The Commercial Loan – Underwriting and Portfolio Management

Paying Attention to Underwriting and Asset Management

The task of the commercial lender is not an easy one. Commercial loans are customized to meet specific financing needs of borrowers, which is very different to the “cookie cutter” approach that most residential and consumer lenders enforce. As a result, there are quite a few things that can go wrong with the underwriting and management of a business loan.

Performing Borrower Due Diligence.

It all starts with knowing your customer and making sure that the request makes sense. It could very well be that the borrower is asking for financing that does not match its needs or the rationale for the requested facility is not sound. The first thing that I do when I underwrite a customer, and this is something that I tell all of my analysts is that they must understand the business of the borrower. The underwriter must know how the business makes money, and how does the proposed lending facility is going to help them in the process.

After the initial vetting, there needs to be sufficient due diligence regarding the financial information (do the financials make sense?). Questions about the collateral need to be answered at this time. The expertise of third-party professionals is required.

- For real estate collateral, lenders will use commercial appraisers and environmental engineers.

- For lending that involves construction, the plans and costs would be reviewed by a consultant.

- For working capital lending in the form of ABL, an auditor would most likely perform a field examination.

Commercial Underwriting Failings.

Underwriting deals with two major aspects. Depending on the way that the workflow is setup at the lender level, it is possible that the underwriter might be locked out of the structure negotiations. However, it is important that weaknesses in the structure must be noted.

Possible structural weaknesses:

A mismatch between the purpose and the use of funds.

Terms of repayment not appropriate (including overly generous maturity)

A junior lien position on primary collateral.

Possible credit weaknesses:

Failure to identify and mitigate critical issues.

Insufficient analysis of the primary repayment source {cash flow / debt service coverage}.

Insufficient analysis of financial trends.

Insufficient analysis of secondary repayment source {collateral liquidation / recourse to guarantors}.

Portfolio Management

Even after performing excellent due diligence and underwriting, a commercial loan can create problems if it is not properly managed. Assuming that loan administration has prepared the documents up to standard and appropriate liens have been placed, the next biggest source of risk is not performing required loan covenant calculations or performing them incorrectly. The reason for those covenants is to act as a warning of the deterioration of  a borrower’s performance or condition so that the lender can perform a protective action. However, the warning does not work if the process is ignored.

 

You can find more information about credit analysis by buying the following book from Amazon Credit Analysis 102 or Credit Risk Management: How to Avoid Lending Disasters and Maximize Earnings

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