This element of credit underwriting has come to light recently in some deals that I have in the works, so I thought I would write about it and encourage any feedback or comments from my readers. For those of you that are not familiar with the term, concentration risk in the context of this discussion is the risk a company has by having “too many eggs in one basket” so to speak. In C & I underwriting, when we analyze a business, we look for any one client that makes up greater than 20% of their revenue in a given period. We analyze this monthly, quarterly and annually. To further illustrate this point, let’s look at a revolving line of credit secured primarily by accounts receivable. Now each bank will have its own method of calculating a borrowing base for this type of credit, so please don’t try to “correct” me to match what you are familiar with. I am using generalizations based on my personal experience. For simplicity, lets say that you have a $1,000,000 revolving line that is secured by A/R at an 80% advance rate. That would mean you would need $1,250,000 in eligible A/R to have the full $1 million available. Most borrowing base reports will have a concentration exclusion of anything in excess of 20% to one account. In this example that would mean that any one A/R account that exceeds $250,000 would have the amount over 250,000 excluded. This is where the client jumps in “But Bill, that account is a fortune 500 company with a high credit rating, etc. etc., how can that be excluded?” Well the list goes on and on of Fortune 500 companies that have gone bankrupt over the years, but the concern in my mind is really not as much that, as it is you being too dependent on that one account. Additionally, I have seen cases where the much larger company the A/R is with, disputes the receivable due to work not being completed properly or specs not being right, etc., and it still can become uncollectable for a non credit reason.
So what is the point and who cares? If you have read this far, I bet you are thinking that. The point is, that if the bank is worried about a concentration in A/R maybe you should be too. I have read plenty of articles bashing banks and bankers and claiming we are not interested in helping businesses. With 15 years in the industry, I can tell you that is not true for me or many of my colleagues throughout the nation. At the end of the day, we are managing the risk to the bank of being repaid. In this case, your business would have that same risk that we are concerned about. So next time you are looking at that multi million dollar account that will catapult your business to the next level, just keep in mind that any account that can dramatically change your business can destroy it as well.
Bill King
Green Bank
Dallas/ Ft Worth