More on the Transparency in Banking Transactions

Adding Loan Transaction Clarity

In a recent blog, we discussed transparency in banking, which in a corporate setting is the degree to which a company shares its leaders, employees, values, culture, strategy, business processes and the results of those processes with the public and customers.  We further asserted that banks should strive to increase transparency in their business because in the long-term this strategy will lead to better customer satisfaction, more efficient customer selection and result in greater bank earnings. We would like to share a short toolkit that commercial lenders should share with prospective borrowers to help promote transparency at their bank.  The toolkit focuses on just one bank product, commercial loans, and explains both what the bank wants to share with the borrower and what the borrower should share with the bank.  Each bank should develop and customize a toolkit like this to share with its clients for the various products that the bank offers.

 

Commercial Loan Borrower Toolkit

 

Every bank should explain its decision-making process to the borrower, which entails the steps and the time to closing and loan funding.  The general information that each bank should convey is as follows:

  1. Define the doable deal.  If there are loan categories, geographic locations or types of entities that the bank does not favor, those should be communicated to the borrower verbally.  For example, lenders should know and be able to explain to borrowers upfront that the bank will not entertain loans on landfills, or consider construction loans on residential condominiums.  Any geographical limitations should also be clarified. The banker will also want to communicate the bank’s sweet spot for loan size. This initial step will eliminate many loans that have no opportunity of acceptance at the bank and save the borrower and banker much time. 
  2. The bank should have a written explanation of the steps to loan funding.  For example, banks can outline their underwriting procedure, when and how they may use third-party appraisers and their documentation process.  The bank may want to number the steps as follows:                                                                                                          
    1. Prescreen your loan – we will do a brief analysis of your financial position and collateral to decide if the loan may be acceptable to us on the terms we verbally discussed and the information you provided.
    2. We will issue to you a term sheet to indicate our interest in your loan, outlining our proposed terms and pricing for the credit.
    3. Full underwriting – you will furnish us with appropriate tax returns, financial statements and other information that we may need.  We will then perform a full review of your financial position, assess the quality of your collateral and analyze the strength of credit support.
    4. We will issue to you a commitment letter outlining the important conditions of your loan and explain how your loan is priced.
    5. You will pay us a commitment fee or loan origination fee.
    6. We will order an appraisal of your collateral to establish market value, and we may require an environmental review.  We will disclose to you the cost of third party vendors involved in the closing of your loan.
    7. We will draft loan documents for execution and schedule a signing date. 
    8. We will fund your loan on a specified date.
  3. In addition to explaining the steps above, the bank must also state a range of time it typically takes to accomplish each step above, assuming all information is furnished on a timely basis by the borrower. 
  4. Many clients, despite their level of sophistication, are borrowing-neophytes.  They may be intimidated by banks, or are not numbers people, or simply have not had exposure to the borrowing process.  In fact, even seasoned borrowers may close less than one loan per year (plenty of time to forget what was learned).  Bankers should describe the key elements of their underwriting parameters and help the borrowers understand how a credit decision is made.  The following should be defined for the borrowers in a simple to understand language in a marketing brochure:
    1. Loan-to-value ranges that the bank finds acceptable for various loan categories.
    2. How the bank calculates debt service coverage ratio and the minimum the bank expects to see on a particular project.
    3. What is debt yield ratio (NOI divided by the loan amount) and minimum requirements from the bank, if any.
    4. What credit support the bank may need and why it is needed.  Explaining the bank’s requirements for guarantees or how a loan could qualify on a non-recourse basis is important for many borrowers.
    5. Explain important but contentious loan terms, such as the bank’s need for escrow funds, or reserve amounts.  There are six to ten heated loan documentation subjects that can be addressed upfront and save the borrower and banker much time and goodwill at closing.
  5. Give examples to your borrower for them to better understand the process.  Provide a few case studies (which may be anonymous).  This helps the borrower better understand the process and the bank gets an additional marketing play from the effort.

 

The banker should also have a brochure or marketing materials in the toolkit that explain what the borrower should provide to the bank to make the borrowing process go smoothly.  Transparency is a two-way street and managing the borrower’s disclosure can be helpful for both parties.  The general information that borrowers should provide to the bank are as follows:

 

  1. Commercial lenders are busy and close only a small percentage of loans that come across their desk.  To get the lenders attention and get the best terms from the bank, borrowers should present their loan request in a short package.  An executive loan summary no more than two pages are ideal to start the application process. 
  2. Studies show that a color photograph of the property, plant or equipment create a more memorable impression on the reviewer and increase chances of credit approval.  Always include at least one photo.
  3. If possible and when asked, provide the banker with operating statements, rent roll, schedule of leases, and tax returns.  It also goes a long way if you can share last year’s P&L and have pro forma numbers. If you cannot create a full pro forma balance sheet, income statement, and statement of cash flows, then any topline pro forma information is better than none at all.
  4. One of the most effective ways of getting a lender’s attention is to establish a depository relationship with the bank.  From the bank’s perspective, deposits transform a transaction into a long-term banking relationship.  State upfront how much deposits or other business you would like to establish with the bank.
  5. Highlight to the lender your money at risk.  Demonstrate your skin in the game through equity, outside support or personal guarantees.  Banks only lend when your equity is truly at risk and the more equity you can show at risk the better the terms and pricing on the credit.
  6. Make sure your loan request is understandable.  A confusing request is more likely to lead to a turndown or higher perceived risk (leading to higher pricing).  One area requiring clearer communication is corporate structure.  Create a corporate chart and label borrower(s), affiliates, and guarantors. 
  7. Know your numbers.  You will impress your banker getting to a quicker decision, and hopefully, a better deal if you can show that you crunched your numbers.  If you can, show your current balances on loans, prepayment penalties, if any, and contingent obligations.  Also, if possible, show your current business ratios such as loan to value, debt leverage, and net worth to debt. 

 

Conclusion

 

Community banks should strive to increase transparency in their business. One way to do this is for the marketing department to create toolkits that lenders can use to educate the borrower about the bank’s products.  Commercial lenders work in the banking market and take for granted the arcane and idiosyncratic world of credit.  Most borrowers can use the handholding, explanation, and examples to help them understand how a loan decision is made, and what is expected of them in the process.  This transparency leads to more satisfied customers, more business and better bank performance.