Using SWOT Analysis for Bank Borrowers

We are currently considering an interesting loan opportunity for a community bank. The loan is an $11mm term credit to finance the construction and operation of a cold storage facility. The warehouse will be operated by a medium-sized regional company. Our bank was asked to participate in the credit, and our analyst took only a few hours to spread the numbers. All of the cash flow, liquidity, and leverage ratios were analyzed. In the preflight meeting, the CCO looked at the numbers and asked basic industry questions such as level of competition, barriers to entry, labor costs – all standard SWOT analysis. The room was silent as neither the analyst nor the lender had any answers.  Every underwriter and lender must have a fundamental knowledge of SWOT analysis and access to industry reports in order to reference industry trends, current conditions, and growth forecasts.

 

Current Practices

 

Every month we see hundreds of credit write-ups on C&I and CRE credits (both owner-occupied and non-owner-occupied). Most of the credit analysis on the borrower, guarantor and collateral are thorough and professional. Most underwriters can identify the sources of loan repayment, identify key credit risks and assess the mitigation to those risks.  However, we rarely see any analysis outside of the company’s financial statements and the appraisal value.  

 

Every credit memo should have a SWOT section. SWOT or the strengths, weaknesses, opportunities and threats of a company was made popular by Michael Porter and provides the following information:

 

  • Strengths: Characteristics that give the business an advantage over others.
  • Weaknesses: Characteristics that place the business at a disadvantage relative to others
  • Opportunities: Aspects in the environment that the business can exploit to its advantage.
  • Opportunities: Aspects in the environment that the business can exploit to its advantage.
  • Threats: Aspects in the environment that could be challenging for the business.

 

The reason that SWOT analysis is important for community banks is that academic literature shows that SWOT factors directly account for 36% of business-specific variation in profits and cash flow.  By performing historical financial review, balance sheet composition and historical cash flow composition, a bank is analyzing only a part of the credit risk.  The SWOT analysis is equally important for C&I and owner-occupied CRE loans because CRE is secured by assets that operate businesses – be it medical office, restaurants or parking facilities.  Therefore, understanding the operating environment of both a business or major tenant forces bankers to better analyze the potential volatility around a stream of cash flows. 

 

A borrower may show robust historical performance and a healthy balance sheet but could be vulnerable to many aspects of its operating environment, such as the emergence of disruptive competing technologies (example of Amazon and retail CRE), changing consumer preferences (such as fintech and banking) or shifting macroeconomic trends (such as recessions or changes in government regulations or subsidies). These SWOT factors typically do not appear anywhere on financial statements, but they directly affect the bank’s loan quality.

 

Model Approach

 

No company operates in isolation.  Every borrower is part of a chain of suppliers and customers, it is influenced by labor, raw materials, and government forces.  Each borrower has different operating conditions, threats, and opportunities.  Below is a simple example of how to view the business environment of a company.

 

SWOT For Bank Borrowers

 

The environment for each borrower is then divided between internal and external elements as shown below.  And each element is considered as a strength, weakness, opportunity or threat for the borrower.

 

Borrower Risk Analysis

 

Specific Borrower Example

 

Using the elements shown above we can now perform a SWOT analysis on our borrower, and a condensed review appears below.

Projected Growth

 

Refrigerated storage revenue growth has averaged 1.4% per annum over the past five years.  The industry has benefited from rising levels of consumer spending and trade activity.  The industry is expected to grow revenue at 1.5% per annum for the next two years.  Slow growth is a threat to our borrower. However, earnings in the industry have been stable for the last 5 years (a mitigant to lackluster growth). 

 

Barriers to Entry

 

Barriers to entry in the industry are moderate and rising.  There are substantial initial capital costs required to setup operations. In addition, facilities must be located in attractive geographic areas, near population centers, ports, railroad hubs and major highways.  Operating climate-controlled facilities is expensive, and new entrants can expect to initially operate at a loss.  Barriers to entry continue to grow as many companies have come to offer a number of ancillary value-added services such as logistics.  Participants often enter into long-term contracts with clients, making it harder for competitors to win business. This is a major strength for our borrower.

 

Life Cycle

 

The industry is in the mature stage of its life cycle.  The industry’s contribution to the overall US economy is projected to grow at about the same growth rate as the economy (thus a definition of a mature industry).  The industry's customers are well-defined and largely limited to food and pharmaceutical manufacturers, wholesalers and retailers.  While the industry is developing new processes and technologies, the industry is not developing new markets, nor is it offering new services.  This is a weakness for our borrower.

 

Competition

 

The industry is competitive and is expected to remain so.  However, competition for the business of smaller companies is relatively light versus the intense competition for contracts with leading food manufacturers, importers, and exporters.  Our borrower is opening a plant in the South East where competition is moderate.  This specific warehouse is located near major population centers and manufacturing with few competing facilities. Our borrower is also able to provide significant logistics planning and support and thus will have a competitive advantage.  This is an opportunity for our borrower.

 

After analyzing the important elements for our borrower, we were able to arrive at a SWOT risk factor (just like a credit risk score).  We are taking this loan back to the CCO and will use our SWOT analysis to help us be strong advocates for the credit.

 

Conclusion

 

Community banks do a good job of analyzing the borrower based on historical financial performance, and most bankers are adept at analyzing various sources of loan repayment.  However, very few community banks are currently taking the time to conduct a SWOT analysis on the borrower and the industry.  Without taking into account industry trends, current conditions and growth forecasts, and full SWOT understanding, bankers are missing over one-third of the risk factors affecting every borrower.