Credit Sense – Approach and Perspectives

If you were to randomly ask any lender to rate themselves on their credit skills, the answer would invariably be 10 on 10. Risk officers and Relationship managers are always at each other’s throats owning to difference in their perspectives. Although in the eyes of the regulator, there is no such distinction between the two. This piece is an attempt to share some tools I have used over the years, while approaching a credit. Even when the optics appear to be fine, there are qualitative aspects such as credit meetings with customers and need to look beyond the conventional ratios, that are crucial to the process.

1. In a credit meeting with the customer, bankers tend to make the discussion like a question answer session, at times rapid fire, because of paucity of time. I feel bankers should go in small groups, than unwieldly teams and let only one person do the talking to keep the discussion focussed. We should maintain eye contact at all times and allow the promoter to speak. No interjections! There should be a pause after each discussion point, which may cause some discomfort for the borrower. This may prompt the borrower to speak again and at times they start contradicting themselves.

2. Luncheon meetings are best avoided, if the focus and seriousness of the meeting is to be maintained. People tend to break into courtesies, their adventures on a vacation and it becomes difficult to bring the discussion back from the tangent.

3. The most squeaky-clean balance sheet with current ratio of 1.33x can often give away clues. There are certain other aspects behind the optics, which can come in handy –

• • Private equity funded companies – These companies can be riding a tiger. Equity infusion optically improves the D-E ratio, which enables the company to borrow more, say 2x. While the company is able to manufacture 2x of inventory, the question arises – how would the channel partner, typically an MSME, manage 2x incremental working capital limits to buy the inventory, in the absence of equity infusion and additional collaterals. Any limit increase beyond, 10-20% is to be viewed with caution. This is where, some of the PE funded companies have gone into trouble – they are unable to push huge inventory into the system, leading to negative cash from operations.

• • Often, companies undertaking relentless Capex YOY tend to buck the trend and show supernormal profits. They have large capital WIP, capitalised product development and R&D expenses. I have even seen R&D expenses capitalised in job working and foundry businesses, where the only machinery in their sheds is a few lathe machines. One should deep dive and seek details of revenue expenses and trial run expenses capitalised.

• • Companies with high ratings having unusually high cost of borrowings (COB); COB is greater than ROCE. The highest mortality in the Indian corporate sector has been in AA rated companies. Such companies displaying COB of 12-13% means they are concealing their true debt. This could also be because of ingenuous accounting or company is resorting to double financing through bill discounting, factoring limits or supply chain limits, which should be factored in the ratios.

• • During periods of fall in commodity prices, drawing power of the companies remain intact. This should be questioned – since the inventory value is not devalued in DP statements. Such companies tend to resort to extended export credit and buyer’s credit limits and frequent Capex to fund the accounting entries.

• • Groups and companies resorting to frequent mergers and de-mergers and name changes. This is done to hide the reality of numbers, in the name of creating equity value. Banks should examine the situation thoroughly before granting NOCs. There is at times undue pressure to grant NOCs because of the threat of losing business.

• • • There have been instances of leveraged holding companies trying to de-list cash cow-operating companies. Why is that? This is because, by de-listing, they have access to 100% dividend payouts.
  
  
  • It is also important to understand the maze of group holding structure and check for intra-group transactions.

This is by no means the exhaustive be-all end-all approach. I am sure each one of us has a story to tell. There can be different perspectives !