What to Consider in Your Industry Analysis
Conducting and documenting the analysis of a borrower’s industry is a crucial aspect of the loan approval, renewal, and review process. To get a clear picture of the total risk in lending to a company, you need to understand the prospective borrower’s industry. Ultimately, you’re doing research to ensure you have the information necessary to determine if the company has a business strategy that makes sense within the context of general industry characteristics and economic trends. But what exactly should your industry analysis include?
Determine the right level of analysis
Before you begin, you will have to decide how deep to dive into a particular borrower’s industry. As with any kind of analysis, there is a risk and reward tradeoff. Economic justification for the amount and depth of analysis will be based on the size of the loan or relationship as well as the stage of the lending relationship – is this a brand new approval or a simple annual review? You will also need to consider your institution's total exposure to the industry. All parties at the bank, such as relationship manager, underwriters, analysis, and the rest of the credit team, also will need to get up to speed on the industry – particularly if it is not a space they have done much lending in.
Once you’ve established the appropriate degree of analysis, there are three views to consider when conducting your industry analysis.
General profile of the borrower’s industry
To start, you’ll need to get a high-level overview of the borrower’s industry. You can do this by researching the following factors for the industry:
- Cyclicality and seasonality
- Environmental and labor risks
- Potential for new entrants into the industry
- Power of suppliers to drive up costs
- Power of customers to drive down price
- Threat of substitutes
You might recognize those last five as Porter’s 5 Forces, which is a useful framework for understanding the competitive landscape within an industry.
Once you understand the borrower’s general industry profile, the next step is to gather information about how the industry is performing. To do that, you’ll need answers to the following questions:
- How did companies in this industry do in the last five years?
- Are there growth or contraction expectations for industry in the next five years?
- How is the industry impacted by macroeconomic and regulatory factors – including unemployment, consumer confidence, and discretionary spend?
Once you have all of this context about the industry in general, it’s time to look into a set of specific companies that are considered to be the borrower’s peers.
Comparison to peers
A company may seem like it is in a strong financial position, but you won’t actually be able to confirm that without comparing the company to its peers. For example, a company with 4% revenue growth and a 10% net profit margin may sound solid. But if its peers average 6% growth with 13% margins, you will need to understand why your borrower’s financials look different. Some factors to compare could include:
- Revenue, profit margins, debt-to-equity ratio, and cash flow
- Market share, growth rate, and market position
- Executive leadership and management team quality
- Technology and innovation
- Customer retention
Of course, the areas of comparison can vary by industry and some types of business may warrant a deeper analysis than others. There may be very logical and compelling reasons that the borrower is doing something different than its peers that warrants deeper exploration.
Continuing the relationship
Industry analysis isn’t a “one and done” task. You will need to deepen your level of knowledge about the borrower’s industry as the lending relationship advances. It’s important to stay current on your borrowers’ industries so you can understand their challenges – and recognize the opportunities for the bank.
ABOUT THE AUTHOR
With a background in funding, Associate Product Manager, Kate Perniciaro, prides herself on helping clients reach their potential. Before joining the RMA team, she held the position of director for a business loan entity where she assisted businesses of all sizes with lucrative and affordable funding solutions. She is currently at the helm of RMA’s eMentor product and takes an active role in guiding banking teams to bolster their knowledge and reach their potential. Kate holds a B.A. in Psychology with a minor in Sustainability Studies from Stony Brook.
Contact Kate at firstname.lastname@example.org