Jeff Judy

Jeff's Thoughts -November 3, 2015

Look Where You're Going!

Let's try a little experiment.

Tomorrow, when you get in the car, keep your eyes glued on your rear view mirror. Don't bother looking through your windshield, guide your vehicle entirely by what you see behind you.

How to you think that's going to turn out?

Credit involves an awful lot of looking in the rear view mirror. We pore over borrowers' financial histories, and extrapolate the past to give us a hint as to their probable futures.

And, if truth be told, we often respond to, rather than anticipate, changes in market and business conditions.

The problem is that we depend so much on the past, in our business, that we develop a mindset, a habit of looking back most of the time. Oh, we talk about forecasts and predictions and anticipating changes that affect the credit environment.

But habits are strong, and you really have to make an extraordinary commitment to the anticipatory side of things. At many institutions, "anticipation" and "forecasting" just mean extending the trend lines from the recent past. No wonder so many of us are surprised when we hit the occasional minor, or major, pothole in the road.

One good habit to get into is requiring credit staff to talk about what's outside the financial statements. It's easy to plug in numbers -- "sales expect to increase by X%" -- but can they tell you about important market events and trends without referring to borrower numbers?

For example, is unemployment falling in your area? What does that mean for labor costs? Will it be harder for the borrower to find and keep good employees? Will turnover costs go up?

And most importantly, has the borrower thought about those questions, and responded according to the answers they came up with?

Making this approach a habit across credit staff isn't easy. It requires constant communication. It demands that approvers ask for predictions about key conditions that affect the borrower and the probability of repayment.

It requires guts, frankly, to step beyond the historical trend line approach to financial statement analysis into a broader credit analysis that looks at the environment and the borrower's responses to it.

This kind of thinking is at the heart of credit risk management. And make no mistake, in the credit industry it is our job to take on risk and manage it, not to simply avoid it.

Playing it safe by always playing the (historical) numbers will probably produce average results, since this practice is so common in our industry. But taking the risk of making and backing predictions about future conditions is what will separate you from the pack.