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NEWS RELEASE
Nov. 24, 2009
ABA Media Contact: Carol Kaplan
(202) 663-5471
E-mail: ckaplan@aba.com
DEMYSTIFYING THE SMALL BUSINESS LOAN DECISION
What a Banker Looks for When Reviewing a Commercial Loan Request
Note to Editors: Over the coming weeks, the American Bankers Association will release several white papers intended to assist small business owners navigate the new banking environment. The papers, written through the viewpoint of a former commercial banker, give small business owners a rare glimpse into how bankers think and are intended to help them develop a mutually beneficial relationship with a bank, prepare to get loans, and evaluate offers. The following is the third paper in the series.
By Robert C. Seiwert, Sr. Vice President and Director
ABA Center for Commercial Lending & Business Banking
A good banker will ask numerous questions of a small business loan applicant before deciding to grant the request for funding. Here is a sampling that bankers will seek to answer while evaluating your loan application.
1) Are we comfortable with this industry or are we overexposed?
The loan request may be perfectly sound but if a bank has a large concentration of loans in one particular industry, it may decide to limit additional credit exposure.
2) What is the character of the borrower?
If the borrower has the money to repay the loan, will they? If the borrower gets into trouble, will they work with the bank to get the loan repaid?
3) What are the loan proceeds going to be used for?
A loan must not only be used for legal purposes, but also be one that bank policy allows. Banks have different policy restrictions on the types of loans that they will make and these restrictions may change based on economic conditions.
4) Why does the firm need to borrow?
Some reasons to borrow are good and some are not. Loan requests to support profitable sales growth are more likely to receive favorable decisions; loan requests to support unprofitable operations or to replace funds taken out of the business to support the owner’s lifestyle are not likely to yield a favorable decision.
5) How much does the firm really need to borrow?
Is this loan request just the tip of the iceberg? For example, if a customer wants to purchase a competitor, the acquisition loan may need to be supplemented by additional loans to support the planned sales growth of the combined business entities. The bank needs to be comfortable lending the firm all of the funds it needs to survive and thrive in today’s economy.
6) How are we going to get repaid? What is the primary source of repayment?
A banker can’t answer this question if they misdiagnose the reason the customer needs the loan (see question 4). Understanding how the bank will be repaid is critical because it dictates the type of loan repayment structure that the firm can afford. Loans to support a seasonal sales growth (i.e., to finance additional inventory and accounts receivable) should be repaid at the end of the season. Loans to finance the purchase of additional equipment need longer terms since the cash flow to repay these loans will occur over many business operating cycles.
7) What are the risks to loan repayment?
Bankers look at both the firm’s capacity to repay the loan (e.g., financial risks) as well as non-financial repayment risks (e.g., business vulnerability to changes in technology).
8) How do we mitigate these risks?
The primary source of repayment for most business loans is the cash generated by the firm over one or more operating cycles. If that source of repayment is unavailable due to unforeseen financial or non-financial risks, then the banker will need a secondary source. Secondary sources of loan repayment could include the pledging of business or personal collateral or the guaranteeing of the loan by the firm’s owners, suppliers or customers.
9) How good is the financial information on which the loan decision is based?
Is the information prepared by an independent third party or is it internally prepared? If the financial information is prepared by a third party, is the accounting firm known to us? What is the quality of their audits? Their reviews?
Robert C. Seiwert is a Senior Vice President of the American Bankers Association. Prior to joining the ABA, Mr. Seiwert was a banker for over 30 years, serving as President and CEO of a high-performing community bank and Director of Commercial Marketing for one of the nation’s largest financial institutions.
The American Bankers Association brings together banks of all sizes and charters into one association. ABA works to enhance the competitiveness of the nation's banking industry and strengthen America’s economy and communities. Its members – the majority of which are banks with less than $125 million in assets – represent over 95 percent of the industry’s $13.5 trillion in assets and employ over 2 million men and women.
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