Searching for impacts of the crisis on your business clients

When I was young, I loved reading the detective stores of Encyclopedia Brown and The Hardy Boys. As I aged this changed to Sir Arthur Conan Doyle’s stories of Sherlock Holmes. I enjoyed trying to find various clues to get to the answer before it was revealed in the story. Most of the times I did not get it, but I still loved trying to find that out.  

I think this curiosity is essential in credit management and underwriting. It is naturally needed skill for everyone in your credit department. Those who love solving puzzles are the ones you want working on your team. The first step in this is to search for the clues.

The clues are essential in determining the risk profile for your commercial member. Some institutions may use third parties to do surveys with some of their customers as one of these clues. Most of these are done directly with the field officer as knowing your member is key. What are some of the clues you should be looking for as you visit with your borrower?

The first area is what impact has the crisis had on your revenues? Some possible clues to look for are:

• How do current period revenues compare to pre-COVID revenues? How do the quarters compare to last year?
• Have the sources of revenues changed?
• What revenue projections does the company have for the upcoming quarters? I usually like to see a best case, worse case, and something in the middle.
• What disruptions have occurred in your client’s business that is impacting yours? E.g. we have seen hotels lose room revenues as conferences have cancelled, while we have seen grocery stores thrive.
• What other lines of business do you have as a lender that may be impacted by your client’s business changes?
• How are businesses changing now that more are emerging from lockdowns?
• In some cases, it may be good to shock the projections to see a range of different outcomes.

The next area to look for clues is in the area of cash flow. Cash is king as cash is what is used to pay the bills. Here some clues could be:

• 13- and 26-week cash flow projections
• Watch deposit accounts for cash inflows and outflows (If you do not have the main operating account at your institution and are financing the business, you should!)
• What are their projected cash budgets on a monthly basis for the next 12 months?
• Have they made use of any government programs like the SBA PPP and EIDL loans to help bridge cash shortfalls?

If you have rental real estate as your collateral some clues could be:

• What does the current rent roll look like compared to the past?
• Did the owner have to give any rent concessions to the tenants?
• Projections for rental income, occupancy, expenses, net operating income
• What regulations have been put in place by local governments that restrict landlord income or limit evictions? 

If you are finding clues to the management skills, some good questions are:

• How good is their record keeping and financial reporting?
• Do they understand their cost of production?
• Do they have a budget? Have they tested the sensitivity of the budget? Do they know break-even revenue and expense levels?
• Do they understand financial ratios?
• Do they have a budget for upcoming capital expenses?
• How do they help manage their loan covenants?
• Do they have a transition plan for their top leadership?
• Are they teachable and constantly seeking to learn?

If you have a farm or ranch client, some clues you want to understand are:

• What is their crop and livestock production? How does it rank with their neighbors?
• What is their herd health?
• Do they have a written marketing plan? Risk management plan?
• Do they manage their family spending well? Do they have a budget?
• Do they use tools to protect revenues like crop insurance, contracting, hedging?

(By the way, we have a great tool on our website to help rate the management and production skills of your agricultural client.)

Some other clues you want to look at are:

• Updated guarantor or sponsor information (personal financial statements, liquidity, taxes, contingent liability analysis)
• Interim financials for most recent 30-45 days
• Accounts payable and accounts receivable trends, terms with creditors
• Inventory audit
• Contingency plans for unforeseen events
• For hotels: trends in occupancy and rate, comparison to other similar properties in the area 

These suggestions are not an exhaustive list of what items you need to look at as you are picking up the clues to understand the impact of the economic downturn on your business client, his present condition, and direction for the future. Of course, as you study the clues you have been given, this may lead to new items to look at as you peel back the financial onion layers to get to the core. Today, it is so important, perhaps more than in times of great economic strength and business activity, to have a clear understanding of the financial situation of your borrower.  

Let your curiosity roam as you are looking at the various clues. Look at this work as reading a good detective story as you use your sleuthing skills to uncover reality.