Jeff Judy

Jeff's Thoughts - May 13, 2009

Ever Have a Number Pay You Back?

Credit people, including loan officers and credit analysts, love numbers. They gather them, crunch them, interpret them, and rely on them to reveal the past, present, and future financial health of their borrowers. In other words, all that number processing is aimed at determining their level of confidence that the loan will be repaid.

But when is the last time you were repaid by a number?

Numbers don't pay, or do, anything. They are very abstract bits of information, and they can definitely help us to measure various aspects of human (business) behavior, to identify important trends and patterns, to get beyond the numbers, if you will.

All the same, I have taught credit analysis for many, many years, and I cannot escape the conclusion that a considerable portion of the financial services staff involved in lending decisions are fooling themselves. They think they are assessing "creditworthiness."

But they are merely assessing "financialworthiness," if I can coin such an ugly word.

"Computing" and "calculating" are not the same as "thinking" and "deciding." No ratio, no matter how precisely determined, has ever paid back a loan. Numbers are the tools we use to help us make better decisions, not to make decisions.

The best performing institutions know this well. After all, let's be honest: we all calculate the same ratios and cash flows and various intricate subtotals, in pretty much the same way. If we all just follow the numbers, we will all produce exactly the same results from any given pool of customers.

But some banks do better than the rest. Some have healthier portfolios, and stronger profits, because they don't just blindly follow the numbers. They have good reasons to approve a loan request, when the numbers aren't perfect. And just importantly, they know when they have to be cautious about a borrower who knows how to play the numbers game all too well.

What is the real difference between those better performing lenders, and the run-of-the-mill institutions? It isn't computing power, or better spreadsheets. It is things like courage . . . judgment . . . responsibility.

I meet so many loan officers and other credit-related staff who love the "numbers tell the whole story" approach precisely because they are afraid to run the risk of making a mistake, of applying their own judgment to make a final decision -- which is, after all, a statement about what the banks anticipates for the borrower's future -- that turns out to be in error. They want to point to a number, and a threshold, so they can say they "followed guidelines," meaning, they very narrowly applied "the rules" to cover their butts.

There will still be bad decisions, opportunities missed, loans in default. But for these individuals (and, often, the corporate cultures they work in), being right is not nearly as important as not being at fault. If a deal goes bad, but the numbers were "within parameters" when the "decision" was made, that's fine with them.

That is one philosophy of credit (in reality, if not officially acknowledged by management), and you may be comfortable with it. I am not. I help financial institutions and their employees to outperform the average, to produce better outcomes than their competition. I believe that what puts you at the top of your market is the willingness to truly make decisions, not delegate them to rows of numerals. I believe that the courage to apply some personal judgment -- along with the knowledge and skills to develop that judgment -- separates you from the pack.

Certainly, learn to crunch numbers as well as you can, take the most precise measurements you can get. But more importantly, have the courage to interpret those numbers in the context of your standards and values, your risk appetite, your qualitative analysis of your borrower, your ability to mitigate risk through sound structure, your experience.

Without that kind of courage, you will never be a market leader.