Jeff Judy

Jeff's Thoughts - October 3, 2018

Monitoring Credits in Good Times

Problem credits arise in every portfolio, that’s just the nature of the risk management business we’re in. But what can we do to minimize the impact of problem credits?

The first answer I get when I ask that question is, “Make good credit decisions in the first place.” Indeed, I spend a lot of time, and cover a lot of miles, to help credit staff develop analysis and decision-making skills that will get every credit off to a good start.

And that’s important. But I believe that what happens after the credit is booked plays just as big a role in managing problem credits. To put it another way, many problems could be contained quickly, doing minimal damage, if we paid more attention to the information we get from, and about, borrowers in the months and years after signing the agreement.

As I see it, effective monitoring has two parts. The first happens when you negotiate the loan agreement. That's where you put the requirements for financial reporting (quarterly or semi-annual statements, etc.) and the "triggers" that will lead to a closer review (e.g., key management player leaves).

The second part of monitoring happens as those financial statements and other updated information come in as scheduled, and this is where opportunities for early intervention are often missed. Take a look back at the ugliest outcomes in the portfolio and you will often find that one or both of the following mistakes occurred:

The temptation to procrastinate around monitoring is always strong – there are plenty of things to do that most of us think of as more pressing – but it is even stronger in a good economy. Everybody seems to be doing well, we don't expect problems, and we don't look for them.

But even in a great economy, there are good reasons to be diligent about monitoring. Take the tariff wars I have written about in recent issues of this e-zine. A quick look at the numbers, or a call to your borrower, should be enough to alert you to possible issues.

After all, if I were lending to a soybean farmer right now, I'd be keenly interested in their sales. With the biggest market, China, looking for sources outside the U.S., those numbers could be tanking before our eyes.

Or consider companies that import metals or components to produce a final product and/or service. Is Cost of Goods Sold rising much faster that total Sales? Is Gross Profit being squeezed as they try to absorb some of the cost of imported components?

If you invest a little time in thinking through the threats to your borrowers' businesses, even in good times, it won't take much more time to check how those borrowers are faring. (And, of course, if your borrower suddenly seems more reluctant to provide information or answer questions, you should be a little concerned.)

You invested a lot of time and effort into determining that the borrower was creditworthy in the first place, and then more time and effort in structuring the credit wisely. Don't be seduced by the good economy into being complacent about the monitoring that plays such a crucial role in minimizing the impact of problem credits on your bottom line.