SIMPLE VS REVOLVING CORPORATE CREDIT: WHEN AND FOR WHAT?

Transcription

1 SIMPLE VS REVOLVING CORPORATE CREDIT: WHEN AND FOR WHAT? Sirenia Vázquez I. Introduction Companies need liquidity in every stage of their development. At first, they need resources to initiate operations, and once they are operating they need liquidity to face their financial obligations or to undertake new investment projects. One way of obtaining liquidity is through the accrual of cash. When, in a positive economic environment, the profits of a company grow, the company may reserve part thereof and then use them in a more adverse economic situation or when a good investment opportunity arises. But the generation of profit takes time and it is possible that such opportunity arrives earlier and the company cannot wait any longer to accrue the resources required to invest in that opportunity. There are however other forms for companies to obtain liquidity. One of them is bank credit. The credit provides the company with immediately available resources and, if the economy is doing fine, it is only natural to think that the company has expansion plans and will approach a bank to apply for one or several credits to finance its growth. The type of credit requested by the company and granted by the bank will depend on different factors: the age and financial robustness of the company, the term, destination of the credit and the economic conditions of the country at the time. Though it is unclear whether more or less credit is demanded when the economy is growing, the most recent data show that among the Mexican companies that obtained some type of financing, the main sources of resources were the capital paid in by partners and, in second place, bank credit. 1 Due to the importance and dynamism of the banking I would like to thank Claudia Ruiz Ortega from the World Bank for her valuable comments and suggestions. 1 In the 2009 Economic Censuses by the National Institute of Geography and Statistics (INEGI) there in public information on 3.4 million economic units (businesses) operating in From these, little over 959 thousand (28%) obtained some kind of financing. 77% of these companies were financed with resources from partners, owners, family members or friends, 17% through banks, 167

2 portfolio in the last decade, there have been countless studies at international level that analyze this from different points of view. For instance, the studies by Sufi (2009), Demiroglu et al. (2009) and Acharya et al. (2009 y 2012) who study US companies or the one by Jiménez et al. (2007) for Spanish companies. Although the data available allow for investigating, even if with limitations, the evolution of and the factors affecting corporate credit supply and demand, there are still many aspects to understand about the behavior of this portfolio. One of them is the type of revolvency of corporate credits and their relationship with the economic cycle. So far little is known about whether companies who finance themselves on the banking market do it mainly through simple credits (non-revolving), revolving credit lines or a combination of both, and whether this financing changes depending on the characteristics of the companies or depending on macroeconomic conditions. In other countries, mainly in the US, there are studies that analyze the credit revolvency from different viewpoints. Many of them analyze the determinants of obtaining financing through cash flow versus financing through a revolving credit. For instance, Sufi (2009) shows that, although lines of credit do offer a flexible financing source, this flexibility is not unconditional. He finds that banks grant lines of credit to companies with higher profitability and condition them to maintain a certain level of profits to avoid having to withdraw the financing. Other studies have extended this analysis by comparing liquidity alternatives among public and private companies. Demiroglu et al. (2009) find that in the US, companies not listed on the exchange have a lower probability of obtaining financing through lines of credit than with their own cash flows; and the lower the creditworthiness of the company and the lower the access to other equity sources, the lower will be the opportunities of financing through a revolving credit. Acharya et al. (2009 y 2012) propose a model to explain the determinants of a company choosing to finance itself with its own cash or through a revolving credit (lines of credit). The hypothesis of this model is that the risk of a company is negatively related to the use of a line of credit. By empirically testing the model with a sample of companies, they find that more profitable companies with better creditworthiness are in principle those that contract lines of credit. On 9% through savings funds, 8% through suppliers, 3% through private lenders, 3% with government resources and 2% through other sources. Since companies could reply with one or more options in the questionnaire, the sum exceeds 100%. 168

3 the other hand, companies with liquidity needs and whose profitability is correlated with other companies that are also in need of external resources use more their own cash flow instead of a line of credit. On the other hand, there are studies that focus on the relationship between the economic cycle and the intensity of the use of revolving credit. For instance, Jiménez, et al. (2007) find that the increase of the Gross Domestic Product (GDP) in Spain is negatively related to the use of lines of credit. The literature on the intensity of the use of credit and its relationship with the cycle and creditworthiness of companies and individuals is broad. 2 So far there have not been studies that analyze corporate credit in Mexico from this perspective. The lack of investigation in this regard has to do with the scarcity of information. Except for the companies listed on the Mexican Stock Exchange, that are bound to disclose information with a certain degree of detail about the credits they have acquired, it is practically impossible to obtain detailed information about the characteristics of both the credits and the companies that contract them. In this sense, the National Banking and Securities Commission (CNBV) has the great advantage of having this type of information, collected through regulatory reports requested from all banks. It is with this prerogative that this descriptive study is the first of its kind in Mexico. Its main purpose is to understand better the behavior and characteristics of the corporate portfolio in terms of its revolvency and its relationship with the economic cycle. For this purpose, in this study we have classified corporate credit into two categories: revolving credit and non-revolving or simple credit. The first makes reference to lines of credit in which the borrower can once again make use of these resources once he has repaid, in whole or in part, the agreed amount of the line. In the second type of credit, withdrawals are previously established and there may be one or several of them during a specific period of time, as provided for in the agreement. But, why does the type of revolvency in the credit portfolio of Mexican businesses matter? We can think, at least, of three reasons. In the first place, because its analysis could tell us more about the credit preferences of companies or even about the financial development of a market. Revolving credit is probably more flexible than simple credit but, at the same time, it may be more expensive or more difficult to 2 Demiroglu (2011) and Jacobs (2010) make a concise review of the literature. 169

4 obtain. What is more, if the revolving credit is riskier for the lender, it is possible that countries with a more sophisticated financial structure for instance, with better risk management tools or more and better information about their borrowers may maintain a higher ratio of revolving credit than countries with less developed infrastructure. In the second place, the question matters because if entrepreneurs and bankers make their business decisions prospectively, and if there is also a relationship between the revolvency of the credit and the economy, the mixture of simple and revolving credit could be an advanced indicator of economic performance. In the third place, the question matters because regulatory and supervisory authorities, such as CNBV, are interested in knowing and monitoring the risk assumed by banks. Just like consumer credit, a revolving credit could be riskier for both the borrowing company and the bank, due to the uncertainty regarding the use of this type of credits and the exposure at default of the bank. If a revolving credit implies a greater risk, and there is a relationship between the share of revolving credit and the performance of the economy, CNBV would be interested in analyzing whether an increase in said share could translate into a higher systemic risk. As we will see further on, the data show that in Mexico the type of credit revolvency is closely related to the performance of the economy. Between 2001 and 2012, the period covered by this study, there is a significant relationship, though of different magnitudes and in different senses, with macroeconomic variables such as GDP, unemployment rate, interest rate and exchange rate. This study also analyzes the relationship between the type of credit revolvency and the interest rates charged by banks. Revolving credits have been found to have a higher interest rate than non-revolving credits, controlled by the diverse characteristics of credits and borrowers. This empirical work takes an exploration approach through an empirical analysis in a reduced form. The advantage of this approach is that it allows us to be agnostic regarding the behavior of companies, avoiding making assumptions about such behavior. Taking this approach also allows for responding economic and public policy-related questions in a simple way. The main intention of this work is to stimulate people s curiosity. First, by formulating questions that could hardly be formulated when 170

5 data are not available, and second, by waking interest to develop strict models that answer these questions from a theoretical standpoint. II. Information on corporate bank credit CNBV possesses financial and operational information on each and every one of the institutions under its regulatory power. In addition to the specific information that CNBV might request from an institution, it also receives detailed data on a periodic basis though regulatory reports. 3 One of these reports is on commercial loans, or report R04-C. Its purpose is to collect data on the financial characteristics of every active commercial loan, either in the balance sheet or under the administration of banks, Sofoles and Sofomers. 4 Commercial loans are loans that financial institutions register as granted to companies, individuals with business activities, to other financial institutions, to the federal government and to local governments (state and municipal). CNBV has this information since September 2001, and receives it every month within the first seven days following the closing of the period being reported. It is an abundant data source, as it contains information on the characteristics of the borrower, the general conditions of the credits at the time of their origination, and the behavior of each credit withdrawal. Furthermore, it allows for following up on borrowers throughout time as it includes their Federal Taxpayer Registration number (RFC) and on credits as well, since it has a unique id for both the credit and for each time the credit is drawn from. This study used information on businesses (legal entities and individuals with business activities) that have obtained bank credits between December 2001 and March 2012, building a panel-type 3 Details about the content of each of the regulatory reports are found in Annex 36: Regulatory Reports of the Bank Circular Letter, available on the CNBV website at: 4 Limited-Purpose Financial Entities (Sociedades Financieras de Objeto Limitado or Sofoles) are financial entities that only capture resources coming from the credits of other financial entities or from the placement of tradable debt instruments and that grant credit to a specific activity or sector. Regulated Multiple-Purpose Financial Entities (Sociedades Financieras de Objeto Múltiple Reguladas or Sofomers) are financial entities that grant credit but that can also undertake financial leasing and factoring transactions. They are regulated since they have a patrimonial nexus with a bank or financial group. 171

6 borrower database. 5 Although the information of CNBV is monthly, this study used the data from the closing of each quarter. III. Simple credit and revolving credit: different products and companies? Starting with their definition, a revolving credit is different from a simple credit. A revolving credit functions in a way that is similar to a credit card: it has an amount available for use, determined at the time when it is granted (line of credit) and it may be drawn as many times required and as payments are made in part or in whole. A company may use the revolving credit for diverse purposes, though due to its nature that includes being a short-term product- it is reasonable to assume that it is used to finance working capital. If this is true, then it is also possible that small businesses use this financing more frequently than large businesses, since the latter can have access to more alternative sources to finance their operations. A simple credit, in turn, may only be drawn from as agreed in the loan agreement and during the time established therein. Furthermore, the term of these credits is longer than that of revolving credits. It could then be thought that companies turn to simple credit when they need to finance the acquisition of a fixed asset or to finance a medium or longterm project, and that the companies that use them are larger in size or have expectations of growth. It is worth mentioning that taking one type of credit or another does not only depend on what the company requires. It really is a combination of what the company requests, of what the bank offers, and the project the company wants to finance or the use it intends to give to the credit. For banks, offering a certain type of credit is related first and foremost to the risks their policies allow them to assume and, in the second place, to the business sector they wish to penetrate (MIPYMES, local larger-size businesses or large transnational corporations). 6 5 Credits backed by resources of the Procampo program granted by some banks to farmers since 2005 were excluded. The reason of this exclusion is that, since payment is made with public resources, these credits are considered to have characteristics that differ from the rest. In the period of study, the balance of these credits represents, in average, 0.1% of the total of the balance in the sample and, in terms of borrower number, it represents 27%. 6 Micro, small and medium businesses are known as MIPYMES. For companies with active credits before and after 2009, the definition of size is consistent with that of the Ministry of Economy, obtained through a combination of the number of employees, annual income and the economic sector (trade, 172

7 Finally, it may also be related to the operating process of the company the bank is willing to finance (working capital, fixed asset or investment project). For instance, there may be banks that, given their risk-yield policies, are focusing on companies with a high potential of growth and are therefore looking for increasing value over the current clients. If so, it is possible for the bank to first offer the company to finance its working capital only and grant a revolving credit. As the company grows, the bank will start offering other types of products, such as a simple credit, which the company may use to finance an investment project. There may be other banks with a more aggressive strategy whose purpose is not only to make their existing client portfolio grow, but also to capture new clients, mainly smaller in size. They will probably offer standardized retail products, such as corporate credit card. What is more, there are banks that focus on clients that, due to their socioeconomic characteristics, would have access to informal financing sources only and that, for now, only need a simple low-amount and short-term credit, just like those that these types of banks offer. Certainly there are as many banking business models as there are banks in Mexico, but at the end of the day, the type of products we see on the market and that are reflected in the data is a combination of the client s needs and of what the bank offers according to the risk-yield it is willing to assume. That is, what the data show is equilibrium. The purpose of this study is not to unveil whether it is supply or demand that determines the type of credit that businesses have. The purpose is to explore equilibrium. Then, what do the data tell us about the companies that have simple credits and revolving credits? In the first place, chart 1 shows that, between the fourth quarter of 2001 and the first quarter of 2012, commercial banks granted credits to over 650 thousand businesses, 97% of which are MIPYMES and only 2% are large businesses. From the total of businesses, 37% have received financing through simple credits only, 35% have used only revolving credits, and the remaining 28% have received financing through a combination of both credit types. Chart 1 also shows that the composition of simple and revolving credit is slightly different with respect to the size of the business. In general, seven out of ten accredited MIPYMES tend to use only one type industry or services). For companies that had credits with a maturity before 2009, the definition of company size is that of INEGI, using the economic sector and employee number. 173

8 of credit, either simple or revolving. But among large companies, although almost half of them use revolving credit only, four out of ten are financed with a combination of both types of credit. Chart 1. Number of businesses and types of credits, December 2001-March 2012 Businesses by size and credit revolvency Thousands of businesses % All businesses Simple credit only Revolving credit only A combination of both MIPYMEs Simple credit only Revolving credit only A combination of both Large businesses Simple credit only Revolving credit only A combination of both Size not specified * Businesses with size not specified correspond to borrowers with old credits (prior to 2001), for which there is no information on size. Source: R04-C Report, CNBV Differences in the composition of the type of credit among MIPYMES and large businesses seem to obey the fact that simple credit and revolving credit are different products used for different purposes. Among the characteristics that differentiate a simple credit from a revolving credit are credit balance, term and interest rate. Chart 2A shows the mean, the median and the standard deviation of these three indicators, according to revolvency type. In the first place, the mean and median of the credit balance of revolving credits are less than those of simple credits. The mean term of revolving credits is slightly shorter. This is consistent with our assumption that this credit type is used by companies for smaller acquisitions and with shorter terms. In the second place, the standard deviation of the balance of simple credits is significantly higher than that of revolving credits. This observation is consistent with the fact that simple credit is rather custom-made, that is, banks establish simple credit lines case by case and according to the characteristics of each business. Therefore, since there is a wide range of companies, there is also a wide range of credits granted. In contrast, revolving credit may seem to be a more standardized product, at least with respect to the amount of the credit. 174

9 In the third place, both the mean and the median of the interest rate show that revolving credit is more expensive than simple credit, and that the variance of its rate is higher, contrary to what occurs with the credit balance. Chart 2A. Characteristics of credits by type of revolvency, December 2001-March 2012 Total Variable Obs. Mean* Median St. Dev. (thous.) Credit balance (million pesos) Revolving 3, Simple 3, Weighted term (years)** Revolving 1, Simple 3, Weighted interest rate** Revolving 3, Simple 2, Source: R04-C Report, CNBV. * A difference test of means and standard deviations was done for the three indicators, and results were significant. Despite this fact they were not included in this chart because they do not offer much more information since, by being the data the total population of borrowers and not a sample thereof, means and standard deviations estimated correspond to the population parameters. **Weighting was done based on the amount of the line of credit. To compute mean term, credits with undefined term were excluded. The characteristics of credits can also be analyzed according to business size. Chart 2B shows the same indicators as chart 2A but separated into MIPYMES and large businesses. The differences between revolving credits and simple credits are the same: revolving credits have lower balances and shorter terms, but higher interest rates. When comparing the mean and median of the credit balance of MIPYMES and large companies, the latter is significantly lower in the former than in the latter. This is consistent with what would be expected, given the differences in size between ones and the others. On the other hand, MIPYMES have slightly shorter terms in revolving credits and longer terms in simple credits. Though, in general, differences are not large: for both types of businesses, the mean term of revolving credits is around 2 years, while the term of simple credits is between three and four years. With respect to interest rate, the interest rates of MIPYMES are significantly higher than those of large businesses. These differences may be related to diverse factors, such as the economic sector, the company s creditworthiness, its years of relationship with the bank, etc. 175

10 Chart 2B. Characteristics of credits by revolvency type and business size, December March 2012 Variable Obs. (thou.) MIPYMES Mean* Credit balance (million pesos) Med. Std. Dev. Obs. (thou.) Large businesses Mean* Med. Std. Dev. Revolving 3, ,223 Simple 3, ,200 Weighted term (years)** Revolving 1, Simple 2, Weighted interest rate ** Revolving 2, Simple 2, Source: R04-C report, CNBV. * A difference test of means and standard deviations was done for the three indicators, and results were significant. Despite this fact they were not included in this chart because they do not offer much more information since, by being the data the total population of borrowers and not a sample thereof, means and standard deviations estimated correspond to the population parameters. ** Weighting was done based on the amount of the line of credit. To compute mean term, credits with undefined term were excluded. In summary, the data show differences between revolving credits and simple credits, and these differences by type of revolvency seem to be the same for MIPYMES and for large businesses. On the other hand, the data also show that, regardless of the type of credit, the credit conditions in terms of balance and interest rate of MIPYMES and large businesses are different. Finding the cause of the difference in said conditions according to business size goes beyond the purposes of this work, so other lines of investigation may be opened in that sense. IV. Revolvency and economic environment Differences between simple credit and revolving credit are also observed when comparing their behavior with changes in macroeconomic variables, such as interest rates, GDP growth, exchange rate, among others. This section analyzes the behavior of these types of credits and their relationship with those variables. A revolving credit is different from a simple credit, and companies seem to use it for different purposes. No doubt, the characteristics of the company can influence the type of credit obtained. For some, a revolving credit such as a credit card could be convenient, from which they may draw at any time and in any amount to solve their short-term financial needs, while a simple credit could be better for other companies, with 176

11 fixed term and payments. But it is not only the characteristics and need of the company that explain the type of credit acquired. The country s macroeconomic conditions also have a significant influence. Credit mix in the last decade The balance of the revolving credit divided by the total balance of the credit is a measure that summarizes, for every moment in time, when it is only about revolving credits, when about simple credits and when it is a combination of both. This measure may be called revolving credit mix. When the mix is equal to 100%, it means that the entire balance of the credit is revolving, and when it is 0%, it means that the entire credit balance is simple. A mix between 0% and 100% means that there is a combination of both types of credit. Graph 1 shows the evolution of credit mix between 2001 and When comparing its evolution with GDP growth, at a first glance a negative relationship is observed. If we divide the duration of the study into four periods, we see that whenever there is less growth or even a decrease of GDP (periods I and III) the credit mix, i.e. the percentage of revolving credit, is higher. In times of stability and economic growth (periods II and IV) the mix is low, i.e. the balance of simple credits increases. The correlation between mix and GDP growth in the period is Graph 1. Revolving credit mix by business size I II III IV MIPYMES Empresas grandes Total PIB(eje der.) Fuente: reporte R04-C CNBV e INEGI 177

12 Graph 1 also shows different behaviors among MIPYMES and large businesses. Period I was a stage of economic recovery, after a recession that extended up to the first quarter of The credit mix was the highest in the entire decade (around 60%), and there do not seem to be large differences by business size. Differences start to arise in period II, characterized by a greater degree of stability and a mean GDP growth of 3.7%. In that period, the credit mix was lower, i.e. the balance of simple credit increased, more evidently among MIPYMES. Period III coincided with the financial crisis in the US, which had a negative effect on the Mexican economy. In that period, a general increase of credit mix was observed, and it seems that large businesses were the ones that reacted more to the crisis. In fact, it seems that they did it even before the decrease in GDP. Finally, at the beginning of the new decade (period IV) there was a rebound of the economy accompanied by a reduction of credit mix, to levels around 26%. Chart 3. Mean and standard deviation of some macroeconomic indicators by periods of time I II III IV Total GDP growth (%) (1.85) (1.10) (4.08) (1.31) (3.48) 28-day TIIE (%) (1.57) (0.97) (1.69) (0.05) (1.69) Exchange rate (0.72) (0.33) (0.83) (0.66) (1.23) Unemployment rate (%) (0.51) (0.35) (0.70) (0.37) (0.94) Standard deviations in brackets. Period I ranges from the fourth quarter of 2001 through the second quarter of Period II ranges from the third quarter of 2004 through the second quarter of Period III ranges from the third quarter of 2008 through the second quarter of Finally, period IV ranges from the third quarter of 2010 through the first quarter of Source: National Institute of Statistics and Geography (INEGI) and the Bank of Mexico. During this period not only GDP changed, but also other macroeconomic variables. Chart 3 presents the means and standard deviations of GDP growth, 28-day Interbank Equilibrium Interest Rate (TIIE), dollar/peso exchange rate and unemployment in the four periods. Chart 3 shows that in periods I and III there was lower growth, and higher interest rate and exchange rate, with more volatility than in periods II and IV. Although it is interesting that the mean 178

13 unemployment rate has been slightly higher in periods II and IV than in I and III, respectively and, in general, a negative relationship was observed between economic growth and unemployment. In summary, the aggregate data indicate that the revolving credit mix is countercyclical and different among businesses depending on their size and the moment of the economic cycle. Nonetheless, we have not said anything about the magnitude of the impact of these variables on the credit mix. The regression analysis and micro-data available allow us to say something in this regard. Chart 4 shows the results of a regression analysis performed using the micro-data. Each column indicates a regression. In all regressions, the dependent variable is the credit mix, and the explanatory variables are the macroeconomic variables. To capture only the effect of macroeconomic variables, independently from the characteristics of the business, fixed effects by company were included in all of the regressions. The coefficients of each regression may be interpreted as the additional percentage points in the credit mix in case of a marginal change (i.e. of 1 percentage point) in the macroeconomic variable. It is worth mentioning that though the chart only shows six regressions, other specifications were also tested, combining different variables in the regression, but all of them provided results similar to those presented herein. Chart 4. The impact of macroeconomic variables in the credit mix A B C D E F GDP growth (-0.56) 28-day TIIE (-6.37) Exchange rate (logarithm) (2.60) Unemployment rate 4.92 (6.62) 28-day TIIE volatility* 5.83 (1.25) Exchange rate volatility* 1.77 (0.44) R squared Dependent variable: credit mix. Number of observations: 5,184,783 in 42 periods (December March 2012) for 620,042 businesses. T-statistic in brackets. Volatility was obtained by computing the standard deviation, in each quarter, from TIIE and the exchange rate, using daily data. Source: with R04-C data of CNBV, Banxico and INEGI. 179

14 Columns B, C and D show that interest rate, exchange rate and unemployment have a significant relationship with the credit mix. The sign of the coefficient in TIIE is negative, indicating that in case of marginal increase of the interest rate, the revolving credit mix decreases, in average, by five percentage points. This seems to indicate that in good times of greater stability in terms of inflation, hence in interest rates simple credit is favored; and in bad times, revolving credit increases. Likewise, the positive signs in the coefficients of exchange rate and unemployment seem to confirm that the credit mix is countercyclical. As mentioned before, higher exchange rate and higher unemployment rate are related to times of contraction or economic slowdown. Therefore, a positive relationship would be expected between credit mix and these variables. The data show that increases in the exchange rate or in unemployment are related to a higher credit mix and that that magnitude of this relationship is 26 and 5 percentage points, respectively. Although GDP growth, exchange volatility and interest rate volatility have the sign we would expect to see (columns A, E and F), they do not have a significant effect on the mix. But this does not mean that there is no relationship with credit revolvency, since the aggregate data (graph 1) shows such correspondence 7. A possible explanation of why micro-data do not reflect what we observe in aggregate data is that what changes with time is the composition of businesses. This means that, when the economy is slowing down, it is not that companies that already had a credit change their mix. It is possible that a certain type of company liquidates its credit and leaves the banking market, and another type of company jumps in and takes a credit, mainly revolving. This behavior however is not captured in the regressions estimated, because since they have fixed effects, they do not capture changes in the composition of businesses, only in their credit mix. Borrowing businesses: entries, exits and credit mix A simple credit is different from a revolving credit and, in addition, its mix is related to the situation of the economy, regardless of the characteristics of borrowers. This is what we observe in aggregate data, and micro-data also seem to confirm, in part, this relationship. 7 Graph 1 compares credit mix to GDP growth only, but this graph was also tested with other macroeconomic variables, and results were very similar. 180

15 It is also possible that the entry and exit of companies on the bank credit market and the mix with which they enter is also related to the economy s performance. What, then, happens with the borrowing businesses? Are they the same throughout the period or do some of them enter and others exit? Do they enter with a specific mix? How do they change with time? To answer these questions, a quarter of each of the four periods analyzed in the previous section was selected. Years were selected in which, from one end to the other, relevant changes in credit mix were observed. The quarters of each selected year were the same in order to avoid the effects of seasonality. Chart 5 presents some characteristics of the borrowing businesses in each quarter. In the first place, the total number and disaggregation of the total of businesses is shown according to their type of credit. The following lines show the mean balance of the credit, both total and by type of credit. Finally, the last two lines show the credit mix in each quarter and the difference, in percentage points, between one quarter and another. Chart 5. Characteristics of businesses and credit mix in selected quarters Q3 02 Q3 06 Q3 08 Q3 11 Number of businesses (thousands) Simple credit only Revolving credit only A combination of both Mean credit balance (million real pesos) Simple credit only Revolving credit only A combination of both Credit mix 55.3% 31.9% 48.3% 30.3% Difference (pp) -23.4% 16.4% -18.0% The quarters selected were from years in which the largest changes in the credit mix were observed, in order to better appreciate the differences between one period and another. The quarters of each selected year were the same in order to avoid the effects of seasonality. Credit mix is defined as the percentage of the revolving credit balance with respect to the total balance. Balances in real pesos were computed using INPC and taking the first quarter of 2012 as the base period. Source: R04-C Report, CNBV. The first noticeable thing in chart 5 is the increase in the number of borrower companies to more than twice their number between 2002 and If we consider that in 1995 the Mexican economy suffered one of its worst collapses ever, and credits contracted to historically low levels, it would be logical to think that, due to the risk aversion prevailing 181

16 among banks, credits granted to businesses in 2002 were still lower than in the years prior to the crisis. 8 This makes 2002 a low comparison base with respect to As an additional data, in 2002, credit to businesses represented only around 40% of the total balance of commercial loans (also including corporate credit, credits granted to financial institutions, to the federal government and local governments). Currently, the balance of corporate credit represents around 70% of commercial credit. Changes both in the number of businesses and in credit balance are related to fluctuations of the mix. In the third quarter of 2002, the mix was 55%, and in the third quarter of 2006, it decreased by 23 percentage points (pp). The fall is related to an increase by more than three times in the number of businesses that only had simple credits and to a reduction in the number of businesses that had revolving credits only. In the third quarter of 2008, the mix increased by 16 pp with respect to the third quarter of This increase was due to the growing number of companies and the average balance of those with revolving credit only; also due to the increase of the number of companies with a combination of both. Finally, in the third quarter of 2011, the mix fell by 18 pp with respect to the third quarter of Although between one quarter and another, the number of companies with revolving credit only increases, the balance of these credits decreases, while the balance of simple credits increases. The different combinations of the credit composition and balance of businesses have changed the credit mix with time, but it was not the existing companies that contributed to these changes, but new borrower companies. Chart 6 presents the decomposition of the difference between quarters presented in chart 5. The lines indicate the contribution to this difference according to the type of credit granted to the companies. Columns show the contribution depending on whether businesses are new borrowers, whether they already existed, and the total. For instance, between the third quarter of 2002 and the third quarter of 2006, the credit mix decreased by 23 percentage points (pp). Who contributed most to this change were new borrower companies, with a reduction of the mix by 18 pp. Among the new borrower companies, who contributed the most to this reduction were the ones 8 The literature on the causes of the 1995 Mexican crisis and its impact on private sector credits is vast. Among the works that address this topic are those by Krueger and Tornell (1999), Gonzáles-Anaya (2003) and Haber and Musacchio (2008), just to mention a couple. 182

17 with revolving credits only, i.e. in those two quarters there were more companies that entered the market with simple credits only. In all periods, companies that contributed the most to the changes, both positive and negative, have been the new borrowers. The principal difference is in the type of credit with which they enter or exit the market. As mentioned before, between the third quarter of 2002 and the third quarter of 2006, the increase of new borrowers with simple credit only was what contributed the most to the reduction in the mix. In the following period, the entry of companies with revolving credits only increased the mix. Once again, between the third quarter of 2008 and the third quarter of 2011, the increase of simple credits among new borrowers lead to a decrease in the mix. Chart 6. Contribution to the changes in credit mix in selected quarters Change in credit mix New borrowers Already existed Total Q3 02 vs Q3 06 With revolving credit only -15.6% -6.2% -21.8% A combination of both -2.3% 0.6% -1.6% Total -17.9% -5.5% -23.4% Q3 06 vs Q3 08 With revolving credit only 7.3% 1.3% 8.6% A combination of both 1.6% 6.2% 7.8% Total 8.9% 7.6% 16.4% Q3 08 vs Q3 11 With revolving credit only -12.1% -0.1% -12.2% A combination of both -6.0% 0.2% -5.8% Total -18.1% 0.1% -18.0% The quarters selected were those in which the largest changes in the credit mix were observed, in order to better appreciate the differences between one period and another. The quarters of each selected year were the same in order to avoid the effects of seasonality. The contribution to the change in the mix results from the difference between one quarter and another of the balance of the revolving credit as a percentage of the total credit balance. Source: R04-C Report, CNBV. Considering the four points in time analyzed, the data suggest that the entry of new businesses into the bank credit market with different mixes and characteristics has influenced the aggregate behavior of the mix in time. But, in general, is the status of the new borrower related to the higher mix? Apparently yes. By including a variable in the regressions of chart 4 that indicates whether the company appears for the first time as a borrower, coefficients are positive in all cases. Though the mere fact of being a new borrower does not explain the change in the mix, the status of new borrower turns out to be significant when combined with interest rate (column C). In this case, the relationship is 183

18 clear: the entry of borrower companies is positively related to the credit mix. Chart 7. The impact of macroeconomic variables and new businesses on the credit mix A B C D E F G New borrower (0.97) (0.82) (3.16) (1.50) (0.83) (0.69) (1.00) GDP growth (-0.51) 28-day TIIE (-6.72) Exchange rate (logarithm) (2.64) Unemployment rate 4.93 (6.60) 28-day TIIE 5.71 volatility (1.24) Exchange rate 1.87 volatility (0.46) R Squared Dependent variable: credit mix. Number of observations: 5,184,783 in 42 periods (December March 2012) for 620,042 companies. Includes fixed company effects. T-statistic in brackets. Source: with R04-C data of CNBV, Banxico and INEGI. Although these results are purely descriptive, they help us to understand better what is going on with corporate credit in terms of its revolvency. In the first place, the data show that the credit mix is negatively related to economic performance. In the second place, they show that the entry of new businesses is positively related to the mix. But, why does this happen? The answer goes beyond the purposes of this study, the discussion can however be enriched by proposing reasons for this behavior. On the demand side, we might think that if a company expects economic performance to be adverse the coming year, it is possible that it also expects its liquidity to decrease when that moment arrives. So, before things get worse, this company might decide to apply for a credit. But since it does not know whether it will be able to handle a simple long-term credit with fixed payments, it might just apply for a revolving credit, with which it will have recurrent resources for a relatively short term. On the supply side, the logic could be similar. On the one hand, it is possible for the bank to expect a smaller economic growth, but on the other hand, it will not want to stop granting credits or increase its client portfolio. It may then decide that its best strategy is to grant more revolving credits. Though they may generate higher charges for reserves 184

19 than a simple credit, it is possible that the rate charged helps to compensate this cost. And if the bank is selective when granting these credits, it is possible that the probability of default of these credits will be low and its losses will not be that high after all. So, how much more will the bank charge over these revolving credits? This is the subject matter of the next section. V. The price of revolvency When a bank grants a credit, either simple or revolving, it is interested in knowing the probability of default by the borrower company and the loss given default it will have over the credit in case the borrower incurs in a default. Even so, the risk of a simple credit can be different from that of a revolving credit due to one main reason. In a simple credit, in which payments are predetermined, the bank knows its exposure in each period, in case of default by the borrower company, it is the balance due. It also knows that, as the borrower pays, the exposure decreases. But since revolving credit lines offer businesses the option of withdrawing funds depending on their needs, the bank knows that the limit of its exposure at default will be the amount of the line of credit granted, but that this exposure will not decrease because it cannot know, ex ante, how intensively the borrower will be using the line of credit. Let us for instance imagine that the company Emprendedores S.A. contracts a revolving credit line with the bank called Creditodo. To simplify things a little, let us suppose that the cutoff and payment date is the first day of each month. During the first month with the credit, Emprendedores S.A. does not use its line, but the last day it draws from it until depleting it. The first day of the second month, Emprendedores S.A. pays the balance due and, for the rest of the month, it draws several times from the credit. This time, when the first day of the third month arrives, it does not pay all its credit, only the minimum amount. Due to the flexibility this credit provides to Emprendedores S.A., the bank called Creditodo has to reserve, from month one and until the maturity of the credit, the total amount of the line granted to Emprendedores S.A., as neither the company nor the bank knew that in the second month it would pay the entire balance and in the third, only the minimum. It does not know either how it will behave in the following months or even if it will deplete its line and immediately after incur in noncompliance. 185

20 This cannot happen to a simple credit. If Creditodo would have granted a simple credit to Emprendedores S.A., draws and payments would be established from the beginning. If the contract specified it so, Emprendedores S.A. could only draw once, but if it would make several draws, they would have to be on dates previously agreed upon. Likewise, payments made by the company on this credit would be entered on the dates set forth in the contract. In this case, Creditodo would reserve, in the first month, the total amount of the line, but in the following month it would reserve the balance thereof, according to the payments and draws made by Emprendedores S.A. Furthermore, Creditodo would know -as Emprendedores S.A. pays its installments, that the amount to be reserved would be lower every time, as the debt would also be decreasing. Even if Emprendedores S.A. incurred in default after having behaved well for a couple of months, the exposure of Creditodo at the time of the default would be lower than when the credit was a revolving credit. Although both cases are hypothetical, in other studies about the use of revolving credits such as that by Jiménez et al. (2007) in Spanish companies, evidence has been found that borrowers that are closer to default use their line of credit more intensively. In the same way, in empirical studies about the use of consumer credit in the US (Agarwal et al., 2006) it has been found that reductions in the creditworthiness of borrowers are related to increases in the use of their lines of credit. In Mexico, so far there has been no study on the use of credit. But if there were borrowers behaving the same way as it has been observed in other countries, the bank would have to reserve a higher amount over revolving credits than over simple credits. Due to these asymmetrical information issues, ceteris paribus, the risk of a revolving credit is greater, thus it is only natural to think that the price of these credits is higher. In addition to interest rate, there are other costs associated to credit, such as commissions. Unfortunately, the R04-C report does not contain data on commissions for the entire period of study, only since This study therefore only focuses on interest rates. To know whether companies in Mexico pay higher interest rates on revolving credits than on simple credits, a regression analysis was once again used 9 In July 2009, the R04-C report underwent some changes that allowed for collecting much more information than what was reported before that date. An example of this is data on commissions: from September 2001 through June 2009 banks did not report information on the commissions they charged. 186

21 with data from the R04-C report, this time only with information at the closing of March In the regressions, the dependent variable is the interest rate collected over credits, and the explanatory variable is a dichotomous variable indicating whether the credit is revolving. Every regression in chart 8 includes different data controls in order to capture the condition of revolvency better. The first regression includes only the dichotomous variable as explanatory variable. The second, in addition to that variable, also includes categorical variables such as controls for the characteristics of credits (whether it is a new credit, whether it is in the past-due portfolio, the bank that granted it, type of rate, amount of credit line, etc.). The third regression also includes fixed effects per company, to control by their characteristics. Regressions D, E and F include controls like in A, B and C, but only use information of borrowers with two or more credits with different types of revolvency. This means that the sample is smaller, but the variation of rates is identified with companies that have both types of credits. Chart 8. Interest rate and credit revolvency Variable A B C D E F Credit revolvency, Revolving credit = 1 (69.65) (83.05) (10.26) (-16.89) (9.63) (8.68) Controls by credit No Yes Yes No Yes Yes characteristics Fixed effects of borrower No No Yes No No Yes Only borrowers with 2 or No No No Yes Yes Yes more credits w different types of revolvency R squared Observations 867, , , , , ,724 Dependent variable: interest rate on credits. The explanatory variable is a dichotomous variable that indicates whether the credit is revolving or simple. Some of the regressions include controls by credit and borrower characteristics. Includes information up to March 2012 only. T-statistics in brackets. In practically all of the regressions, the sign of the revolvency variable was positive and significant. Only in regression D was the sign negative and significant. But if we consider regression F, which is the one that includes more controls and is the preferred specification, we might say that the revolving credit s interest rate is in average 13 base points higher than that of a simple credit. It is worth clarifying that, even if regressions show a positive relationship between the type of revolvency and interest rate, the results of estimates do not imply causality. That is, the fact that a company has a higher interest rate than another is not necessarily due only to the former having a revolving credit and the other not. There may be other 187