In the current economic environment,
obtaining a business loan can prove to be
a challenging task. In order to improve your chances, it is important to understand
what criteria banks are looking at when making their decisions.
It is also important to understand that the
relationship established between a bank and
a borrower does not conclude once a loan
has been disbursed.
“A commercial banking relationship is not
just about providing loans and banking products to a customer,” says David Song, first
vice president of Comerica Bank’s Western
Market. “A bank needs to make the utmost
effort in understanding the dynamics of its
customer’s business to be able to provide
optimal banking solutions to the customer in
a proactive manner.”
Smart Business spoke with Song about the
hurdles that businesses must overcome in
order to obtain a loan, how banks analyze
risk and under what circumstances yield
requirements may be waived.
What basic hurdles must be surmounted in
order to obtain a business loan?
In general, there are six hurdles that businesses are subject to when obtaining loans:
- Credit policy: Every bank has a set of
credit or loan policies. These policies generally determine the types of lending transactions acceptable to the bank. - Credit analysis: This hurdle focuses on
the risk of the proposed loan transaction. - Loan structure: This determines whether
the repayment terms and conditions sufficiently match the repayment capabilities of
the borrower. - Loan and account profitability: A loan
request may pass the first three hurdles with
no problems but fail miserably if it provides
little profit to the bank from the transaction. - Loan documentation: A loan cannot get
funded until it is properly documented and in
compliance with guidelines and policies. - Loan management: The final hurdle
focuses on how the fully disbursed loan is
managed by the bank. It mostly involves the
bank’s internal procedures but requires the
borrower’s compliance with the terms and
conditions of the loan.
How does the bank analyze the risk of a proposed loan transaction?
The credit analysis hurdle is ultimately a
test of management’s skills and capacities. It
is management’s policies, decisions, investments and actions that determine whether
the bank gets repaid. Credit analysis involves
historical analysis and projected analysis.
While historical analysis focuses on past
financial performance and the borrower’s
track record in repayment of debt, the projected analysis focuses on the borrower’s
prospect of generating sufficient cash in
future periods to service the debt.
There are five possible sources of cash to
pay interest and amortize debt: cash from
operations, additional equity, sale of nonoperating assets, additional borrowing and liquidation of business. A bank analyzes and
assesses the prospect of generating cash
from all of these sources with primary
emphasis on the first one. The better the
prospect of the first source, the more likely
the loan will get approved.
Why do banks establish minimum yields?
Just like the businesses receiving the loans,
banks must ensure that their cash returns
exceed their expenses. Most banks have established minimum yields on loan transactions, depending on the loan size and risk levels. Thus, a loan proposal is subjected to a set
of minimum yield requirements, which consider the cost of the transaction in terms of
the cost of funds and overhead expenses as
well as projected revenue from the interest
income, fees and deposit balances.
Under some circumstances, yield requirements may be waived. Sometimes, a bank
may do certain transactions that do not meet
the minimum yield requirements if there are
other relationships with the same borrower
or related entities that provide sufficient yield
from the overall relationship. In the current
difficult banking environment, this has
become extremely important to all banks.
What type of documentation is required for
funding to be released to the borrower?
Full documentation of all of the agreed-upon terms and conditions, including the
loan amount, interest rate, fees, repayment
schedule, collateral, UCC (Universal Commercial Code) filings where appropriate, loan
covenants, reporting requirements and so on,
must be documented before funds can be
released to the borrower. Required documents include a promissory note, loan agreement, security agreement, guaranty (most
cases), resolution to borrow and agreement
to furnish insurance. Depending on the case,
additional documentation may be required.
For example, when there is a shareholder
loan or loan from an affiliate, banks may
require a subordination agreement.
How important is the banking relationship
after a loan has been disbursed?
The relationship between the bank and the
borrower does not end with the disbursement of the loan but actually begins with the
funding, as the bank and the business continue to develop a long-term mutually beneficial
partnership. These days, everyone talks
about relationship banking, but it is much
easier said than done. Ongoing communication based on trust and sincerity usually
forms the basis of an enduring relationship
between a bank and its customer.
DAVID SONG is first vice president of Comerica Bank’s Western Market. Reach him at (562) 463-6502 or [email protected].