl VaUey Trad CompiD?, ol Sl Lonla. Missouri, to esUbllih banUnB rolatlona aod do buili«n vltb borelnafUr called prlDdpal, and tald TniM ConipaDf baa conneoled to to do upon condlllOD Ibat the naderalcDed eXMutO and deliver thle aKreement to (aid Tniat Corapany and faliblullT and promptly keep aod pertonn tlie coTeuDU barelo oa tlia part ol the imderalBDed to be kept and perlonned: SiOIO. Ulhprpljirf , U conKlderaUoa of iha accepUncf and traDueUoa of tncb bailneu, and In con-' eldaratlon ol tbe aum at One Dollar (11.00) to oacb of tbe UDdenlBoed Id bied paid by Uld Trait Company, tbo receipt wbereof la ackoowledgeil by eacb of tka voderalcned, tba aodenlKDed, reipeuivalj, «acb for tbemielve* and their legal repreteDtallvee, Jointly and aevenllr, hereby warrant, covenapt and aired, a* Joint and aoTeral euretlei, with llabllltlea aa co-prloclpala wttb eald princlpa], lo promptly pay, with Interast and coata of coHec- (lan, any and all debts, demaoda, and IlablllUea which arid principal baa eiecuted or created, or caused to be eiecated or created, and now held by lald Truit Company, whether said debte, demeodB, lleblliciea or obligations are now due or to become due 'hereafter, and alto all auch debti, demands, obllgatloDa and ItablllUes which may be hereafter created and bocOme due from time lo time beraalier from aald principal to aald Trust Company, wbetber upon nDteB, acceplAncee. dratis, letiers-ot-credlt, ctaecka, blllt^f-eiehanse or other necoUable or iraciCeraUft written Inatrumeata or obllssllona esecuted, accepted, drawo. endoraed, negotiated or Iranstcrred by satd principal as maker, cO'tnoJcer, surety, co-surety, Kn*nititer, coguarantor, aiilgner or endorser, and wbether original lasthimenta or miewBls from time to time In whole or part v[ former Instruments, or whether upon open account with sold principal or hy way of OTenJratts of mny chuiklDB sccounu of aald prloclpsl with said Trust Company. The undersigned Jointly and severally coTcnant to'toaka payments as aforeiald, without prerloua notice as to detoand of payment, proleat or notice of protest of any debt, demand or liability due said Trust Company by laid prin- cipal, and Immediately on demand of said Trust Company by ordinary mall, addressed ta (he undenlsned respectlTaly at their respective addresses given below, tor ibe payment, wJtb Intereil and costs, of any and all msCnred debts, demanda and liabilities due from aald principal to aald Trust Compsny and of all debts, demanda and llabllltlea of aald prin- cipal doe aald Traat Company and payable on demand. The undersigned Jolnily and severally agree that tbey respec- tively will from time to time make suck payments to said Trust, Compaay, wHhDut first requiring It to Institute suit or endeavor otherwise to enforce said payments to be ma'de by eald principal, and wlihont Brtt requiring aald Truat Company to have recoursa to any security or collatenil pledged to It by said principal, and without flrst requiring It to have recourse sgalnsl any other poraon or persons iolntly or severally respooslble (or aqy iucb debts, demands or liabilities dne from said principal to said Trust Company. The Dnderslsned respectively agree that the covenants of tbe nndenlKBed hereunder are and shall be onllmlled and continuing obUgatlons, and shall apply to ell debts, demands and liabilities of said principal to said Trust Com- pany whensoever and bowsoever arising, untU actual written notice shall be given to tbe President, or a Vice-President. of the Secretary, of aald Trust Company, of the Intention of the undersigned respectively to tarmtnate future obliga- tions o( the undersigned respectively hereunder. Any (ucb nollee given shall not affect, alter or dlmlnlslt tbe obllga- llona and liabilities of tbe underslEned respectively as to loy debt, demand or liability of said principal to said Trtut Compsny, Incurred prior to aforesaid actual notice. tn the event of default by the undersigned respectively In the payment as aforesaid of any debt, demand or lioblllty of said principal, payment whereof may have been demanded from the undersigned respectively. It is agreed .that said Trust Compsny may place said debt, demaod or liability lA the bands of an attorney or attomeye tor collection, and In such event the underelgned respectively covenant to pay llheeD per cent (1G%> additional ot the amount of Interest and principal duo on aald debt, demand or liability, as eompeniBllon ot such attorney or attorneys tor the collection thereot from the undersigned respectively; and the undersigned rospectlvely afcree in addition thereto to pay all costs ol court. It any. The underalgned covenant that tbe death d( any of Iha UDdenlffned from time to time ehsll not affect, alta or diminish tbe liabilities hereunder of the then survivors ot the undersigned, and that, notwithstanding any such death from time to time, the then eurvlvors ot the undersigned shall cootlnue bound hereunder lo all respects as U bo death bad occurred. Tbe tmderstgned respectively expressly waive notice of acceptance of this snretyship agreement by eald Trtist Company, as well as prior notice as to tbe Incurring of' any debt, demand or liability of said principal to said Trust Company, or ot the renewals from time to time Id whple or part of any sucb debt, demand or liability, or of tho eichange and^or substitution ot obligations held hereunder for other obtlgatlona. IN WITNESS WHEREOF, the undersigned respectively have hereunto tet Ueir bands-. Signed and delivered In the presence ot: Exhibit No. 31 — Surety Agreement BANK CREDIT METHODS AND PRACTICE When the bills receivable of the correspondent bank are taken to secure its borrowings, as a general rule, it is always best to make an arrangement in ad- vance that no one of such receivables will exceed a specified amount. This tends to limit the risk and in case of failiire of the bank, the creditor bank would stand a better chance of realizing a large per- centage of its claim through the collection of many small notes than it would through the collection of a few large ones, some of which might be involved in the failure of the bank. Whenever possible, the lending bank should have a statement of the borrowing bank on a special blank furnished by the lending bank. A suggested form to be used in such cases is as shown in Exhibit No. 32. Some large banks use a special form for record- ing the comparative statements of the borrowing banks. A very simple form used for this purpose is shown in Exhibit No. 33. It will be noticed that the columns given are in- tended to show only the sahent points in the com- parative statements, it being assumed that the cred- itor bank is interested most in the features showing progress or lack of progress and also liquidity of the borrowing bank. On the reverse side is a record for average balances, the use of this being recommended 237 •T. XMVIM, SlIHMOURI. Bdow will be found 3 copy of the report of our condition at the close of business on the.- day of „ _ „ 10 _ Name of Bank _ -■ ^ ,„_ , _,.. , „..-....„_ _, Location Officer Mnking Report... RESOURCES LIABILITIES Loans and Discounts S Coital Stock paid in.._ s 1 Overdrafts ~ .... Surplus Fund — _ .... .... „.. •■ ... .... .._ Stock, Federal Reserve Bank. Due to Banks and Bankers, subject Banking House Furniture a/Id Fixtures' Due from National Bank of Commerce Due from Federal Reserve Bank. . .... .... Demand Certificate* of Deposit.. .... ™ ... ,_ .-.- Due from ... ... Due from.. _ I Rediscounts Federal Reserve Bank..L...i ... ; I Certificates of Deposit representing funds borrowed _..„ __.. ' Currency ... -.., , 4... Other Liabilities — - . , Specie _ . . _ ■!■ „..L. _.. — — Redemption I'uud , ; : 1 Total ■ Total - , ;.... _ i Pres V Pres Cashier - Asst. Cashier . Bank orgfanized . Annual Dividend - Exhibit No. 32 — Bank Statement BANK CREDIT METHODS AND PRACTICE to institutions where the card system previously ex- plained is not used. CO.* Other Side for Average Balances. AJAr. ....°.v...... o..».-.. .„,1:;:.... u.;.":.v."i::;... =,.,..,. ..... ....... « - - ~ - u. -■ f" 'P.r..cl.RI v,«.p,« CuhK. I A.', CI. 1 I-., How S^cu..d P.id Up 1 1 REMARKS \ Exhibit No. 33 — Comparative Bank Statement BANK CREDIT METHODS AND PRACTICE In the consideration of renewals of country bank loans, a fact that should not be overlooked is that although security may be ample and the bank in a splendid credit position, its checking account may be undesirable through its tendency to draw on "float". For this reason the Credit Department should keep in close touch with the Department of Account Analysis and the Country Bank Depart- ment. In the majority of cases where "kiting" is prac- ticed by a country bank, it is an indication that the bank is not in good shape or that it is improperly managed. A simple illustration might be given of how kiting is practiced. A has two bank accounts, one at the Bank of B and the other at the Bank of C. He issues a check to a commercial creditor, drawn on the Bank of B, and covers it with a check drawn on the Bank of C. The check drawn on the Bank of B would have overdrawn the account at that bank if it had not been covered by the check on the Bank of C. He then later issues a check on the Bank of B and de- posits this check at the Bank of C in order to save an overdraft that would have been caused by the check given to the Bank of B. This practice should be immediately stopped, and if the correspondent bank repeats the offense, relations with it should be discontinued. 240 BANK CREDIT METHODS AND PRACTICE The Credit Department, as it grows older, can greatly increase its usefulness to the financial insti- tution. The forms and methods described in the foregoing chapters can be used as a nucleus around which to build a methodical and systematic depart- ment. As the institution grows and the volume of business increases, additional methods can be employed and forms modified to suit changing conditions. THE END 241