Underwriting Structural Weaknesses
While it appears that loan credit quality is improving, bankers are reminded that many pitfalls of credit remain. When underwriting a loan one is bound to run into weaknesses. There are many types of weaknesses out there. We will focus on structural weakness associated with underwriting credits. A small degree of structural weakness exists in all credits. The presence of multiple structural weaknesses may bring increased scrutiny of a credit by your regulator. Lenders should analyze the overall state of a borrower’s industry, financial condition and banking relationship to determine structural weaknesses.
Bank examiners’ reviews of loans include the following structural weaknesses: indefinite purposes, liberal repayment terms, weak covenants, poor financial performance and analysis, insufficient collateral analysis, and inadequate guarantor support. We will take a brief look at each of these topics.
When underwriting a loan the purpose should explicitly state how the proceeds will be used. Loans with ambiguous purposes will garner extra regulatory scrutiny. A loan without a clear and reasonable repayment program presents extra risk. Maturities should relate to a repayment horizon, stale lines of credit should be amortized and loans should never be rewritten to postpone maturity, loans should not be advanced to fund interest, and maturities should match useful asset lives.
Loan covenants are an important aspect of providing proactive relationship management. Covenants should not be waived or rewritten due to a borrower’s inability to maintain the original standards of the loan. Financial performance and analysis is paramount in underwriting credits. Companies need sufficient cash flow with acceptable cushion; tangible net worth should be present to provide for a cushion for unforeseen circumstances. Ratio analysis is also another valuable tool in understanding the financial position of a credit.
Collateral documentation is very important. Loan officers should make sure liens are attached and perfected, collateral margins are sufficient to provide a cushion in the case of collection, and advance rates should reflect the useful life of the collateral pledged. Loan officers should analyze guarantor support in the context of actual expectations of the guarantor. One should ask if the guarantor can and will be able to support the debt in the event that the borrowing entity cannot repay.
Actively searching for structural weaknesses in underwriting only helps to maintain the financial health of your bank and is a prudent lending practice. For more information, please contact Dan McDonald, Director of Loan Review Services at email@example.com or 303-548-5041.