Jeff Judy

Jeff's Thoughts - April 9 , 2014

A Recommended Obsession

In the process of analyzing a prospective borrower, of deciding whether they present an acceptable risk and a realistic profit opportunity, you dig deep into the borrower's past, and follow up with questions about their present. With thorough financial statement and cash flow analysis, with a complete credit write up, you develop a pretty clear picture of the borrower's current health.

And along the way, you also develop some notions, hopefully, about the borrower's future, about whether they will be more successful, or less, or about the same a couple of years from now.

Intellectually, you know that your credit will be repaid in the future, with the resources the borrower has available in the future. But even with all of today's number-crunching technology, the decision whether or not to lend is rarely a purely intellectual exercise.

How often does the borrower's future truly end up being the most important time period, in terms of making the credit decision? More often, that future is overwhelmed by the borrower's present and past.

Why does this happen? Well, chalk it up to human nature, two important aspects of which we might refer to, in today's text-speak, as TMI and CYA.

TMI: "Too Much Information". When performing borrower analysis, you collect a ton of information about their past, and you spend a lot of time probing their present. If you put the solid information you had into three buckets, the "Past" bucket would easily weigh the most, and would be several times heavier than the "Future" bucket. This naturally lures you into looking backward more than you should, and looking forward less than you should.

CYA: "Cover Your ..." well, you know! Assuming your borrower has been honest and forthcoming with you, the information about the past and present qualify as "facts". It is hard for them to be wrong, and it is hard to get in trouble for using them. The future, on the other hand, is more about forecasting and prediction and, shudder, judgment! If things don't turn out as expected, you'll have to defend your vision of the future (which you should be able to do), and that's a lot scarier than defending the "facts" of the past and present.

There's one more catchphrase I'll throw in here: "No Risk, No Reward". We are in the business not only of avoiding excessive risk, but of identifying acceptable risk and managing it. One of the good risks you actually want to accept is that your understanding of the borrower's future could be off the mark. After all, if you have taken that forecasting process seriously, you won't be surprised too often.

The real risk that too many institutions accept is letting decisions be driven too much by the past and present, thus missing opportunities and overlooking problems. They just extrapolate the lines from the past, instead of anticipating what could change in the future, and that's a sure path to ugly surprises.

It pays to be a little bit obsessed with your borrower's future. The past and the present will take care of themselves. It is when you put some extra effort into creating, and using, your vision of the borrower's future that you get the full return on all that analytical power you apply to credit decisions.