Assessing Creditworthiness of a Corporate Customer A Field Perspective

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Authors: Rajiv Fernando
Faculty Associate,
ICMR (IBS Center for Management Research).

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Credit Assessment at the Field Level

The loan officer or client relationship manager, who is in direct contact with the customer, has a pivotal role in assessing the credit quality and minimizing the credit risk. Being close to the ground, he/she has access to information that may sometimes elude the number crunching credit scoring models. In the past, it has been observed that a large proportion of Non Performing Loans (NPL's) has been due to deficiencies at the source i.e. the credit appraisal stage or improper credit assessment at the ground level. In a way, the officer at the frontline is a protector of the quality of the bank's assets, because any negligence or oversight on his/her part can prove costly in the future. The incidence of NPL's can thus be reduced by having a proper system to check the credit quality at the customer interface level itself.

The basic information needed to assess the creditworthiness is what most of us would have learnt in our basic economics class i.e., the 3 C's of Credit: Character, Capability and Collateral. However, another interesting way of evaluating credit risk through a 'rule of thumb 'approach is to find the answers to the following questions:

a. What does the customer want the loan for? A banker must ascertain the purpose for which the customer is seeking the loan. The funds need to be deployed in ventures that are productive. One of the major causes for bad loans is that the funds are diverted for purposes other than that intended. An understanding of the client's track record, managerial expertise and integrity will help the banker's assessment regarding the safety of the bank's funds. A basic understanding of the nature of the client's business is necessary while evaluating the loan proposal.

b. How will I (the banker) get the repayment back?A good understanding of the revenue model and the business environment of the client will definitely help in assessing the return of capital employed. Does their business model add value to the firm's customers? Will the projected cash flows be sufficient to service the debt? Are the assumptions of the model realistic?

c. What will the customer do to pay me back if his/her theory does not work? Does the company have any contingency plan? What is the type of security/collateral being offered? Is the security liquid enough so that it can be disposed off easily in the event of default? Are the asset cover/debt service cover sufficient? Are there any third-party guarantees? .

Exhibit II: Financial Parameters and Rating Benchmarks

Parameter	AAA	AA	A	A-	BBB
Net Sales (Rs. crore )	>300	>200	>100	>50	<50
EBIDTA (Rs. crore)	>50	>30	>20	>10	<10
Net Profit Margin %	>10	10-Jul	7-Apr	4-Feb	<1
ROCE %	>15	15-Oct	10-Jul	7-Apr	<4
Total Debt/ Net Cash Accruals	0-0.25	0.25-0.5	0.5-1	1-1.5	>1.5
Total Liabilities/Tangible Net Worth	0-0.5	0.5-1.0	1.0-1.5	1.5-2	>2
PBIDT/ Interest	>3	3-Feb	2-Jan	0.5-1	<0.5
Note: The above parameters and respective benchmarks are given as an illustration. These may vary across financial institutions & industry sectors.

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