Bank credit appraisal criteria for borrowing firms in vietnam

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS BANK CREDIT APPRAISAL CRITERIA " FOR BORROWING FIRMS IN VIETNAM A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By LE DINII THUY NGAN Academic Supervisor: Asso.Prof.TRUONG QUANG THONG - HO CHI MINH CITY, DECEMBER 2010 CERTIFICATION I hereby certify that the substance of this thesis has not been submitted for any degrees and is not being currently submitted for any other degrees I also certify that, to the best of my knowledge, and any help received in preparing the thesis and all sources used have been acknowledged in the thesis Signature Le Dinh Thiiy Ngén Date: December, 2010 ACKNOWLEDGEMENT This research is impossibly completed without the valuable guidance, encouragement and advice from numerous individuals including VietnamNetherlands program lecturers, friends and my family members I am really indebted and grateful to what they have done for my thesis completion First of all, I would like to send my deepest gratitude to my supervisor, Professor Truong Quang Thong who always gives advice and comments during my completion of the thesis I am grateful for Professor Nguyen Trpng Hoai and Professor Peter Calkins for their precious advice and comments from the initial ideas of the theme for my thesis Many especially respectful thanks are sent to my family for encouraging and providing me with an opportunity to pursue my desires in higher learning and for their love, affection and sympathy that have helped me to gain more strength and motive to complete this thesis LIST OF TABLES , Table l : Rating symbols long-term and short-term debt Table 2.2: Weighted points of non-financial criteria Table 2.3: Weighted points of financial ratios and non-financial criteria Table 2.4: Weighted points of financial ratios and non-financial criteria Table 2.5: Rating symbols of VCB "Fable 2.6: Profit and tax with two different capital structure Table l : Sort credit rating business Table 3.2: Business structure has ability to repay Table 1: Following explain the meaning of variables (see appendix l) Table 4.2: Points of cash flow factor Table 4.3: Points of management quality factor Table 4.4: Points of relations with banks factor (see appendix 3) Table 4.5: Points of business environment factor II l4 15 15 16 18 25 26 31 37 38 3'J 4(I Table 4.6: Points of other activities factor Table l : Descriptive Statistics Table 5.2: Correlations (see appendix 4) Table 5.3: Model summary (see appendix 5) Table 5.4: Anova Table 5.5: Coefficients of models (see appendix 6) Table 5.6: Distribution graph Table 5.7: Spearman rank correlation 4"able 5.8: Standardized residual graph 41 44 45 46 46 46 48 48 49 ABBREVIATIONS BIDV: Bank for Investment and Development of Vietnam CIC: Credit information center EBIT: Earning before tax and interest rate EU: Europe FDI: Foreign Direct Investment GDP: Gross Domestic Products GSO: General Statistics Office of Vietnam MM: Modiglian Miller SBV: State Bank of Vietnam SMEs: Small Medium Enterprises U.S.: United States VCB (Vietcombank): Bank for Foreign Trade of Vietnam WACC: Weighted average cost of capital ABSTRACT Capital credit is very important in business activities of enterprises The ability to repay loans model in this thesis shows an important role when the bank make a lending decision This study examines and analyses credit rating criteria affecting borrowing firms on bank credit appraisal in Vietnam through applying cross-section data from Credit Information Center which concentrate on forty firms including the medium-sized enterprises that has equity capital more than five billions Vietnam dong or number labor more than two hundred people in leatherfootwear industry The regression model is estimated based on the multiple linear regression function The ability to repay loans is dependent variable in the thesis model, and independent variables are current ratio, quick ratio, inventory turnover, receivable turnover, total asset turnover, debt to equity ratio, debt to total asset ratio, return on asset, return on common equity ratio, net profit margin ratio, delinquency ratio, cash fiow, management quality, the relations with banks, business environment, other activities and corporate income tax (new added) As results, corporate income tax factor affecting Vietnam Moreover, the results seem to be appropriate to answer questions of the research, borrowing firms are perceived to be information on the lending decision at banks in TABLE OF CONTENTS LIST OF TABLES ABBREVIATIONS ABSTRACT CHAPTER 1: INTRODUCTION 1.2 Research objective i 1.3.Research questions 1.4.Methodology 1.5 The structure of thesis 1.1 Problem statement CHAPTER 2: LITERATURE REVIEW 2.1 Theory background 7 1.1 Credit appraisal 1.2 The definition of credit rating 2.1.3 Objective of credit rating 1.4 Role of credit rating 1.5 Principle credit rating 1.6 Credit rating model 1.7 The basic elements of credit rating 1.7.1 The number ranks of credit rating 1.7.2 Scale of criteria 10 2.2 Some model of credit rating 10 2.2 Moody’s rating analysis i0 2.2.2 Z-score model of Altman 12 2.2.3 Credit rating of credit information center 13 2.2.4 Credit rating VCB 13 2.3.Corporate income tax 17 2.3.1 Assumptions and proposition ofM&M theory 17 2.3.2 MM proposition I (corporate taxes) — The value of levered firm 17 2.3.3 Optimal capital structure theory 20 - , CHAPTER 3: OVERVIEW OF LEATHER — FOOTWEAR INDUSTRY IN VIETNAM 23 3.1 Reasons of using data in Vietnam‘s leather — footwear industry 23 3.2 Overview of leather — footwear industry in Vietnam 23 3.3 Credit ratings data of the leather-footwear industry in year 2008 24 3.4 Summary 27 CHAPTER 4: METHODOLOGY 28 4.1 The econometric design 28 4.2 Suggested research model 29 4.3 The conceptual design 32 4.3 Criteria that banks use to appraise Y 32 4.3 1.1 Current ratio - CR 32 4.3 1.2 Quick ratio - QR 33 4.3 1.3 Inventory turnover - IA 3o 4.3 1.4 Receivable turnover - RT »4 4.3 1.5 Total asset turnover - TAT 34 4.3.1.6 Debt to total asset ratio - DA 35 4.3 1.7 Debt to equity ratio - DE 35 4.3.1.8 Net Profit margin - NPM 3f› 4.3 1.9 Return on assets - ROA 36 4.3 1.10 Return on Equity - ROE 3f› 4.3 1.11 Cash flow - CF 37 4.3 1.12 Management quality - MQ 38'i ' 4.3 1.13 Relations with banks - RB 39 4.3 1.14 Business environment - BE 39 4.3.1.15 Other activities - OA 41 4.3.1.16 Delinquency ratio - DR 42 4.3.2 Corporate income tax (new factor) - CIT 42 4.4.Data collection method 43 4.5 Summary 43 • CHAPTER 5: DATA PROCESSING AND EMPIRICAL RESULTS 44 5.1 Descriptive statistics 44 5.2 Regression and hypothesis testing 45 5.2.1 Correlation analysis 45 5.2.2 Evaluating the reliability of multiple linear regression model 45 5.2.3 Test the relevance of the overall regression model 46 5.2.4 Test the significance of partial regression coefficients 46 5.2.5 Assumption of multiple linear regression model 47 5.2.5.1 Linearity Assumption 47 5.2.5.2 Homoscedasticity 48 5.2.5.3 Distribution standard of residual 49 5.2.5.4 No-serial correlation 49 5.2.5.5 Collinearity diagnostic 50 5.3 Summary CHAPTER 6: CONCLUSION REFERENCE APPENDIX APPENDIX APPENDIX APPENDIX APPENDIX APPENDIX 50 However, limited data of thesis only study the impact of corporate income tax factor in credit rating for medium size enterprises in leather and footwear industry of Vietnam In order to apply new corporate income tax factor conjunction with factors are used at banks to evaluate repayment ability of borrowers in credit appraisal, author recommends banks as follow: • Make research in the broad about influence of corporate income tax factor to access credit for enterprises in many sectors with different scale enterprises • Must build experimental model have corporate income tax factor for enterprises to consider ability to repay loans of borrowers before and after application corporate income tax factor Thus, banks in credit rating will test the model by adding points for enterprise and its number depends on total corporate income tax of each enterprises Banks can increase the limit loan for enterprises following the number of adding points After some time monitoring the repayment of the enterprises, if enterprises have ability to repay loan well by increasing limit loan following level of corporate income tax, prove that the real impact of corporate income tax factor in credit rating relevant with the content of the thesis • Study to build credit point table which has new factor is corporate income tax for using in banks Thus, the bank established credit rating system for borrowers, in which corporate income tax factor will be established by a weight that follow the affecting level of corporate income tax is calculated by further research With enterprises In case, if enterprises have capital structure to save corporate income tax, they will use a part of contributed capital to other investment and the other investment will bring profit for enterprises When enterprises use contributed 52 “ capital for other investment, they need to add bank loans to produce business Consequently, need for bank loans of enterprises increase and it made an increase interest loans expenses, they will be reduced corporate income tax, leading saving corporate income tax Thus, when enterprises represent the optimal capital structure to saving the corporate income tax, means that enterprises have to pay much corporate income tax Therefore, enterprises increase using debt to saving the corporate income tax And banks base on the corporate income tax before businesses have optimal capital structure, to increase reliability in the credit appraisal by banks with enterprises have to pay much corporate income tax Since then, banks can increase limit loan for enterprises The limitations of the research: Although there have been attempts, but the author acknowledges that the thesis remains limitation in the processing thesis, such as: • Sampling method has only been a sector and a group enterprise Therefore, it can affect the research results • The specific direction: because of limit time, enterprises not be directly interviewed by author Consequently, data is used to processing and calculating in this thesis is data which is collected by Credit Information Center about credit rating of enterprises 53 REFERENCE 1) Altman, E.I., (1993), “Corporate Financial Distress and Bankruptcy”, New York: John Wiley & Sons, Chapter 2) Andre, P.H., (2009), “Advanced risk management for financials”, JFPS Group, Singapore 3) Bhattacharya, H., (1998), “Banking strategy, Credit appraisal and lending decisions”, Oxford University Press 4) Cortes, C., and Berggren, A., (2001), “Financing growth of Vietnamese firms”, Discussion papers, Central institute for economic management of Vietnam 5) Credit information center - The state bank of Vietnam (2008), “Credit rating enterprises”, Labor publisher 6) Dan Meng, Xu Yang, (2007), “SMEs Credit Rating Method with Heterogeneous Information: a Chinese Case”, Research paper 7) Decision No 57/2000/QD-NHNN, dated on 24 Jan 2002, issued by State Bank, “Guide and implement credit rating for enterprises” 8) Frank, M.Z., and Goyal, V.K., (2003), “Capital structure decisions”, Working paper, University of British Columbia & Hong Kong University of Science & Technology 9) Fitchrating, (2006), “International Issuer and Credit Rating Scales” http://www.fitchratings.com/creditdesk/public/ratings defintions/index.cf m?rd fi1e=1tr , accessed on September, 2009 10)Hoang Trong, Chu Nguyen Mong Ngoc (2008), “Analysis research data with SPSS ”, The statistic publisher 11)Jonathan Golin, (2001), “The bank credit analysis handbook: A guide for analysts, bankers and investors”, Singapore: John Wiley & Sons, 2001, Chapter 12)J.P Morgan, (2004), “Determining optimal capital structure”, Research paper 13) Kare1 Jansen, (2008), “Money & Banking” Course 14) Le Thi Thanh Ha and Le Hoang Vinh, (2008), “Building optimal capital structure model for enterprises in Vietnam”, Master thesis, University of Economics Ho Chi Minh City 15) Lee, Y.C., (2007), “Application of support vector machines to corporate credit rating prediction”, Pergamon Press, Inc, Tarrytown, NY, USA, Volume 33, Issue 16)Limsombunchai, V., C Gan and M Lee, (2005), “Lending decision model for agricultural sector in Thailand”, Research paper, Lincoln University, New Zealand 17)Moody’s, (2004), “Moody’s rating symbols & Definitions”, http://www.moodvs.com , accessed on September, 2009 18)Michel Crouhy, Robert Mark, Dan Galai, (2000), “Risk Management”, t Edition, McGraw-Hill, Chapter 19)Nguyen Dang Hung, (2009), “The process of international economic integration of Vietnam in the backround of a new world economy”, NJ: Ministry of Foreign Affairs Vietnam 20) Nguyen Minh Kieu, (2008), “Credit apprisal”, The statistic publisher 21)Nguyen Trong Hoai, (2008), “Econometrics”, Course 22) Nguyen Thanh Huyen (2008), “Credit rating system”, Master thesis, University of Economics Ho Chi Minh City 23) Nguyen Van Cong (2006), “Determinants of capital structure of manufacturing small and medium enterprises in Dong Nai”, MA thesis in Economics, Vietnam-Netherlands program 24) No 60/2005/QH11 dated on 12 Sep 2000, “Enterprise Law”, Vietnam 25) Ross, S.A., Westerfield, R.W., Jaffe, J.F., (2005), “Corporate Finance”, h 7' Edition, McGraw-Hill and Irwin, Chapter and Chapter 15 26) Standard & Poor’s, (2006), “Corporate rating criteria 2006”, www.corporatecriteria.standardandpoors.com , accessed on September, 2009 27)Steven M Sheffrin (2003), “Economics: Principles in action”, Prentice hall, Chapter 28)Tran Ngoc Tho (2007), “Corporate finance”, The statistic publisher, Chapter 15 29)United Nations, (2008), “Credit rating agencies and their potential impact on development countries”, Discussion papers 30) Vietcombank, Ernst & Young (2008), “Credit handbook”, Joint stock commercial for foreign trade inVietnam 31) Zan Huang, Hsinchun Chen, Chia-Jung Hsu, Wun-Hwa Chen, Soushan Wu, (2004), “Credit rating analysis with support vector machines and neural networks: a market comparative study”, Decision Support Systems 37 APPENDIX Table 4.1: Explain the meaning of variables Odd , - Definition of variables Variables CR Current ratio - Current assets/ Current liabilities QR Quick ratio = (Current assets — Inventories)/Current liabilities IT Inventory turnover - Cost of goods sold/Average inventories RT Receivable turnover - Accounts Receivable/Annual credit sales/365 TAT Total asset turnover = Net sales/Total asset DE Debt to equity ratio = Total debt/Total assets DA Debt to total asset = Total debt/Total equity ROA Return on asset = Net income/Total asset ROE Return on common equity - Net income/Shareholder’s equity 10 NPM Net profit margin = Net profit after tax/Sales 11 DR Delinquency ratio - Delinquency/ Outstanding debts 12 CF Cash flow measures the ability of the borrower to repay loan form the cash flow 13 MQ Management quality measure the top management team’s capability in controlling and managing the business 14 RB The relations with banks measure credit relationship with banks 15 BE Business environment measure the percentage of sales made to the single largest customer, purchase sourced form the single largest supplier and environment risk Other activities measure diversification of activities by industry, market, position; 16 OA 17 CIT income from export activities; dependence on partners; profit of companies in recent years; status of enterprises Corporate income tax ratio - corporate income tax cost / earnings before interest and taxes APPENDIX “ '” N o' repay Current ratio Quick retio Inventory' Receivable Totel aseet turnover turnover Debt te Debt to rqu ity ratio I 92.4 !4 09 10.3 55.4 2.400 0.466 0.873 93.2 I 0.6 10.6 l 35.8 I 400 0.052 0.055 92.6 I ,5 78.8 I 800 0.477 0.913 93.8 2.4 1.4 5.4 24.8 100 147 173 1.1 18.4 39.8 2.900 0.688 6D4 0.600 0.213 91 l 9D2 ll 06 65 52.2 100 88 1.5 1.4 24.5 61 1.4 10 802 Net profit margin Delin quency 0 Return on nsiet Rctu rn on Caeh 0.072 169 0.316 100 124 173 183 100 19 0.217 0.4 16 100 130 0.143 167 100 Management The relations with 80 80 80 80 80 80 80 80 0.062 0.070 0.040 0.568 0.039 0.083 I 200 0.605 0.036 0.044 I 45.5 1.900 0.647 l 833 0 130 0.253 67 16.4 2.800 0.838 185 0.27 l 11 80 1.6 I 19.5 79.9 0.500 127 145 12 82.4 1.3 0.7 5.4 52 1.600 0.509 I 038 13 84.3 I 0.9 I 4.3 34 I 4.800 0.787 3.699 100 193 0.7 18 100 80 80 80 100 80 80 100 60 60 0.036 Business environment (0.086) (0.040) (0.051) 20 60 0.013 0.021 0.043 00 80 0.009 0.04 l 192 00 80 60 60 60 80 80 l0”0 09 09 9P0‘0 08 08 09 08 08 08 08 08 08 08 08 08 I0 08 SOO 600 l0'0 01' 09 9‘C 00£‘0 £‘80Z l66‘0 00£‘Z 8‘6£ 6t'S 001 I £”6£ 808'0 /.I1 006‘0 95 891 I S6S”0 009”7 l’E9 Z9t 006‘0 9‘0 I' 8‘59 6Z I '69 8£ 8‘t'£ 9Z 6'69 t'Z I' 09 09 6‘5 I £9‘0 t'EE‘0 I I 6S9‘£ $’E6 £0 8‘0 08 00 I 09 09 t'60”0 8£0”0 08 08 8S0“0 08 08 $|J0 08 08 08 09 @t 08 l’EDt 08 ll0‘0 08 09 5” I 6’0£ TZ 80 80 [9[ OE 8‘6£ 81 08 0Y 96Z”0 P” 690‘0 800”0 9‘9l 860‘ I 9’S 09 09 Z00”0 09 08 08 08 £”t'6 08 08 [’6E 08 ‘8 6’[ I I £‘ I 9‘t'8 9I 6‘0 I I £8 5I 09 09 09 09 09 09 tlO’0 08 8Z0‘0 09 09 9E 09 09 09 09 09 08 08 600‘0 08 08 0Z l90‘0 08 O8 09 09 09 08 09 016‘ I 6’t S‘0 9'0 8'Z9 6£ 9S9‘0 00£‘0 Z‘90 I S”0 I” I 6”9S L£ 888‘0 00£‘0 4'9 Z‘0 6‘0 6‘99 9£ £6S‘0 006‘0 E'0 60 Z9 t'E £‘0 Z' I £”t'9 I£ 6¼’t 8‘8 09 I.t'0‘0 08 08 08 08 08 09 09 08 9I 0’0 P88”0 69t'”0 00£”0 8‘68 I 699‘0 00S'0 6’SE 6‘0 APPENDIX Criteria Repayment schedule Points 100 > 36 60 80 12-36 months 1- 12 months None debt Overdue debt in the past Total commitments No information (new Non-pay debt on time borrowers) months The times of the extension 20 40 times in past 12 months times in past 12 months ? times in past 12 months times overdue times overdue under 30 times overdue under 30 times overdue under 30 days under 30 days for days for the past 12 months; days for the past 12 months; or the past 36 or times overdue under months; or times overdue times overdue under 90 days for months 30 days for the past 36 under 90 days for the past the past 36 months Solvency in past months Solvency in past 12 month Insolvency 36 months in the past 24 Insolvency in the past 12 months times in past 36 months None Never incapacity payment (letter of for 24 month months the past 12 credit, guarantee or other commitments) Information is provided Yes, in Yes, in past 12-36 Yes, in past ft 12 month No information (new sufficient according to past 36 month borrowers) requirement of banks month Source: VCB, Ernst & Young (2008) None • APPENDIX Table 5.2: Correlations Ability to repay loans Current ratio Quick ratio Inventory turnover Receivable turnover Total asset turnover Debt to equity ratio Debt to total asset ratio Net profit margin Return on asset Return on common equity Cash flow Management quality Relations with bank Business environment Other activities Corporate income tax Pearson Correlation Sig (2-tailed) Pearson Correlation 0.037 0.343‘ Sig (2-tailed) 0.030 Pearson Correlation 0.142 Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation 0.382 -0.366‘ 0.020 0.462" 0.003 -0.561" 0.000 -0.019 0.907 0.409" 0.009 0.628“ Sig (2-tailed) 0.000 Pearson Correlation 187 Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation Sig (2-tailed) Pearson Correlation Sig (2-tailed) • Correlation is significant at the 0.05 level (2-tailed) • 0.33 I’ •• Correlation is significant at the 0.01 level (2-tailed) 0.248 0.624" 0.000 0.536" 0.000 0.669” 0.000 0.556” 0.000 0.530" 0.000 0.674” 0.000 APPENDIX Table 5.3: Model summary • R Square Adjusted R Square Std Error Durbin- of the Estimate Watson Model R 0.674' 0.454 0.440 8.9029 0.796 b 0.633 0.613 7.3960 0.859' 0.738 0.716 6.3381 0.884‘ 0.782 0.757 5.8592 0.919’ 0.845 0.822 5.0214 0.932' 0.869 0.846 4.6752 1.990 a Predictors: (Constant), Corporate income tax b Predictors: (Constant), Corporate income tax, Relations with bank c Predictors: (Constant), Corporate income tax, Relations with bank, Cash flow d Predictors: (Constant), Corporate income tax, Relations with bank, Cash flow, Total asset turnover e Predictors: (Constant), Corporate income tax, Relations with bank, Cash flow, Total asset turnover, Debt to equity ratio f Predictors: (Constant), Corporate income tax, Relations with bank, Cash flow, Total asset turnover, Debt to equity ratio, Other activities g Dependent Variable: Ability to repay loans APPENDIX - Table 5.5: Coefficients of models Coefficients Model Unstandardized Standardized Coefficients Coefficients B (Constant) 69.272 Std Error • 0.288 0.068 (Constant) 43.251 4.560 Corporate income tax Tolerance Beta 0.674 5.624 0.000 VIF 1.000 1.00 9.713 0.000 0.476 4.325 0.000 0.820 1.22 0.467 4.250 0.000 0.820 1.22 9.485 0.000 0.392 4.055 0.000 0.777 1.28 5.032 Corporate 63.135 14.596 jncome tax Relations with bank Sig 1.819 Corporate 89.473 15.908 income tax (Constant) 48.875 t Collinearity Statistics 52.078 12.844 Relations with bank 0.232 0.060 0.376 3.869 0.000 0.770 1.299 Cash flow 140 0.037 0.355 3.792 0.001 0.828 1.207 (Constant) 43.355 4.216 10.284 0.000 Corporate income tax 54.555 11.910 0.411 4.581 0.000 0.773 1.294 Relations pith bank 0.203 0.056 0.330 3.600 0.001 0.742 1.348 Cash flow 0.113 0.036 0.287 3.181 0.003 0.762 1.312 Total asset turnover 2.912 1›091 0.228 2.669 011 850 176 58.316 (Constant) Corporate income tax 5.426 Relations 52.250 10.226 10.747 0.000 0.394 5.110 0.194 Cash flow 2.232 0.000 0.770 1.299 0.032 0.069 0.608 0.033 1.645 0.662 1.019 0.715 1.511 1.398 2.936 0.603 1.657 Total asset turnover 2.116 0.042 0.Debt 176 to equity ratio4.413 (Constant) 0.346 4.330 0.000 Corporate income-tax 10.850 Relations with bank 50.625 -0.322 -3.695 0.001 5.919 8.553 0.000 0.287 3.428 38.036 11.096 0.002 0.567 1.764 0.210 2.598 0.050 0.014 0.130 0.604 1.657 0.056 0.031 Cash flow Total asset turnover Debtto 4.462 0.949 equity ratio Other activities 2.734 11.002 28 0.051 0.141 1.795 0.082 0.641 1.560 0.350 4.701 0.000 0.715 1.399 -0.326 -4.023 0.000 0.603 1.658 0.194 2.494 0.018 0.653 1.531 Dependent Variable:Ability to repay loans ... analyses credit rating criteria affecting borrowing firms on bank credit appraisal in Vietnam through applying cross-section data from Credit Information Center which concentrate on forty firms including... What criteria are currently used in banks for credit rating of enterprises in credit appraisal in Vietnam? • Does corporate income tax factor affect lending decision of banks in credit appraisal? ... exploit credit information of customers at other banks, banks often seek information through the Credit Information Center of the State Bank of Vietnam Credit rating points for relations with bank