How a Bank's Risk Appetite affects the Borrower

Many companies are currently in their Bank's Special Assets or “work-out” division, however, they may not necessarily deserve to be there.  These companies are still paying on their loans; perhaps they had a bad year, but they’ve taken corrective actions.  This could be due to the Bank not understanding their business, the relationship manager has changed or does not want to monitor the company's progress, the Bank has been acquired, or the Bank has changed their appetite for the industry the business is in.

There are multiple reasons why a Bank would develop an exit strategy for a business, but it may have little to do with a company’s overall performance and more to do with the Bank’s risk appetite.  If a company is coming off a bad year, it is difficult to find a new source of financing; so where does this leave the borrower?  The borrower is already dealing with the difficult economic environment, but now has to deal with the Bank’s rigid work-out division adding to the complexities of their banking relationship.

Not all Banks are built the same, and all have different appetites for risk.  Banks manage their portfolios to control risk and will change their risk appetite for various reasons such as interest rate risk (i.e. the maturity of their portfolio is too long or short) or high concentrations of a certain asset (i.e. to much real estate on the books).  If a Bank was just acquired, there may be a large transformation of the credit culture, from lenient underwriting to conservative, which may leave many bankable companies looking for new Banks.  In order for a company to find a new Bank when the industry is in such a flux, the company needs to be able to tell their story successfully, both qualitatively and quantitatively, so that it mitigates any underperformance it has experienced in the past.  

The Risk Management Association (RMA) recently conducted an online survey in March 2010 and found that Banks of all sizes overwhelmingly indicate that the amount of risk they are willing to undertake has decreased over the past 12 months.  As a result, they have implemented tighter underwriting standards and have not extended credit to portfolios with significant concentrations.  Given this, the Borrower will be more successful if it finds an alternative Bank that does not have a concentration in the type of funding needed.