XI Investigating the Credit Risk

CHAPTER XI INVESTIGATING THE CREDIT RISK As we have observed, the purpose of the banker in asking the borrower to submit a statement, whatever form that statement may take, is to discover the truth concerning the business condition of the applicant for credit. The measure of truth revealed by a statement depends upon several factors. If the borrower is honest and has good judgment of values in his business his statement is valuable. If he has bad judgment even honesty and veracity lose their force. If he has neither honesty nor good judgment his statement is valueless. Where honesty and good judgment of values are coupled with adequate accounting machinery even the uncertified statement of the borrower may be looked upon as a sound basis of credit negotiation. Such a borrower, thoroughly understanding his own affairs, relieves the banker of much responsibility. Danger is sighted in time to prevent loss to borrowed capital.

But the banker never knows without investigation whether the borrower's oral or written statement is true or false, or, better perhaps, to what extent it is true and false. The task of the banker is to find the facts concerning the borrower's affairs and character and then from those facts reach a sound conclusion as to the payment or non-payment of the amount which the borrower hopes to obtain. Accordingly an effort 214 INVESTIGATING THE CREDIT RISK 215 is made, through tapping a large number of sources of information, to supplement and to test the borrower's estimate of himself, an estimate that experience has generally shown to be too high. Handbooks as a Source of Information Banks having large and active credit departments utilize trade reference works, which are valuable in "routing" investigations as well as for the information they contain. The Textile Trade Directory, for example, contains the names of most, if not all, of the manufacturers of textiles in the United States together with a brief description of the property, names of officers, a list of concerns handling raw materials used by the manufacturers, and the names of wholesalers and jobbers throughout the country. Corresponding handbooks for other trades are used in a similar way.

Among such books the bank directory also has a prominent place. The Mercantile Agencies Every bank of importance is a subscriber to Dun's and Bradstreet's. The rating books of these mercantile agencies and their special reports, although inadequate and not always in accord with the facts, are of more than merely confirmative value. The agency reports frequently throw flashes of light on the character of the management, giving facts as to age, fires— not unimportant,—litigation, and failures, and may throw out hints as to methods of pay.1 1F. W. Crane, Commercial Paper Purchased front Brokers, Proceedings, Thirty-sixth Annual Convention, Illinois Bankers' Association, 1916, p. 135.

216 BANK CREDIT The Trade Probably the most important single source of information for the banker is the "trade." Checks and drafts passing through the bank give the names of houses with which the depositor deals and these houses are a source of information as to how accounts for merchandise are taken care of.1 As the "trade" is one of the main sources of credit information, it follows that a great commercial center like New York would afford superior information facilities and possibilities. Even the class of firms from whom goods are bought is an excellent index of the credit standing of the buyer. A poor credit risk may possibly do business with one or two first-class houses, but it will be difficult to do business with a half dozen or dozen houses of a high order, as houses that investigate the credit standing of their customers are not likely to sell to those of doubtful reputation. In other words, if a dozen mercantile credit men pass favorably upon the subject after looking him up thoroughly, the chances of all being led astray are very remote. Consequently the applicant for a loan who deals in the regular way with a number of first-class houses has that circumstance distinctly in his favor.2 Mercantile credit men are generally very willing to answer the questions of the outside man representing the bank. To an experienced credit man the ques1S. R. Flynn, A Twentieth Century Credit System, Proceedings, Thirteenth Annual Convention, Michigan Bankers' Association, 1901, p. 31.

2 J. G. Cannon, Credit, Credit-Man, Creditor, Bankers' Magazine, Vol. LIII, July, 1896, p. 39.

INVESTIGATING THE CREDIT RISK 217 tions of the bank man are of great value. He often wants to know from what source they emanate and precisely why they are made. The mercantile credit man may often receive more information than he imparts.1 "Scanty fare for one will ofttimes make a royal feast for two." Both bank and mercantile credit men do not regard their knowledge and ideas as their own individual property. Of course information given a bank by a borrowing customer is generally treated by the bank in a reasonably confidential manner. The credit man and the outside men should be good investigators, capable of asking the right questions. In illustration of this point may be mentioned a case where a credit man called upon the head of a firm to secure information regarding a certain concern. When asked if he sold to this concern, the head of the firm being interviewed replied, "Without limit."

It occurred to the inquirer that it might be advisable to ask the terms upon which the goods were sold, and the response was, "Always for cash." The successful credit investigator is a patient inquirer, always preferring to wait rather than interrupt. Having secured an audience with the credit man or the person attending to the credit of the house, the investigator will tactfully ask such leading questions as: Do they pay their bills promptly? For what length of time do you give them credit? How long have you been selling to them and do they buy largely from your house? Do you think their expenses are heavy? »76íd.

218 BANK CREDIT Do you think they are making money? Have you heard anything said about their responsibility or character? It need scarcely be said that the investigator will not be satisfied with equivocal or fragmentary information and a considerable number of inquiries may have to be made before convincing and decisive facts are got. The credit man wants to know whether the statement tells the truth and accordingly presses to the fore his inquiries concerning the moral hazard. The trade expert plays a role in connection with the work of the bank credit man that has not been appreciated fully. The credit man of the bank goes to a certain point in the analysis, applying the principles with which he works familiarly and then turns to his trade acquaintances for information that constitutes the finishing touches—to men who have made a life study of the particular line and whose'' sensitive finger-tips are at all times upon the pulse of trade forces." The banker's field of necessity covers such a wide range in credits that he cannot apply the closest tests based on daily or weekly advices coming to the trade specialist, whose channels of information have been built up and preserved with the utmost care through a period of years.

One of the trade opinions that the banker has learned to prize highly is that of the mercantile expert who sits at the table in the board room of the bank. This man has a dual responsibility which he quickly measures. He knows whether it would be advisable to extend a merchandise credit when he is reasonably sure the account would be discounted and the profit a good one, and he also knows whether to recommend the concern's INVESTIGATING THE CREDIT RISK 219 note for discount at his bank on long time and at a low rate. He may favor one and oppose the other.1 Bankers sometimes inquire for information, in the case of paper offered by brokers, directly of the concern the purchase of whose notes is under consideration. Such inquiries, whether concerning mortgage debt or some other matter, may be intended only as "feelers," and to satisfy curiosity as to what manner of men the makers are.2 Banks Banks are also an important source of credit information. Hour after hour investigators from other banks call to make inquiry regarding customers or concerns in whose paper correspondents of the inquiring banks are interested. Although the calling of investigators is an interruption, an opportunity is afforded to the banker to whom the inquirer comes for comparing notes and the "inquiree" may receive the benefit of information coming through channels that might otherwise be closed.

The replies of bankers to inquirers concerning the financial standing and character of their fellow townsmen can not always be relied upon implicitly, although bankers as a rule are thoroughly honest with one another; bad judgment may at times creep in and, very rarely, intentional misrepresentation.3 Four of the leading bankers in a leading city reported that a 1 William Post, A Ten-Minute Ramble in Credits, Bulletin, American Institute of Bank Clerks, Vol. VI, p. 254. 2 Idem, The Loan and Credit Department, Bulletin, American Institute of Bank Clerks, Vol. Ill, p. 167. • Cƒ. S. R. Flynn, op. cit., pp. 32,33.

220 BANK CREDIT certain manufacturing concern had good local credit standing. At that time each of the four bankers was carrying the paper of the concern and knew that it was not "an available asset." Subsequently,—perhaps after the bankers had sloughed off some of their own holdings,—losses on this paper were heavy. The problem of the credit manager is to get an opinion of the maker of the paper from a banker who knows the risk at first hand, and this is not always an easy matter. If the maker of a note does business in Seattle and information concerning him comes from Philadelphia via Chicago and San Francisco, it may be garbled, being an indirect quotation, generally tinctured by the minds through which it has passed. Some banks attempt to protect themselves by means of a system of triple or quadruple checking through additional centers. Even then it may happen, however, that all the intermediaries are relying on one primary source, and the result may be, in essence, a single opinion.1 Nevertheless, banks, especially correspondent banks, are storehouses of information that is scarcely available elsewhere.

Any surprise that banks should go to great lengths to secure credit information for their correspondents and in many instances for their competitors is quickly dissipated when it is recalled that in serving others, they serve themselves. Fresh information obtained is carefully recorded for possible future use, before it is transmitted to inquiring banks. Furthermore, an inquiring bank is a possible source of information and 1F. B. Snyder, Credit Service, Bankers' Magazine (New York), Vol. 88, May, 1913, p. 557.

INVESTIGATING THE CREDIT RISK 221 the cultivation of cordial relations is of mutual importance and advantage.1 The Interview The banker who is able to interview his borrowing customers has a decided advantage. The bank officer who interviews applicants for credit ought to be a good judge of faces and character, and to the extent that the countenance is the index of the heart, the officer may be able to tell whether the applicant is telling the truth. Mr. J. G. Cannon used to contend that a great many people talked to the bank officer or credit manager without coming down to facts.2 The interview affords the banker an opportunity to find out in an indirect way the borrower's notion of what constitutes honesty. Another point that commands attention is the circumstances under which the borrower started business life. It should make a difference whether the borrower's money was made by his own efforts or came to him through the assistance of friends or relatives, or through inheritance.3 What has come by dint of hard work is less likely to be squandered or lost through reckless management than funds acquired without effort.

There is little doubt that the borrower's personality has a distinct bearing upon the decision of the bank officer when he says "yes" or "no". Hence it is desirable to scrutinize the figures presented by the borrower 1 William Post, Bulletin, American Institute of Bank Clerks, Vol. Ill, p. 168. * J. G. Cannon, Credit, Credit-Man, Creditor, Bankers' Magazine (New York), Vol. 53, July, 1896, p. 37. *lbid.

222 BANK CREDIT and come to a conclusion from an analytical as well as from a personal standpoint. Some of the best talkers and some of the most attractive personalities are among the poorest business men.1 Accordingly, when the banker feels the personal influence or persuasive power of a prospective borrower, let him invoke the purely impersonal and cold-blooded analysis. A banker may easily reach a conclusion concerning extending credit before the matter of figures is reached. From brief conversation the banker may make up his mind: "This is a man I don't want to have anything to do with." The banker should rely upon his intuition under those conditions, says Mr. James B. Forgan, and should not let "mathematics or science or theory or anything else change his mind."2 The Method of Investigation in a Particular Case We may now profitably consider the way in which the credit standing of a given concern is investigated.

Take a shoe manufacturing concern located at Huntington, Indiana. The concern has opened an account, let us say, with the Mechanics and Metals National Bank of New York, and has applied for a loan. The first step might well be to secure a report from Bradstreet's or R. G. Dun and Company, which would contain a brief record of the company. Then the New York bank would inquire of bankers in Huntington, 1 Joseph B. Martindale, The Business of a Commercial Bank and how to Safeguard the Investment of its Funds, Proceedings, Thirtyseventh Annual Convention, American Bankers' Association, 1911, p. 699. s James B. Forgan, Proceedings, Twenty-Third Annual Convention, Michigan Bankers' Association, 1909, p. 57.

INVESTIGATING THE CREDIT RISK 223 with whom the concern would also, almost of necessity, maintain an account. Inquiries would also be addressed to banking connections that the concern might have in other cities. The New York bank would also communicate with banking friends, from whom close information might be obtainable, in Indianapolis, Toledo, perhaps Cincinnati and St. Louis. The Mechanics and Metals National Bank would also have friends in the leather trade in Chicago and elsewhere to whom inquiries would be sent. Letters might also be sent to certain competing shoe manufacturers in order to ascertain the quality of the concern's product, the demand for it, and perhaps certain facts as to production and selling methods. If the Huntington concern bought raw materials and supplies in New York, the bank's investigators would canvass the houses selling the subject company. The closest investigations are made in connection with new accounts and, as in this case, when opportunity for an interview may be lacking. Not infrequently, however, the credit man or bank officer will buy a ticket, take a train, and make a careful investigation of the personnel and plant of the concern applying for a heavy initial loan.

In addition to gathering facts on the given name tinder consideration the investigators, interviewing wholesalers, jobbers, manufacturers and others, also collect valuable information relative to general business conditions underlying each trade. Through this information concerning the trade and business outlook, the credit man is better able to appraise the credit deserts of the borrowing customer.