JEDDAH, 19 May 2003 — In the Kingdom, the local and joint venture banks determine if a certain entity is creditworthy or not based on several important factors, which can and do differ from bank to bank.
First, every company in the Kingdom falls into a certain banking category, either consumer/retail (small) banking, commercial (middle market) banking, or corporate (top tier) banking. Generally, the banks establish which market segment the business suits, based on their total revenues/sales. Each bank sets the target market (who fits where) for each segment based on its own segmentation concepts. For example, in general a company with SR10 million turnover is considered a consumer/retail banking customer, and a company with SR100 million turnover is considered a corporate banking customer by nearly all the banks.
Once the banks have established which segment that specific company fits, the second step is to establish which market/industry sector it operates within. Essentially, each industry, whether it be contracting, trading, manufacturing, or services, all have different financial industry norms and critical success factors. These standards and factors are what the company and its operations are benchmarked against.
Now that the banks have established which banking category and industry the company corresponds to, they begin analyzing the current and future industry basics. Generally, the banks look at growth trends, future prospects, competition, market leaders, and the company’s market share. This gives the banks a clear picture of the strength of the industry (growing or not), the factors that will support the industry’s continuity, the companies operating in the industry, and how the company in question ranks against the others.
Generally, a stale industry, with a large number of players, raises red flags. The outcome of such an environment is usually profit-eroding price wars to gain market share, which in many cases can restrict the company’s ability to achieve its financial goals.
Each bank has a lending portfolio, which comprises a mix of loans to companies in different industries and with different tenors (short-term or long-term). The banks’ credit portfolio committees establish the banks’ appetite for each industry, to maintain a certain balance, which is also governed by a legal lending limit set by SAMA based on the financial institutions’ capital base. Sometimes if the institution is overextended/positioned in a certain industry, they tend to reduce their exposure by selling it off to other banks or by reducing unutilized facilities extended to their current customers in that industry. On the other hand, if a bank identifies an industry where they are underexposed, they tend to entertain increasing exposures to their customers in that industry, and heavily market other creditworthy companies within the same sector.
Following the analysis of the industry and the lending portfolio, which establishes the banks appetite to lend to the specific industry and to what level that is allowed, they then look at the legal structure, ownership, and management of the company. When analyzing the legal structure and ownership, the banks look for possible succession issues, and the level of the commitment exhibited by the owner(s). Succession issues arise when the legal owners of an entity are elderly people, with heirs that are not involved in the business. The death of an owner, in this case, could disrupt the continuity of the business. Banks put a high degree of emphasis on this point and it can result in a company becoming non-bankable. In addition, the banks assess the level of commitment and involvement the owners have in the business, and their equity stake in the entity and out of it.
Management is considered to be the ultimate link to the success and continuity of the business. The banks look for educated, professional, and experienced management in any company. Management must show their ability to react effectively to market trends and manage the risk involved. It is the management that links the bank to the company and its operations. The information provided from the management must be clear, accurate, and unbiased. The more transparent the management, the more comfortable the bank is with dealing with the company.
The core of the banks analysis of any company and its operations is the financial position of the business. Banks usually judge the actual financial performance of a company based on three-year historic performance and two-year forecasts. The historic analysis is based on the audited financials, and the projections are based on the company’s management forecasts. It is worth mentioning that the auditors preparing the financials are also rated and categorized by each bank. The better rated the auditor, the more dependable the figures presented.
Generally, the banks take the dependability and reliability of the figures into consideration when preparing their analysis. In addition, a qualification to the financials send a negative pulse to the banks, and usually needs rectification.
Each bank looks at certain key financial highlights, which gives them a better understanding of the financial standing of the company, in addition to allowing them to establish the actual level of credit facilities required. Each company’s financial performance is benchmarked and judged against the industry norms, which differs from one industry to another.
Among these key financial highlights are the turnover, gross profit margin, EBITDA, interest expenses, net profit, net profit margin, dividends or withdrawals, asset management (receivables and inventory), asset conversion cycle, working capital, capital structure (leverage ratio), tangible networth, liquidity (current ratio), debt servicing ratios, and cash flows.
The outcome of the financial analysis is usually to determine the overall financial standing of the company, and its ability to service its debt and dues. In general, a growing company with increasing turnover, healthy profitability, good asset management, low leverage, healthy liquidity, and sufficient cash flows is generally considered a good candidate for bank financing.
After the bank establishes the financial capability of any company and the level of credit facilities it needs, they identify the risks relative to their business, and whether they are safeguarding themselves to mitigate these risks. One of the generally identified risks for many companies in the Kingdom are high receivables and delays in its collection, which are usually mitigated by tight credit extension policies with a good track record of collection, and sufficiently available credit lines with banks. Banks usually shy away from being the sole financiers for any company, because if there is no room to grow with that “one bank” customer, it usually holds back the growth of their business.
Other general risks relating to many industries in the Kingdom include, succession issues, inventory obsolescence, supplier/customer concentrations, and competition. These risks need to be mitigated in many cases, for any bank to judge the credit worthiness of a company and its business.
Following the risk assessment, the banks determine their ways out, i.e. how and from where will they be repaid. Essentially, the banks look for at least three ways out. First being the cash flow generated by the business. Second is the equity cushion in the business. Third, the owners personal net worth outside the business, when personal guarantees are provided to support the facilities.
The banks’ ways out can differ from one company to another, given that sometimes the bank is provided with acknowledged assignments of contract proceeds from projects or supply contracts. In this case, the assignment is considered the bank’s first way out. Other items such as a form of collateral offered, corporate guarantees, and bank guarantees, can also change the sequence of the banks ways out, in addition to playing a big part in the pricing standard for the facilities.
After a clear picture is generated on the overall standing of the business and what level of credit facilities are required, the banks establish the pricing of the facilities based on their assessment of risk involved, their comfort level with security/support documentation provided, and the predetermined minimum returns on any credit facility extended. Some banks use the pure profit method, which entails having a generally established minimum level of profit from any customer.
Other banks look a certain profitability ratios such as return on assets employed (ROA), and return on solvency (ROS). These banks set an acceptable ratio that fits the banks profit making strategy. In general, a bank extending SR100 million in credit facilities will not accept an overall return of SR100,000. It is also worth noting here, that total bank charges to a customer, is not the actual banks profit.
The majority of bank charges are funding costs. The remaining fractional charges are the margins, which contribute to the actual profit to the bank.
Facility pricing is usually the most sensitive point with any company; however, the banks should be viewed as investors, given the fact that they have a number of shareholders, which expect acceptable returns on their investment.
In terms of existing bank customers, another factor some banks look at, is the level of credit entries (deposits) entrusted to the bank, in addition to its overall lending share of wallet. These two items go hand in hand, as banks look for an acceptable level of credit entry share of wallet when compared to their lending share of wallet. For example, many banks will be dissatisfied with a 10 percent share of credit entry wallet, if they have a 50 percent share of lending wallet.
To summarize how all the banks in the Kingdom operate, in terms of lending, is difficult, as each bank has its own set of policies, procedures, and credit analysis techniques to guide them. However, there are some general rules and guidelines that are common amongst the banks, which are essential to how they decide who is bankable and who is not.
(Mishaal Abdulmohsen Al-Sulaiman is a Saudi corporate banker based in Jeddah)
