Before and after Featured

8:00pm EDT April 25, 2008

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 dsong@comerica.com.