Banks have always been keen to protect its interests in maintaining their books clean and in the process keep trying their best to issue guidelines through circulars and train, repeating their ways to put checks on the creditworthiness of the accounts to proactively lend an ear to the alarm bells ring.
There are several easily identifiable and known EWS which every corporate banker can easily point out to – such as LCs devolvement, BG invocations, cheque returns, slow-moving inventory, bad debts, frequent irregularities, project extensions, etc. But most of these can be termed under lagged data. Bankers need to react to the lead indicators and not on the lagged data. This article focuses mainly on some unusual EWS for detecting NPAs, some of which are usually missed even by experienced corporate bankers. Bankers neither need to be detectives nor investigative journalists. But a tingling sensation needs to crop up whenever there is a chance of delinquency. Let’s examine two such unusual EWS.
1. Steep decline in power bills in a manufacturing plant
This information can be sourced from site visits/inspections (power bills) and also quarterly financial reports. Credit specialists usually do not focus on data collected by the bank’s field staff, which is very much understated but is extremely powerful. One such example is power consumption data which is not paid attention to on a periodic basis or even if a drop identified, is brushed aside by assuming it as maintenance works. Inspection officers are different from credit analysts and bankers may sometimes fail in connecting such dots. As long as sales, profits, stocks, receivables for those month/quarter endings do not reflect an anomaly, the typical banker will not be alerted. But little do they understand the impact. For instance, if a car manufacturer makes about 1500 cars a day, with $40,000 average cost per car, a day’s power-out would cost the company $60 million in the top-line. There exist several manufacturing activities wherein equipment such as furnace will take considerable time to restart and return to normal activity, impacting the production levels.
As you read this, China is presently grappling with power cuts, and the impact on the industry is expected to be significant, which will come to light in Q1 Y22. Hence, any manufacturer not running for a month in a year, except backed with clear reasoning, can have a huge impact on the financials. In such a situation, if the company could still make up the top-line for the previous year, it may be generating revenues through an alternative route of trading in the raw material and hence caution should be exercised.
Required Due diligence: For certain shortlisted customers within your portfolio, collect and scrutinize the trends in power bills and payments by liaising with the inspection officials.
2. Ratio of raw material, stock in process, finished goods, receivables, creditors, and sales trends change compared to the usual trends
Stock statements are usually submitted at monthly intervals for the calculation of drawing power by the Indian banks. These are usually not utilized to the full extent usually by the credit analyst while performing reviews during the year. As we know, value is locked within the operating cycle or as temporary cash balances and any disproportion among these items may indicate diversion of funds or inherent hiccups. The ratio of these items furnished in the stock statement can indicate very insightful observations such as (i) Pile-up of RM, WIP indicating incidence of hiccups in the manufacturing process (ii) Pile-up of finished goods inventory indicating low demand (iii) Delay in realization of receivables or (iv) Decline in credit for the purchase of raw material. Each of these is a serious issue and they indicate a troubling account in the making, which has to be delved deeper into for action by the banker.
Required due diligence: Trends of stocks, receivables, creditors, and sales to be maintained and compared with half-yearly & yearly financials to identify any disproportions which may impact the credit. The above should also be compared with the credits and debits in the account, which can reveal a plethora of insights about the company’s performance.
The above early warning signals may always not be actual warnings about creditworthiness, which is signified by the word ‘signals’ in this term. They may just be false alarms, but it is better to attend to them rather than ignoring if it is an actual warning signal. Nipping the incipient stress in the bud will improve the chances of rescuing the account from turning bad in the future. For this to happen, bankers need to keep reminding themselves that the ‘Devil lies in the details’ .
N Sai Animesh Kumar works at Ahli United Bank, Kuwait. [email protected]