Philip Knight, credit and risk director at Asset Advantage, says the successful pursuit of the fabled ‘commercial approach’ lies in taking a straightforward and common-sense approach to lending, by lenders who make real efforts to understand their clients’ business.
A ‘commercial approach’ is one of those oft-repeated mantras. In fact, many funders claim it as a badge of honour, indeed a coat of arms. However, if the conversations I have with brokers are anything to go by, it is more akin to the Holy Grail. Much like some credit decisions, the legendary cup was said to have special powers, and was destined to provide happiness, eternal youth and food in infinite abundance, but as the legend goes, it has proved difficult to locate.
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So what exactly defines a ‘commercial approach’?
First and foremost it does not – or rather should not – mean a sloppy or half-baked approach to credit analysis. Nor should it be synonymous with a relaxation of sensible credit assessment – as in: "I know it’s not a very good deal, but couldn’t you take a commercial view on this one?"
The encouragement to apply a different set of criteria to a single deal often goes hand-in-hand with the ‘portfolio’ approach to lending whereby it’s OK to have a few weak deals as they will be offset by other deals which don’t require a commercial approach.
The trouble with this approach is that it’s impossible to manage on a day-to-day basis and, more importantly, the real world of bad debt maths does not work like that.
My view is that a ‘commercial approach’ needs to derive from a deep understanding of how businesses work. This is then combined with a keen appreciation of the business process that is broker-led asset finance. The credit decision is then based on an assessment of facts rather than the breaking of rules.
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By GlobalDataTaking these in turn, let’s look at why it’s important to look at how businesses work. First and foremost, one needs to understand the business model of the customer that’s being assessed in order to build an expectation of that customer’s financials. It’s no good expecting a service-led business such as an accountant or an estate agency to have a huge asset-backed balance sheet.
In order to judge the quality of these types of covenant, one needs to look at other criteria beyond a simple tangible net worth test.
On a similar theme, credit text books might suggest you treat preference shares as debt. However, if the balance sheet entry represents a multimillion-pound investment that was carried out six months ago, it would not be sensible simply to apply a standard gearing ratio criteria as a determinant of your decision. On that same theme, a well-documented post-balance-sheet equity investment ought to be a huge plus for proposal rather than slavishly ignored because it isn’t in the last audited accounts.
At Asset Advantage, our take on ‘commercial approach’ includes meeting with as many potential customers as we can. Meeting with businesses, their management and owners seems to us to be the key to understanding their businesses. Equally importantly, it’s not just about the deal we are working on at that particular time. By documenting and sharing industry sector knowledge within our business we leverage our meetings across all our lending decisions, building core commercial knowledge into the process.
Appreciating how your own market works is also a key component of a ‘commercial approach’. Credit assessment of a proposal should not be treated as an examination-based process in which every ‘i’ must be dotted and every ‘t’ must be crossed. There is most definitely a balance to be had between asking every possible question you could ask about a customer and identifying a few key points.
Having a feel for the internal and external communication routes that a deal goes through is also vital. For example, any response on a proposal ought to take into account the size and type of the customer. A different approach is taken for a sole trader than that which might be used with, say, a finance director of a UK-based subsidiary of a foreign company.
Similarly, we should be sensitive to a supplier-introduced deal in which there is real risk of Chinese whispers-style mangling of a question or condition of sanction. If the worst comes to the worst and the proposal actually has to be declined, I think it’s important that the reasons are given in order that the deliverer of that message – the broker – can present a logical fact-based reason why. A commercial approach is not about hiding behind a generic, ‘not for us’ decline! If the decision contains factual errors, then the commercial approach is to acknowledge the mistake and revisit the decision.
In conclusion, therefore, the search for the fabled ‘commercial approach’ is not really anything like the search for the Holy Grail at all. It exists in a straightforward – if not always easy – common sense approach to lending, applied by lenders which really make an effort to understand business. And to anybody who can’t see that I say: "Your mother was a hamster and your father smelt of elderberries!"
