Assessing Creditworthiness of a Corporate Customer A Field Perspective
 |
Authors
Authors: Rajiv Fernando
Faculty Associate,
ICMR (IBS Center for Management Research).
Links
Tools
Credit Assessment at the Field Level Contd...
|
In order to assess the financial health of the entity, the loan officer will need to obtain the financial reports of the entity i.e. the balance sheet, profit & loss statement, cash flow statement. These statements should be certified by competent chartered accountants. Generally, bankers ask the companies to submit their financial data in CMA format, as this includes the projected balance sheet, profit & loss statement and cash flows for the tenor of the loan. For cases where funds are required to meet working capital needs, the banker can also assess the scale of working capital finance required by estimating the projected gap between the current assets and liabilities. The financial soundness of the business entity can be assessed by tracking a few key financial parameters. By analyzing these financial parameters (Refer Exhibit II), a banker can assess the capability of the company to withstand any uncertainties likely to be encountered during the normal course of business and the inherent capacity to repay its debt. These parameters essentially look at the leverage, profitability and debt service ratios. For example, a highly-leveraged company or a firm with thin profit margins needs to be approached with caution. |
|
Based on the past historical records within the bank, a matrix framework (as illustrated in Exhibit II) that links the financial parameters of a company with the credit quality (read credit rating) can be used as a quick reckoner in the field to decide the credit rating of the company. This enables the field officer to quickly respond to the customer with indicative terms and conditions of the loan proposal, as credit rating is a key factor in deciding the pricing of the loan. Using this framework a company having a net turnover of Rs.30 crore, net profit margin of 0.5%, Return on Capital Employed (ROCE) of 2% and a TL/TNW of 2, can be assigned a BBB rating. Of course, a detailed scoring model, which gives proper weightage to the financial parameters and quantifies qualitative parameters, is essential before the final sanction of the loan. However, with sufficient experience, a banker can develop the intuition or gut feeling to take quick credit decisions.
The loan officer should necessarily look at the financial parameters for the past three years (at the minimum) so as to pick out any trend or change in company strategy. It is also important to benchmark the financial parameters of the client against the industry peers so that the relative performance of the company can be judged. Sometimes, the dynamics of the particular sector has an effect on the financial ratios; for e.g. most trading companies will have low net profit margins.
A "scenario analysis" or "What if" analysis i.e., keeping all other expenses constant, how would the above parameters behave if there were a 10% drop in Sales or a 5% increase in raw material prices? Does the company have any contingency plans to deal with these situations? should be undertaken. While evaluating the exposure to the client, the officer should also look at the non-fund based exposures that are off balance sheet items like corporate guarantees or LC/BG (Letter of Credit/Bank Guarantee) limits. In case of a take over of existing loans, a credit opinion report (a standardized Indian Banks Association format) needs to be obtained from the client's existing bank.
However, many seasoned bankers will recount that sometimes focusing too much on the numbers can be quite misleading. This may be the case with many small and medium enterprises where the quality of the financial data reported is questionable. Sometimes financial disclosures of even large corporate entities are not fully reliable. The recent accounting scandals witnessed in the US like Enron, Xerox and WorldCom are sufficient proof of this. Many of these companies used questionable accounting methods to inflate earnings,
'sugar coat' profits and hide debt. Hence, informal reality checks in the market with the client's existing bankers, their industry peers, former employees etc. will be of immense help.