Jeff Judy

Jeff's Thoughts - August 9, 2017

Where's Your Macroscope?

Over the years, credit analysis tools have become more and more powerful. Every institution has the software to generate a lot of very precise numbers, and those numbers are often the main driver of the credit decision.

We think of credit analysis as "putting the borrower under the microscope." Credit staff envision themselves drilling down deeper and deeper to uncover finer and finer details and indicators of the borrower's creditworthiness.

Especially with the widespread influence of credit scoring, credit analysis has come to be seen as a matter of finding a precise number to compare to a precise threshold. The accuracy of the number has become the primary concern.

Of course, what really matters is the meaning of each number, what information that contributes to our judgment of whether the borrower is likely to pay us back in a timely fashion. And to find the meaning of these wonderfully precise numbers, we need lots of context.

We need to back out of the microscopic view for a moment and put the borrower under our "macroscope", the larger factors that are in play when we extend credit today to be paid back on some tomorrow.

First, we need context at the level of your institution. Which industries are considered desirable, which viewed with more caution? What aspects of the request go beyond "yes or no" to flesh out the decision, say, with structuring that protects your interests? How does the transaction under consideration fit into the overall credit portfolio?

A lot of that institutional context can be found in a good credit policy. And you know that credit policy is not just a list of numbers and thresholds.

Second, what's happening in your business environment that could have an impact on your borrower's future? Is labor cheap and plentiful, or scarce and expensive, in that line of business? Are new competitors entering your borrower's marketplace?

Are new regulations or legislation likely to affect your borrower's business? Sometimes exciting new types of businesses run wild and free for the first few years, but then draw complaints and get the attention of lawmakers seeking to reign in various practices.

How vulnerable is the business to changes in energy prices? Are materials they require likely to become more expensive in the near future? These questions may in part be answered by events on an international scale.

Do the borrowers themselves think about these issues? Are they taking a wider view of their business environment as they formulate strategies for achieving success? Or do they take a narrow view, thinking in terms of today's conditions and today's numbers, as if they will always stay the same?

Most institutions could do a better job at guiding their credit staff to take a wider perspective on borrower analysis. Look at the training you take, or that you send your employees to. Is it all about the microscopic side of analysis? Is the training employees receive at your institution, formally and informally, from internal and external sources, heavily weighted toward the numbers to the neglect of the wider context? When a credit is presented for approval, do the questions, criticisms and debate probe the broader factors that could change the borrower's future from the rosy picture they paint in their application?

Those powerful software analysis tools are truly useful. But they don't provide answers, they provide additional information.

Combining that microscopic information with a macroscopic perspective leads to decisions that lead to profits.