Jeff Judy

Jeff's Thoughts - May 18, 2016

Sustainable Growth is More Than a Number

We are always looking for growth. As financial institutions, we want to grow our credit portfolios. At the same time, we want to see our customers grow their businesses.

But all growth is not created equal, and for us and for our customers, "growth at any cost" can create more problems than opportunities.

In the last decade we have had a dramatic demonstration of the negative impact of that approach at some financial institutions. It is all too easy for the drive to book more credits to lead to short cuts in quality assessment. The excessive risk that brings into the portfolio can exact a high cost for that growth when the economy (national or local) falters.

Similarly, good analysis of a potential borrower includes sustainability analysis. A big increase in sales sounds great, but not if the business can't deliver on its orders. Or a customer might put everything in place to boost market share, only to find margins slashed by supplier problems and increases in cost of goods sold.

Prudent lenders run the numbers and do the "what if" comparisons that uncover risks like those just mentioned. But that is hardly enough.

Sustainable growth has a human side, a management side, that is just as important as physical capacity, supply costs, and other more quantifiable factors.

If your borrower's business doubles, do you expect their current management to be able to handle the sheer quantity of employees and activities? Does a new, larger company demand different knowledge and skills? Are more managers needed, possibly diluting the corporate culture that created the borrower's initial success?

Is the borrower's leadership team aware of the need to adapt as the business grows, especially if it grows rapidly? Are they willing to take the appropriate steps to thrive under new conditions? Or are they going to conduct "business as usual" even though their business has changed in significant ways?

Try as you like, you can't calculate a number to answer those questions. You have to make a subjective assessment of your borrower's management skills, their depth, their willingness and ability to change as the business expands. You have to make a judgment about their ability and commitment to manage the risk that comes with the desired growth.

Some credit staff are uncomfortable with the more subjective components of borrower analysis. They are a lot happier defending numbers and thresholds.

But without those judgment calls, you really do not have a complete picture of how growth will impact your borrower. You could extend credit to a business where the numbers seem to work, only to find that management's failure to adapt quickly enough undermines their success … and undermines repayment of your credit.

Numerical analysis is a powerful tool that protects against lending on too subjective a basis. But it isn't everything.

Making judgments and predictions that go beyond the numbers is part of risk management. And risk management is our job, it is what we do. Using numbers to stimulate questions, observing management behavior, and applying keen judgment are what will give you a long term competitive advantage.