Photo credit: Lendingmemo.com
Credit risk: the potential that a borrower will fail to meet its contractual obligation to make a payment. Credit risk exists with every loan, and at Root Capital, our number one job is to manage that risk while investing in environmentally and socially responsible enterprises that build better livelihoods for smallholder farmers around the globe.
Our ability to manage risk effectively since Root Capital was founded over 15 years ago has allowed us to maintain a 100 percent repayment rate to investors — and we have every intention of maintaining that track record and remaining responsible stewards of our investors’ money through a robust and iterative risk management framework.
Managing risk is not relegated to a particular person or department. It’s carried out by all of us throughout our entire credit process – from loan origination to the moment the loan is repaid in full. In developing and maintaining our credit policies, procedures, and tools, our risk management team helps ensure the sound underwriting, structuring, and monitoring of risks in each loan and across our portfolios.
Sound underwriting is key to ensuring that we take an educated risk by seeking satisfactory answers to questions underlying the “five P’s”:
- Purpose: what is the potential client’s business model and credit need?
- People: who are the people running the business? What are the associated risks of lending to them?
- Payment: what is the business’s debt capacity and what are its repayment sources?
- Protection: how can we structure the credit to mitigate and manage identified risks?
- Perspective: what is the context under which this potential client is operating?
Once a loan is approved and closed, borrower performance monitoring begins immediately. Monitoring entails reporting requirements appropriate for each transaction, staying close to the borrower, and analyzing and communicating a borrower’s condition at any point in time through timely risk ratings. Proper monitoring is essential to help us stay ahead of problems and take action early on.
If an issue with repayment is identified, our goal is to minimize the risk of loss through:
- Heightened monitoring
- Regular communication
- Restructuring, if necessary and possible
- Negotiated settlements
- Legal action, if necessary and cost-effective
Risk management is a constant and dynamic balancing act that reflects the healthy tensions of driving a business that builds a strong portfolio. Toward that end, we are continuously building and improving our risk management practices, which means we’re always looking for ways to improve our entire credit process.
Here’s a snapshot of the risk management improvements we’ve made in just the last three years:
- Improved underwriting formats, such as the credit memo and financial analysis tools, including a projection model for long-term loans
- Refined underwriting guidelines for the three largest industries in our portfolio: coffee, cocoa, and cashews
- Developed and implemented new and improved credit policies and procedures
- Improved credit structuring standards for lending against our clients’ purchase agreements from buyers
- Launched the first phase of a new risk rating system that improves upon our initial system by incorporating learnings from our credit experience over the last fifteen years
- Improved loan documentation
- Strengthened collections and workout policies and procedures
- Created regional risk manager and credit analyst roles
- Developed an ongoing training program for lending staff in all regions
We’ve accomplished a lot, but there’s still more to do.
Perhaps the most important initiative taking place this year is our Risk Appetite Project, a cross-departmental initiative to review our risk profile, risk capacity, pricing policy, provisioning policy, and impact returns all of which will help us refine our risk parameters as we continue to lend responsibly for sustainable impact.