In our quest for a more streamlined loan process, one point of friction was the lack commitment letter presentation or understanding. The commercial loan commitment letter bridges the time between loan approval and loan closing. Bankers do a good job at using the commitment letter for its primary purpose, namely to contractually obligate the borrower. According to our Loan Command Pipeline Management statistics, bankers use a commitment letter about 85% of the time. It is not used when the borrower is already a customer of the bank and/or there is already a level of trust with the relationship. However, banks can still do better, and in this article, we look at how small problems with the commitment letter can turn into more costly closings than need be.
Usually, banks have a certain level of approval or confidence before they issue a term sheet to the borrower. Once accepted, bankers usually move to a commitment letter which is more akin to a contract. At this point, the bank has the borrower approved subject to a set of conditions and the borrower is committing to the bank to take the offer.
In looking over the statistics for a set of banks for loan transactions where the commitment letter is not used, there are few issues. Problems with loan closings are at about the same rate as transactions with a commitment letter, including delays. However, there are a small number of instances for each bank where it would have been good to have a commitment letter. Considering closing delay results in not only $200 to $700 of additional cost in time as documents are regenerated, schedules are cleared, and closing/boarding operations are reset, but the cost is also the opportunity cost of what else that time might have been used for plus the loss of accrued interest. Add all these costs together, and the average, moderately complex commercial loan closing delay costs a bank approximately $1,390.
Given how tight profit margins are these days for commercial loans and how every bank is trying to improve their supply chain of credit manufacturing, and a couple delays per month can start to materially impact profitability.
Many banks are in the process of streamlining their whole loan origination and onboarding process in order to cut time and reduce cost. As banks move to electronic platforms, complete with e-signing, the common practice is now to use a tablet to walk the borrower through the terms, or print a copy out and do the same. The important point is to have a discussion with the borrower about more than just the high-level structure such as rate, fees, and maturity. The commitment letter is the place and time to discuss the next level of details such as covenants, cash flow calculations (add backs, etc.), borrowing base, financial reporting, conditions for closing, and similar. This ensures understanding and acceptance which helps the loan closing process go much smoother. When analyzing closing problems, the borrower not understanding or agreeing to the basic loan terms composes a material number of issues that result in a delay loan close. These delays can often be avoided by a more through discussion between lender and borrower at the time of the commitment letter.
The other dimension that is important is workflow. It is worth taking the time to discuss what processes your bank wants to adhere to. While the process is largely irrelevant in an all-manual workflow, once loan origination goes digital, banks what to relook at the process in order to reduce complexities and gain efficiencies. A process or set of processes needs to be codified and developed so that templates can be designed, email alerts created and tracking can occur. Some lenders go from a verbal discussion to a term sheet to a commitment letter. Others go from a term sheet to a discussion of a commitment letter, while others go from verbal to a commitment letter skipping the term sheet. Given that a proposal may include multiple borrowing facilities, various terms, several options of those terms and do all this over a given time period, complexity can grow quickly.
Some banks expire their commitment letter with the signing of the loan documents. This dramatically reduces legal risk. However, some banks are silent on this point while others create commitment letters that extend over a longer time period such as a year and may contain the terms of several facilities such as a term loan and revolving facility.
Putting This Into Practice
As your bank restructures its loan closing process, being clear on how your bank uses a commitment letter is central to the effort. Building more training around the structure, timing, and presentation of the commitment letter can aid in speeding the loan origination process up while preventing a significant number of delays. Making sure your loan origination work process is efficient and standardized allows your bank to build process and engagement automation to reduce the human effort. Certain verifications, filings, request for documents, borrower education content, document receipt confirmations, third-party credit inquiries, and process updates can all be created that starts with the execution and recording of the commitment letter.
The commitment letter is a major process milestone, a critical sales tool and an important risk mitigate. If you are looking to streamline your loan process and improve your loan win rate, then thinking through and improving how your bank handles commitment letters is a good place to start.
Submitted by Chris Nichols on May 22, 2017