One of the core components of the bank training I present is making sure bankers know and understand CREDIT RISK. I define CREDIT RISK as the Probability of something happening or not happening times the Consequences that result. Managing CREDIT RISK is the primary job of every banker. As the economic impact of the Covid 19 virus hits our clients as well as our banks, it is the perfect time to understand and implement CREDIT RISK management practices.
Our clients are going through a devastating chain of events. Their world has been turned upside down. Many are facing a crisis that they are unsure of how to negotiate. The Payroll Protection Program is a short term lifeline for your clients. However, you need to determine if access to these funds makes sense in the long run for your client.
Each of your clients should be assesses as to whether they are facing a liquidity issue or a solvency issue. The difference is crucial. A liquidity issue is defined as a short term loss of liquidity that the firm will be able to recover from and eventually catch up, repaying their obligations as agreed. A solvency issue is defined as a firm being unable to repay its existing debt due to a lack of long term capacity that is unlikely to change. Adding more debt in this instance will not help them, rather it will dig them deeper into a hole that they are already cannot get out of.
While the PPP financing is forgivable, it is not guaranteed to be forgiven. What is the probability that your client will follow the guidelines to assure the loan is forgiven? The consequence of the lack of forgiveness is that they will have to pay the loan back over a certain period of time. The calculation you have to assess here is will they have enough cash flow to repay not only the existing debt, but the new debt as part of the Payroll Protection Act? The other aspect here is, under the new “normal” do they have the ability to even pay back what they already owe, assuming some loosening of existing terms, such as delay of a certain number of payments? What is the probability that their business will return to past levels? How long will that take? Test the consequences on the ability to repay.
The goal here is to determine if your client is facing a liquidity crisis or a solvency crisis. The answer is critical to the way you should proceed in the relationship. Dealing with the bad news now when they have some ability to repay what is outstanding is optimal. Waiting and funding even greater losses when they cannot repay what they have is just throwing good money after bad.
Stevens Risk Management, LLC has the tools and resources to assist in assessing your clients and helping your relationship managers manage the CREDIT RISK associated within your credit portfolio.