According to a recent study, prepared on the basis of the results of a survey carried out in 16 countries in Latin America and the Caribbean, on the levels of bank penetration in Latin America, published in the panel "Promoting access to financial services", held last November in Miami, within the framework of the Forty-First Annual Assembly of the Latin American Federation of Banks (FELABAN), no country exceeds 60% bank penetration. Most of it is in the “very low access” range to the financial system and only Chile is in the “medium access” range with 60% bank penetration.
According to the same study, in addition to poverty and informality, among the main obstacles that would prevent the expansion of the aforementioned bank penetration would be “the deficiencies detected in the risk assessment mechanisms of the region's banks”.
This last point made me reflect on something that for more than 12 years that I have been linked to Peruvian banking has always caught my attention and that is the way in which credit operations are evaluated in our financial system. Although local banking has evolved to the use of current tools, such as scoring, scorating and rating; I have always been uncertain about whether there really is a correct use of such tools, by pretending that they generate homogeneous analysis criteria, forgetting that they only process quantitative and qualitative data, which do not distinguish the different realities of the country where they are implemented, since they do not It is the same to evaluate in Peru a company from the coast as another from the mountains or the jungle.
Distance, customs, competition and informality affect margins in different ways. Peru does not have the uniformity of a typical European country. Therefore, the scoring or opinion provided by such tools, rather than constituting support for credit evaluation, sometimes contributes to generating doubts in decision-makers.
Another point that has generated a certain perplexity up to now is the fact that ratios continue to be used until now, in my humble opinion, out of date with practice, which rather than help resolution, confuse the analyst.
Both points, I believe, may be one of the factors of our current level of bank penetration, which, in addition to frustrating the generation of new business opportunities, have a negative impact on obtaining a higher ROE for banks, which are well above the average of the Region, could even be better, if more emphasis were placed on the criterion of human capital and the tool were adjusted to our reality than; incidentally, it cannot replace or resemble human judgment.
During the several years of experience I have in banking, I have often heard it said when an application for a loan for working capital or purchase of fixed assets was rejected, that it was denied, because:
- The financial ratios of the business were too "high" or "low". The share capital was "insufficient". There were no “real” guarantees. The “cash contribution in the operation was very“ reduced ”. The client was informal.
When asked: based on which ratios were high or low? I was answered: "based on an" average "ratio table." Obtained only God knows where or from what customer base. Separate mention, if not even taken into account, many times, the context where the credit operation was developed.
To argue this, I will cite the cases of the some denied operations, and the cliché arguments used:
- First, we will mention an interprovincial passenger transport company with authorized routes, with a significant fleet of units, with almost 100% seat occupancy, annual sales growth above the industry average, and a net profit margin nothing disgusting; whose proposal to purchase new units is rejected because its "equity debt ratio is very high and its share capital is very low".
Here it is not even evaluated whether its EBITDA or its freely available cash flow allows it to face the payment of the proposed obligation, worse still, nor does it consider the context where the business is carried out, nor the Projected Cash Flow and its assumptions, these they only constitute a mere bureaucratic procedure.
- The second case corresponds to a heavy machinery rental services company, which obtains a Contract with a mining company, but which could also be with a sugar or agro-industrial company. The Contract ensures a constant income stream and, incidentally, the source of repayment of any credit requirement, but that at the time of the opinion of the requested leasing operation, it is denied, because the client "does not have the initial fee required by the financial institution ”, which within the logic of the bank officials“ would ensure the client's commitment to the operation ”; "Perhaps rectifiable, if the client replaced the lack of cash with real guarantees", read, her house. Here the sustained payment capacity does not matter, only the rigid parameters established by the Entity.
- A third case corresponds to a commercial company of rapidly rotating products, with working capital needs, product of a negative operating cycle or growth in the sector; but whose cash requirement is limited by the Banks, due to the lack of “real guarantees”, despite the impeccable fulfillment of payments that the client registers, the visits to the business that corroborate the effectiveness of the business and most importantly, the prospects of the sector.
- A fourth case, also very common, also corresponds to a commercial company, which does not need fixed assets to carry out its activity, which partly explains its reduced share capital, which, incidentally, never increases, despite the fact that they may capitalize the profits generated by the business; but when applying for a loan, such capitalization is conditioned. The registry expenses that such a request would imply do not matter. Does having a greater share capital result in a greater ability to pay the client?
- The fifth case corresponds to a bodybuilding company, in the midst of the freight transport boom, due to the increase in demand in the transport sector, as a result of the boom in mining, agro-industry and commerce, among others, whose demand for capital Work is limited by the "high obligations that it maintains", without taking into account that they are long-term obligations; whose EBITDA of the business allows it to satisfactorily cover and, the fact that the term of working capital is a maximum of 90 days cancellable.
What a way to limit the growth of companies! and then we ask ourselves: why is the degree of bank penetration in our country so low?
- The sixth case corresponds to a heavy load transportation company with a significant volume of fixed assets, coming from the operating units it has, which were acquired, both with business resources and through financing; but with the “weakness”, as in the first and previous case, of not having an “important” share capital, for not having capitalized its profits. In this case, it is not taken into account that the accumulated results were reinvested, nor are they wondering how the company got its fixed assets. Were they not products of business profits? Technicality is what rules.
- The last case corresponds to a fairly informal client, who when requesting a loan, his proposal is rejected because the confidential figures of his business differ from the official figures. It does not matter that they can be supported by on-site verification of the business or the assets acquired with the profits generated. Mistrust is what prevails.
Less rigid analysis
Situations such as those described imply a loss of business opportunities for banks, which could be different, if the use of rigid and standardized parameters were left aside, although they allow "evaluating" a greater volume of credit operations and complying with analyst demands for increased productivity; they only manage to sacrifice profitability for the bank.
The analysis of ratios and the importance of EBITDA and free cash flow or freely available cash flow.
If the final objective of the evaluation of a credit operation is to determine whether or not a business can assume the proposed obligation, the evaluation of financial ratios should point in the same direction and not focus on the use of traditional ratios, such as, those of liquidity and patrimonial indebtedness.
A relevant ratio would be to calculate and evaluate EBITDA (Operating Profits + Depreciation - Taxes), to know if the business generates sufficient profits for the current payment of its current obligations and the credit commitments it intends to assume.
In this way we could calculate the EBITDA of their stations. historical and projected and verify if these allow you to cover your current current obligations and the current part of the proposed debt.
In the event that the company had significant capital expenditures, free cash flow should be used instead of EBITDA, which is broadly EBITDA less capital expenditures (acquisitions of long-lived assets such as machinery, equipment and other assets that appear on the balance sheet instead of appearing in the income statement).
An analysis of such nature would be more realistic, since it would allow us to calculate the client's actual ability to pay.
In the first case, although the interprovincial transport company had a debt level of 89% and its equity debt of 8.2 times, if EBITDA had been used as an analysis tool, it would have been discovered that the company could cover the all of its financial and supplier debt (for the purchase of fixed assets) within a period of 2.99 years: 50.69% in the following 12 months, 33.69% in the subsequent 24 months and 15.61% at 36 months. So the media effect of a debt ratio of 8.2 times would have been less. Furthermore, it was taken into consideration that in three years the company would already own all of its financed units.
On the other hand, according to its Projected Cash Flow, the company was able to cover all of the new debt without affecting the obligations contracted. In addition to remaining a provisioned balance for the purchase of new units, which within the company's growth projections represent at least 5 units per year.
So: What ratios were most useful to analyze? Equity debt or EBITDA?
On the other hand, the Cash Flow Statement and the Projected Cash Flow, the latter, should not be neglected, considering the assumptions on which it is based, according to the perspectives of the company and the sector.
Statement of cash flows
The Statement of Cash Flow allows us to know where the funds that the company uses come from and where they are being invested. Perhaps the company is not generating enough resources from its main activity and is resorting to financing or asset sales activities to cover its operational needs; Or perhaps it generates sufficient resources for operating activities, but it distributes them via dividends and the investment is made through financing. We can only see this clearly through the Statement of Cash Flows.
Projected Cash Flow
An additional tool, which the analyst must never leave aside, is the Projected Cash Flow, always asking: What assumptions is it based on? Is it in line with the current evolution of the business? Does it coincide with the perspectives of the sector? What scenarios could affect you? If necessary, the analysis could be complemented with Porter's Diamond.
Accrual principle
As we know, income is recorded regardless of payments, thus having nothing to do with its collection. Therefore, by not measuring the profits of the money received by the company, it would be necessary to complement the analysis of EBITDA with a tool that allows us to determine the cash income that the business actually generates for the payment of its obligations. An alternative that could be used would be the following ratio (elaborated by the author of the note):
EBITDA = Adjusted Operating Income + Depreciation - Taxes
Adjusted Operating Income = UO (1 - DPC / 360)
where:
UO = Operating Profit
DPC = Average collection days
This new empirical ratio would allow us to consider only spot sales for the calculation of Operating Profits, to be replaced in the EBITDA formula, which would bring us closer to the client's actual payment capacity.
conclusion
One way to contribute to the banking penetration of our countries is to correct the loose ends that still exist in terms of risk analysis. One of them is to adjust the scoring, scorating and rating tools to the reality of each country and another is to focus the analysis of the ratios on the evaluation of the client's ability to pay, leaving aside all those who do not contribute to what The aim is to know: whether or not the client can pay the loan he is requesting. The rest I think is unnecessary
In a future article, I will comment on another important part of the analysis, which a true evaluation should never leave aside, the analysis of the environment where the companies requesting credit operate, since these are not closed systems, on the contrary, they interact with the environment., both internal and external.
