Managing risks is at the core of managing any financial organization. It is about making tactical and strategic decisions to control risk and to exploit any available opportunities. Lending involves uncertainties and uncertainties lead to risks. There is no written formula to mitigate or diminish these uncertainties entirely because there are elements which would be beyond our control. Best is to predict what could go wrong during the tenure of a facility and to have mitigating factors to either reduce or eliminate these uncertainties.
MDV, based on years of experience in lending to high risk sectors, projects and start-up companies, has developed a risk assessment methodology which covers the full eco-system of a business entity. As mentioned earlier this methodology would not be able to fully mitigate all risks but we have managed to put in place the necessary corrective actions from the very initial stage. Further, this methodology also helps to develop a solid monitoring system of a project during the tenure of the loan.
Below are the summary of each of the 9 key components of MDV’s risk assessment methodology:-
This involves assessing the historical financial performance in order to determine the future financial trend. The most important aim of this financial assessment, is for MDV to see good governance practices are in place, sufficient margin/cash available and management practices a good internal control mechanism. The financials show how capable is management in managing the company and this will be reflected via profit margin, reasonable gearing level, collection of receivables within the given time period, level of stocks and whether there are excessive related parties transactions. A much disciplined company would ensure financial records are well kept and transparent.
This is one of the most important elements in MDV’s assessment. Key management (which constitute the directors and shareholders) plays a vital role in managing the company, the project and the funds allocated. Thus, trust must be placed on the key management and their past performance/behavior will be an indicator. Key management team should have the relevant project deliverables experience and the relevant educational background or at least past project management experience. Their conduct of accounts with other financial institutions will be an indicator to see how committed the management team are in dealing with a financial institutions.
(c) Counter party
This covers the capability and capacity of a project awarder to honor payment to the borrower. In normal circumstances, the project awarder would be a financially strong company with a reputable track record awarding a contract/project to the borrower to be delivered within the specification and timeframe given. MDV would not assess a loan facility when the counter party is a weak company as MDV will be concerned whether the counter party would be able to honor the payment when due.
This involves assessing the capability of the company and the relevant technical team to perform the project. The assessment will cover the key personnel past experience, timeline for the completion whether it is too short, forex exposure risk, which part of the project will be outsourced, acceptable project milestones and capital commitment (contribution) of the management. MDV would also evaluate the capability of the company in meeting the project milestones. The availability of cash in the event of delay and cost overrun. The payment terms for each project milestone. The type of warranty and guarantee to be provided and who will handle the maintenance of the project.
A contract awarded to a borrower is the reason for the borrower to apply for a loan and hence it requires a risk assessment. A contract, depending on its complexity, will be vetted by MDV’s legal personnel and MDV’s panel lawyers (where necessary). MDV must ensure the validity of the contract from the project awarder. Other pertinent points from the contract would be the payment terms which would then be used as a basis for the repayment schedule. Conditions or terms that could lead to the termination of the contract. MDV would also assess the milestones for the deliverables, timeline given and the fulfillment of the condition precedent imposed in the contract. Most importantly, the contract needs to be at arm’s length and reasonable and the borrower is be able to commit.
(f) Cash flow
A cash flow forecast and projection of the project or companywide would normally be the first element for MDV’s assessment. This assessment would determine the actual cash requirement for the company to perform the project. The cash flow must reflect the project milestones and project payment schedule (hence cash inflow profile) and incorporate all cost associated to the project. MDV will access the reasonableness of the cash flow and will perform a sensitization to ascertain several worst case scenarios.
Suppliers/contractors will play a vital role in determining the success of a project. Borrower is expected to appoint suppliers/contractors with a strong financial strength and would be able to provide the needed warranty and performance guarantee (where necessary). Payment terms to the suppliers should commensurate with the work done or delivered. MDV will conduct a search on the suppliers to gauge their past experience and capacity.
Structuring of a facility for the borrower would constitute part of the terms offered to a borrower. It consists type of securities to be given to MDV, disbursement terms that would match the project cost requirements, repayment to MDV that would match the proceeds to be received from the project awarder and covenants during the tenure of the facility. All of these must be intertwined so as to create a control mechanism for MDV and to assist the borrower to deliver the project. The structure will must match the project requirements to ensure funds will be disbursed as and when required to the suppliers. Repayment will match the cash inflow projection after sensitization. Nonetheless, MDV will ensure the facility structure does not burden the borrower but protect the interest of all parties involved.
This assessment will be conducted when there is no specific project awarder but the source of revenue/payment to MDV will derive from the open market. Hence, a thorough analysis will be done which cover whether it is a new industry or a sun-set industry, marketing strategy, distribution channels and pricing strategy. The target market/segment and target demographic will also be ascertained to ensure the projected revenue could be achieved.
The above risk assessment components have been applied to all types of financing in MDV and cover all sectorial assessments. To-date the methodology has been proven to be effective to mitigate risks in lending. We have to accept the fact that risks cannot be eliminated in totality. However, it is very important to determine the risk type and impact of such risk. It would be beneficial to pre-determine the potential risk as well as the acceptable risk tolerance level.
-Rizal Fauzi |Senior Vice President, Risk Management Division