LOAN REPAYMENTS AND CORPORATE CREDIBILITY
Mar 22 - 28, 2010
A corporate banker is trained to evaluate borrowers on three aspects traditionally known as 3Cs - capacity, character, collateral. Capacity underlines a debtor's creditworthiness with regard to the size of a particular loan as well as the business's capability to generate sufficient revenue and cash. The volume of cash generation in particular and its use for timely repayment of bank liabilities determines the level of corporate credibility. A well-established and sound business group will invariably use its market standing to negotiate a lower loan price and offer weaker collaterals (a ranking charge etc.), yet its endeavor would be never to default on its obligations. It is this general rule the corporate banker keeps in mind while balancing the risk and return factors of investment policy.
The capacity building process for a corporate executive is fraught with pitfalls. Once tarnished, the corporate reputation might take too long to be restored. The financial executives on the corporate side are, therefore, wary of liquidity squeeze that puts them and the company in an embarrassing situation. They should be, and normally are, very particular on cash forecasting aspect of the business and undertake rigorous and immaculate cash flow exercises to forestall any such situations.
Since finance is an imperfect science, an unforeseen situation might crop up anyway to put a corporate financial executive in a quandary. What can be done in such cases? A number of options might be available that may include1) tell the bank to make provision for a few skipped loan installments, 2) ask the bank to restructure company's existing liabilities, 3) dispose off an unprofitable company asset to avoid the situation of default, 4) squeeze company creditors and debtors through change in payment and collection policies, 5) obtain a fresh loan from some other bank to pay off the liabilities of the bank in question, 6) inject additional cash in the business through capital base enhancement or through directors' loans to the business.
The selection of one of the options or a combination of options to avoid a default situation will determine the character of the corporate people. Options 1 & 2 might not be so attractive for a company enjoying high credibility in the banking sector as this may be tantamount to default under the prevailing regulatory conditions that require all banks to report to the central bank any delayed repayments or restructurings. Option 3 might only be used in a one-off situation and cannot be considered a practicable option to ward off a looming default. Option 4 is likely to disturb the company relationship with its suppliers and customers who might respond by moving to some other company if market conditions so allowed. Option 5 might afford a reasonable way out, but managing a fresh loan from a different source has time and money costs. A shrewd board of corporate directors would recommend option no six, as it is not likely to send any negative signals to company competitors, investors and bankers. Rather, this might appear, and the corporate people should strive to make it appear, a business expansion move. Going to additional stock floatation, in case of a public limited company, either through a right issue or a new public offering requires a good deal of time. This may be handled through pooling of directors'/sponsors' money in the shape of an in-house bridge finance. The character of a company and its people is, therefore, ascertained by the action they choose in circumstances that look set to precipitate a default. A clean-slate company - one that never defaulted - will never take the situation lightly and try to maintain its pristine position by using the market to raise additional cash without creating a modicum of doubt in the minds of its competitors, investors and bankers. Going for a right issue with premium in accordance with the current market value of its share would, therefore, appear to be the best option.
But, as a corporate banker has to deal with the entire market where companies with a lower credit rating are also operating and where the clean-slate companies are highly in demand in the banking sector, he will have to deal with the defaulting borrowers more often than not. Since low-rating companies are not much worried about the purity of their financial dealings particularly with their bankers, they will frequently come up with a restructuring request asking not only to shift the loan maturities but also to extend them further financing. At this point, the corporate banker will shift his focus to the 3rd C - collateral.
Corporate entities with a lower credit rating are best controlled through the judicious use of the tool of collateral. The company assets in such cases are normally found collateralized to the full, and in some cases even over-collateralized. The corporate banker should now look for additional collaterals in the shape of some prime real estate assets, may be the directors' residences or private land holdings.
Over-collateralized industry assets are known to have given rise to NPL portfolio and unjustified right offs. Unfortunately, in the current decade, corporate bankers in league with some top industrialists and business people are reported to have raised some highly under-collateralized loans for use in the speculative sectors of economy, especially property and share market. One of the ex-governors of SBP is known to have lamented about the meek productive response of a number of bank finance facilities that were obviously misused. The prevailing system that allows bank financing against ranking charges is at the root of this malice. Influential business and industrial groups raise low-priced loans against phony security of ranking charge. These loans are either invested abroad or used to make quick returns through deployment in speculative sectors during boom periods. Eventually, this money gets lost in market bust cycles, and the banks are left to report these loans under their NPL portfolio. The SECP, instead of simply issuing charge certificates, should evolve a formula to determine the maximum amount the assets of a particular company can raise as loans. On reaching this limit, the issuing of further charge certificates should be stopped, informing the bankers that a particular company stands leveraged to the full.
The role of a corporate banker in discouraging the misuse of industrial or business loans also needs to be redefined. He would do well to add a 4th C - consumption - to his risk management tool-kit. It is incumbent on him to see to it that the loan is consumed exactly for the purpose it has been raised.