What makes a good Credit Proposal?
“You should change your projection assumption!”
“You should explain the managements’ experience here!”
“I don’t think this information is relevant in this proposal!”
Dear Corporate Bankers, especially Credit Analysts, have you ever felt confused on how to deliver a satisfying proposal? Perhaps you have tried following previous’ templates, seeking seniors’ advices, or even trying to create the best proposal ever.
However for some reason, your boss or risk management unit will always find something unsatisfactory to your masterpiece. Sometimes to the extent that you become suspicious that they may have negative sentiment toward you.
I am a Credit Analyst, even with my latest position as Relationship Manager, I still prepare my own proposal. However my experience may have been limited to Corporate Banking segment only, with their common characteristics as follows:
a. One of main players of an industry. Therefore has a strong market position;
b. Matured company with strong corporate planning and good financial position. Therefore growth is more sustainable and has better capability to survive a crisis;
c. Dedicated team to monitor the covenants.
d. Subsidiary / SPV of a well-established parent company. Therefore may receive strong financial and operational supports from the parent company.
All these profiles make them has a seemingly lower credit risk, which is attractive to lenders. Competition in this segment is very tight for the lenders, hence sometimes we will see lower interest rates, looser covenants, and tailor-made structures.
Good relationship with customers and strong negotiation skills are usually keys to win the deals. “Speed” is also part of the competitive advantage of a lender. Unfortunately, APPROVAL PROCESS is usually a long and tiring process in this segment, and will be worse depending on the size and complexity of the facility. All these condition brings inner turmoil to the center of this process, which is the credit proposal.
This is a common dilemma faced by banks. Before I continue, I will take this chance to highlight the importance to maintain our integrity as a banker.
Banks are highly regulated industry, because we need to make sure that we operate with prudential. This is noteworthy because bank’s source of fund is mainly from public (from funding activities). Thus, we have the obligation to protect their money. However at the same time, we are pushed by targets and sometimes by “relationship”, which may obscure our judgement.
Otoritas Jasa Keuangan (Financial Services Authority) has mentioned the importance of four eyes principle in Financial Services Authority Circular №34/SEOJK.03/2016. It is also stated in POJK №42/POJK.03/2017 that banks should prepare and implement their own Credit Policy. However, all these principles and regulations will be meaningless if we do not keep our integrity as a banker.
With such integrity in mind, our responsibility is to prepare a satisfying credit proposal to our management. Well-established banks may already have templates to gauge the creditworthiness of potential borrowers, for example, a bank may require 5C (character, capacity, capital, collateral, and conditions) aspects to be included in the proposal. Some banks may elaborate the analysis into more aspects, such as legal, management, technical & production, marketing, social & environment, financial & needs, collateral, risk assessment & mitigation, etc. My current workplace has even elaborated these aspects into more details, with a more rigid template, therefore it is common to see a 50 pages proposal here. It is expected that with more details, one may have a more thorough review of borrower’s condition. It is true, to some extent. However, one of the main drawbacks with such rigid template is that we may forget the purpose of analyzing a particular aspect and sometimes even forget the purpose of preparing a proposal. Remember that we are part of business unit with limited time to analyse everything (“speed” is important). In the end, our proposal may fall into either of two extremes:
1. a proposal with irrelevant information and sophisticated technical calculation, but lose track of the purpose, or
2. a proposal that overlooks some important aspects of credit risk analysis, which cause the “deal” to be more attractive than what it should be.
These are why four eyes principle are very important in lending business. However I will cover that part in future articles.
In the meantime, let’s talk about those extremes in more details.
1. a proposal with irrelevant information and sophisticated technical calculation, but lose track of the purpose
Sometimes, when there is too much information available, we may be confused to choose which information to be included in a proposal. It is not prohibited, but certainly not recommended. For example, when we find that other current assets has increased twice from previous year’s figures. It does not necessary mean we should analyse it, especially if the post itself is insignificant compare to the total assets.
Sometimes a Credit Analyst or Risk Management Unit are tempted to show-off the financial modelling skill and knowledge of the ratios. For example, in creating a projection, there is no limit to how detailed our assumption can be, however sometimes it is just not necessary. Same goes for ratio analysis, there are countless ratios with adjustable formula out there, but all can be classified into either liquidity, solvability, or profitability analysis. So there is really no need to put all ratios in our analysis.
2. a proposal that overlooks some important aspects of credit risk analysis, which cause the proposal to be more attractive than what it should be.
Sometimes, because information and time are limited, we have to overlook some aspects, even if it is important. This practice tends to happen when a Credit Analyst has no strong understanding of credit risk analysis process, which may harm the lender. When a borrower is unwilling to share an important information, it may mean that the borrower is actually hiding some material adverse information. To protect the bank, ideally, a Corporate Banker should have proper training, certification and experience, so that we know what information is relevant and what is not, also what mitigation is needed to cover the risk.
With all being said, so what makes a good credit proposal?
Firstly, we should always remember the purpose of a credit proposal, which is a supporting document for management to make a decision, whether to grant a loan or reject it. In order to do so, a credit proposal needs to be simple, but informative at the same time. A good way to do so is to prepare a proposal in a storytelling process, starting from the company details, positive aspects, negative aspects, the mitigation, and finally the pros and cons of granting a loan to the borrower. The order may differs depending on one’s storytelling style.
The challenge here is usually the “style” difference between checker and maker. Sometimes, a checker may find our proposal to be too wordy, thus confusing to the readers, while sometimes, a checker may find our proposal missing important justification that is key to secure this deal. My solution for this case is to know the personality and style of the checkers and decision makers. By doing so, we can prepare a proposal that answers their uneasiness.
Secondly, we should be able to determine relevant information for the proposal. Templates may help us as a framework of credit risk analysis. However, it is actually not recommended to blindly follow a template. I personally like the concept from Moody’s Analytics in Commercial Lending course I once had, it is said that “the components of credit risk analysis are credit policy, financial risk, management risk, industry & management risk, and facility risk.” In my opinion, covering all those components and combining it with 5C aspects will be enough for most cases.
The challenge here is usually to match everyone’s “risk-appetite”. The more party involved in the credit proposal, the more ideas that need to be accommodated. Therefore it is common to see arguments during this process, especially among people with different “experience” and “risk-appetite”. The effort to reach a consensus will be even bigger if someone is stubborn and narrow-minded. My solution for this case is that we need to be perceptive and be a good listener to find the reasoning behind an idea and the proposed solution.
Thirdly, we should be able to find the most updated information for our proposal. Information is very important. In most cases, it is current information of an industry and borrower that determines whether to enter a deal or not. For example, during Covid-19 situation, a company may needs more Working Capital Loan because it expects higher inventory and longer receivables. The company may mention that the reason for the increase is due to their strategy to increase revenue aggressively. If we do not know the impact of Covid-19 to the company, we may think that it is good to finance the company, while in fact, it is not.
The challenge here is usually the availability of required information. My solution for this case is maintaining good relationship with the borrower, not just with the Directors, but also with the team from different departments. Subscribing to paid information, such as S&P Global, Bloomberg, CEIC, etc, may also help.
Those are my opinions on how to prepare a good credit proposal.
Preparing a good credit proposal is not easy, in fact I am also learning at this moment. In most cases, the assessment of a satisfying proposal may be subjective. It is not about right or wrong, though. The most important thing is that our proposal has to be understandable, with sufficient analysis to support our management’s decision making process.
As an afterword, it is rare to see a facility default during the first year of the loan. It is usually what happens after the loan that cause the borrower to fail the obligation. Therefore please remember that it is also important to have a good credit monitoring system to maintain the quality of the loan.
Good luck!