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Bank credit assessment underpins business growth Back  
Sound credit analysis will always focus on the quality of cashflow and of management writes John McGrane
The exceptional recent growth in bank lending, much of it to businesses, is an inherent part of the overall Irish economic growth story. Indeed, because of the credit multiplier effect inherent in bank lending, borrowing can be argued to be the fuel for the boom itself. And just one step behind those rapidly growing lending statistics are the people and the systems involved in the banks’ credit assessment processes.

Just as the fundamentals of successful selling remain constant over time, the same is true for the fundamentals of sound credit appraisal. At the end of the day, businesses fail because they run out of cash, in turn because their managers fail to prevent it. So sound credit analysis will always focus on the quality of cashflow and of management.

But for all its basic consistency, credit analysis has indeed been developing and has become more pro-active in how it serves the customer. Businesses now benefit from more versatile analytical techniques and also from more comprehensive credit solutions as a growing array of lending products have become available. A key driver for this has been the banks’ need to respond to a fundamental reshaping of the business market as the economy itself has developed. Service businesses are rapidly outnumbering manufacturers and technology-related services are emerging with particular speed (and with considerable appetite for R & D funding). Limited credit assessment models focused on bricks and mortar obviously have little value in such a market. Indeed, the last thing a fast-growing service business typically wants to do is tie up cash in property.

Happily, there are now well-established credit solutions for all of the main asset classes beyond just property mortgaging. These include sale and leaseback for premises, leasing for plant, equipment and vehicles, invoice discounting for debtors and now, through creditor-payment products, finance for stocks as well. These credit solutions allow a much more specific focus on the actual needs of a given business. They successfully link the asset with the cashflow related to it or needed to support it. Indeed, this segmentation approach can sometimes generate scope for a composite funding package in excess of the actual current needs of the business. That excess can then be used to release funding for expansion or diversification or, for instance, to release value to departing owners in a buy-out transaction. The growing volume of such activity reflects the pro-active use of credit analysis in contrast to its more traditional reactive, or even restrictive, role.

Where the available credit products still cannot generate enough funding for a given proposal, there is an increasingly liquid availability of investment equity for those willing to take that route. However, in between the conventional debt and equity solutions, there is a healthy developing market in intermediate funding. Quite apart from conventional mezzanine structures, businesses can now expect a constructive dialogue on the sharing of risks and rewards as lenders fine-tune their risk/reward attitudes.

Whereas larger overseas markets can access sizeable default databases and decision-support models, the absence of comprehensive information in a relatively small market like Ireland means that lending here is still very much a people-intensive and largely relationship-based business. This will undoubtedly be a key area of change in the near future if online business finance is to achieve a meaningful penetration. In the meantime one-two-one credit appraisal is increasingly developing a more sophisticated approach to the risk/reward equation. The return on bank capital was in many cases traditionally supported only by the interest margin. In a climate of widespread low nominal yields, uncertain actual loan durations and the opportunity for the promoter to make significant return on relatively minimal cash input, lenders have sought more specifically to recover costs and to achieve a reasonable participation in the event of a project?s success. Thus, apart from arrangement and management fees, a variety of fees may be linked to key events in the life of the loan. This creative approach is enabling promoters of technology start-ups, for instance, to access debt facilities which would have hitherto been incapable of offering a realistic return on the lender?s risk, while the promoter avoids the alternative equity dilution.

The greater amenability to creative risk solutions is inherently supported by better information. Improved understanding of the basis of risk in any given aspect of a proposal now sees a sophisticated array of loan covenants designed to give ample forewarning of those risks crystallising. This requires the management team to maintain and use good-quality information systems within their business and the central covenant measures are always cashflow-based (such as the level of debt-service cover from annual cashflow net of capital expenditure and working capital growth). Such covenants may be backed up by controls on other key risks affecting the business such as protecting against foreign exchange or interest rate exposures and insurances against such as debtor default, business interruption or keyman demise. Understanding these risks and, in particular, how they can impact on different types of business has been enhanced by the use of sectoral lending teams. Apart form enhancing marketing opportunities, sectoral expertise helps to identify the appropriate management skills and the relevant industrial and regulatory context in which these various pro-active credit techniques are then applied.

So, in overall terms, the growth in credit availability to Irish businesses has been founded not only on long established fundamental credit principles but also on constructive use of those principles in an innovative array of credit solutions.

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