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Underwriting mistakes in the commercial lending industry to be mindful of and make you a better informed loan applicant

Maura Cannon : May 11, 2017 5:13 pm : Uncategorized

What happens when the time comes for your business to seek a loan? How does the loan underwriting process work and how do you give yourself or your business the best chance of being approved? Who is the underwriter and what role do they play in this process? What should you expect from your lender to mitigate potential underwriting mistakes and look out for your best interests?

 

After you supply your lender or broker with the requested financial information for your request, the underwriter takes over and has the job of evaluating every aspect of your loan request from the quality of the collateral, income stream and the quality of you, the borrower to determine if the loan meets the lenders risk guidelines. While the criteria may vary from lender to lender, and each commercial loan application is unique, there are some common criteria that all lenders look for while underwriting your application. Those criteria include the capacity of the income from the business to adequately service the debt; the value and quality of the collateral; the overall creditworthiness of the borrower; the level of equity invested in the business; secondary sources of repayment; any additional collateral or personal guarantors; and the story of your business to put the financial analysis into perspective.

While the underwriting process and amount of information sought from you, the borrower, may seem excessive and tedious, it is critical to cooperate and give the full picture to the underwriter to give yourself the best chance of getting your loan approved. On the flip side, the underwriter and the lending institution need to ensure they complete a thorough analysis while avoiding common underwriting mistakes that occur in the commercial lending industry. What might those mistakes be? Some of the most common mistakes that lenders can make in the underwriting process can include the following:

Communication issues – Far too often lenders fail to ask customers for enough details or don’t listen to specifics with regard to customer needs and place them in a loan type that just is not the right fit. It is also important that the lender manage the borrower’s expectations when it comes to potential rate, timing of the transaction and money needed to close the loan. Lenders should not hesitate to go back to the borrower with more questions, to validate the accuracy of data or get explanations for any inconsistencies.

Failing to get proper training for lenders – It is important for lenders to understand proper underwriting guidelines, recognize bankruptcy risk and other red flags, along with be able to structure a loan the right way to ensure not only that a loan request is processed efficiently, but also to avoid structures that are upside down, negatively affecting cash flow and repayment capacity.

Basic underwriting pitfalls – Strong underwriting involves understanding the risk components of credit, capacity, and collateral, otherwise known as the three C’s of underwriting. Basic controls need to be established by the lending institution to ensure a thorough review of the loan application and borrower documentation so all requirements and conditions are met; validating and revalidating data to avoid incorrect calculations, insufficient asset verification or occupancy misrepresentation; and proper oversight and checks and balances with the underwriting process and decisions.

In summary, as a borrower, you want to make sure your lender is looking out for your best interest and that you have provided all the relevant facts and documentation requested in a timely manner.   It is crucial for them to be able to accurately and thoroughly underwrite your request, along with understand the purpose of the loan and the story of your business, so that they can effectively communicate your story and deliver the desired outcome.

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State of Lending November 2014

admin : November 21, 2014 2:36 pm : Uncategorized

Although there are plenty of economic indicators out there, following what is happening in the lending markets is another good one that is often overlooked. To give our clients a better idea of what is going on in the lending markets, below is a brief summary of what we have witnessed over roughly the last two years.

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At the start of 2013 lenders came out of the gates looking to put new loans on their books, and there was a flurry of activity. However, by mid-2013 that flurry had slowed. Although it is not 100% clear what caused the shift in lenders’ mindsets, it appears concerns over the economy, the government shutdown, lenders hitting goals earlier in the year, as well as a continuing tightening of credit standards are largely to blame for the slow down in lending in the second half of 2013. Many anticipated the start of 2014 would be similar to that of 2013, with a flurry of activity from Bank’s to put new loans on the books. And although most Banks were aggressively out there marketing and claiming to be open for and looking for new business, in 2014 it has been a struggle for most businesses to borrow money. That struggle has mainly been based on a continued tightening of credit standards even further in 2014. Although there are exceptions to that rule, in general most Banks are more stringent today on whom they will lend money to then they were even a year ago.

So why are credit standards even tighter today? It is primarily due to an overall shift in how Banks handle lending. In the past managers and lenders on the origination / sales side often played a roll in the approval process. However, due to pressure from regulators and continued management concerns over a separation of church and state (or in this case lenders and underwriting), the underwriting departments for most Banks have become more centralized and autonomous, operating separately from the sales team. Lenders on the street now have very little to do with the approval process, and in many cases even their managers no longer have a say in what gets approved. In most cases the approval process is now controlled by central underwriters and credit managers who have nothing to do with the sales process and often times are compensated not on portfolio growth but on portfolio performance, incentivizing them to not take on risk. This has left the sales teams at many Banks, who now once again have growth goals, to be on the street actively marketing and looking for deals, but in a position where much of what they bring in gets denied if the credit request is not 100% pristine.

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The good news is there are plenty of Community Banks that have gotten healthy again and are sitting on plenty of cash to lend. Community Banks are aggressive, and often times willing to take on some of the risks associated with deals that the bigger banks are not taking on, partly because the credit team is not as separated and partly because they see higher rates of returns in deals with a bit more risk. There are also plenty of lenders with larger Banks that are getting a handle on the types of deals they can get through their credit departments, allowing for quicker and better feedback. Overall there are still plenty of opportunities to get financing done. But the day of walking into multiple banks and getting multiple approvals is long gone. Now it is much more likely for an individual to walk into multiple banks and get multiple denials, and it is considered lucky to walk into multiple banks and get one approval, making the lending process frustrating for most commercial loan borrowers. It is now that much more important for a commercial loan borrower to not only get to the right institution, but also to the right individual lender within that institution that understands enough about credit that they know how to navigate their Bank’s credit process.

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All of this difficulty in getting financing comes back to the economy. Companies struggling to get the financing they need to grow are limited in the amount of growth they can achieve, and hence the profits and jobs they create. Also, there appears to be a sense that part of the reason credit departments and bank managers are still conservative in whom they will lend to is because they are still not confident the economy has fully recovered. After five years of consistent, albeit slow, economic growth, many credit managers are afraid another recession might be around the corner. What they fail to realize is that it could be their own tight lending standards that hurt small business and help to make another recession a reality.

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Number of Banks in the United States Hits Depression Levels

admin : March 3, 2014 3:26 pm : Uncategorized

The number of banks in the United States has continued to decline, and has now hit its lowest level since the government began tracking data in 1934. At the peak there were more than 18,000 banks, but today that number has dwindled back down to just over 6,800 banks, with more than 10,000 leaving the industry between 1984 and 2011 due to mergers, consolidations and failures. The FDIC indicates that 17% or roughly 1,700 of the banks left the industry due to failure, but those numbers do not take into the account the many others forced to merge or sell due to dwindling capital levels and the prospect of failure if they did not merge or sell.

Although there is no doubt there were too many banks when the level was at 18,000, with a growing population and the large geography of the United States, there is concern that there could be too few banks to properly serve all consumers and small business owners, especially those in rural communities where community banks have historically been the only source of financing for many local small businesses. And it is unlikely the number of banks will remain stabilized at about 6,800. With many community banks still struggling from a capital and regulatory perspective, and many others finding they are no longer very profitable if profitable at all due to the cost of managing increasing levels of regulation, many believe additional bank closures, mergers, and forced sales will continue to shrink the number of banks in the United States for the next several years to come. And it is unlikely new bank start-ups will fill any void in demand since only one new bank has been provided a charter by the FDIC since 2010, and there is only one other application in process for another new bank at this time.

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The number of large banks has continued to increase, and many mid-sized and large banks have continued to move up market from a management and lending perspective. What that means is that they are focusing on larger business clients and consumer wealth management clients, and both the business and consumer products they provide to everyday and small business are more streamlined and model based, and often do not fit the needs of most consumers and businesses. This is making it even harder for small business owners to find the financing and other support they need to grow and succeed. A problem that will only be compounded if more of the community banks fail, and larger banks without much of a market presence or focus on a local community take over.

There are many pushing for the government to lessen restrictions on community banks and provide more flexibility, making it easier for them to remain profitable and succeed. However, until real changes are made to the regulations effecting community banks, additional community bank failures are likely to occur, and any further decline in the number of banks and specifically community banks could be very damaging for United State’s small businesses, and hence the economy on a long-term basis.

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SBA Financing Options May Be Affected by the Sequester

admin : March 22, 2013 2:50 pm : Uncategorized

The media is filled with stories about the different ways the Sequester is going to effect each and every one of us in our everyday lives. And whether you believe all of the doom and gloom or not about what the sequester might bring, sure enough some cuts are going to have an impact.

Unfortunately the Small Business Administration, who administers the SBA government guaranteed and assisted loan programs, is going to feel some of the effects of the sequester. That budget has seen a cut in funding for 2013, and because of that the SBA has had to lay off some employees and make other cuts. However, staffing and administrative cuts were not sufficient, and the total money available to guaranty loans originated under the various SBA loan programs has also been cut back.

What do these cuts mean? Well for one, none of the existing programs have seen major changes or been eliminated, which is good news. Although there may be some minor changes to the programs yet this year, those changes will all fall under typical annual changes to try and make the programs more effective and less burdensome, and will not directly relate to the sequester. However, with less total funds available to guaranty loans, it could very well mean some loans approved under the program this year might not get funded in 2013. Once the SBA uses up all of the funds they have available to guaranty loans in their 2013 budget, they won’t be able to guaranty any more loans until they get their funding for the next fiscal year.

If you look at historical trends, the SBA has not run out of guaranty money the last three years. However, the SBA has seen huge growth in the use of its programs over the past three years, with growth expected again in 2013 as the economy and banking industry continue to recover and more loans are made in general. With total available money to guaranty those loans falling in 2013, and possibly again in future years, it very well could create a situation where there is not sufficient money to fund all loan requests this year.

Ultimately, how could that effect you as a business owner? Well, if you are trying to fund a loan utilizing the SBA 504, SBA 7A, or other SBA loan programs, you better be sure to get it funded sooner than later in 2013. Although there is no guaranty they will run out of guaranty money, we have heard predications that if SBA lending continues to grow at the same rate in 2013 that it did in 2012, that the SBA could run out of funding in the early fourth quarter of 2013. Even if that were to happen, it does not mean an approved project is doomed. But if the SBA does run out of money, it does mean a project approved in the fourth quarter of 2013 may not be able to be funded until the SBA gets its new annual funding in 2014. Which could delay business expansion and job creation. In addition, if the money is to be used to fund the acquisition of real estate, it could create a problem for sellers because they may not want to wait until the SBA funding is back in place. And of course if a bunch of loans get pushed from fourth quarter 2013 into early 2014, that will negatively impact the money available to fund deals in 2014 as more will be utilized earlier in the year, with the impact being especially bad if the budgeted money for SBA loans does not increase in 2014.

This whole problem could get worse if the SBA 504 program brings back their refinance provision, which is currently being debated in Washington. Typically the SBA 504 loan program can only be used for new acquisitions, a substantial expansion of an existing business, or new construction for a primarily owner-occupied commercial property. But in 2011 and part of 2012 the SBA did allow the refinance of owner-occupied properties under that program. The refinance program was very successful and created substantial additional loan volume for the program, and if that refinance program is brought back in 2012, it will likely further eat up substantial funding available because with record low rates and high loan to values on many properties, the SBA 504 refinance program is an attractive alternative for business owners. Although overall bringing back this program would be good for business and the economy, it could negatively impact the funding available for other SBA loans.

There is certainly a lot worse news out in the market then less SBA guaranteed loan funds available for 2013. But still, losing any dedicated funding for commercial loans can be a real negative, not only for the small business owners that utilize the SBA programs to grow their businesses, but also to the economy as a whole because the SBA programs are a proven creator of small business jobs and profits.

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Private Commercial Lenders Flood the Market

admin : June 8, 2012 8:29 pm : Uncategorized

Due to the shrinkage in capital in traditional banking markets, most Banks have lacked the capital to fund large loan growth. Although many Banks have gotten their balance sheets to the point where they are healthy again and are actively funding new transactions, many banks have limited overall capacity and are focusing their loan growth on core low risk lending markets such as apartment buildings, owner-occupied commercial properties, and C&I lending relationships (commercial & industrial lending such as receivable, equipment, and inventory finance). Although some banks will finance investment real estate loans, many Banks are not providing financing for such transactions and the financing that is available is limited to borrowers and properties with the best credit, lowest loan to values, and best tenants.

In order to fill the void left by traditional commercial bank lending, there has been a rush of private capital into the marketplace willing to make higher risk loans. This capital is not always in the form of hard expensive money, but often times is mutual fund, retirement fund, and investor capital looking for a safe alternative fixed rate of return. These lenders have raised capital in funds, or are individual investors willing to get aggressive in offering private capital to fund some of the loan opportunities traditional lenders are just not interested in doing in this market. Below is a sample list of many of the loans traditional banks are not interested in making where private capital has come in and filled the void.

1) Discounted note payoffs. Sometimes commercial loan borrowers negotiate discounted loan payoffs from their commercial lenders due to either a sale of their loan to a new lender or just because the bank wants the loan off its books but the collateral value is no longer there. Traditional banks do not like to finance other banks taking a discount. Private lenders do not have the same concerns, and so long as the loan to values are acceptable, private lenders will provide short-term bridge financing to allow Borrowers time to complete the discounted note payoff and get cash-flow settled into place before refinancing with a traditional lender.

2) Troubled credit. If a Borrower has troubled credit, had to file bankruptcy in order to stay a Bank from aggressive collection action, or has missed some loan payments due to stress with other holdings, most commercial banks want nothing to do with those transactions. Many private lenders can look beyond these issues and look at the true value of the asset and cash-flow they will be loaning against, and make these loans despite some of the story to them.

3) Global cash-flow issues. In this market many commercial loan borrowers that have investment real estate have assets that are doing well and assets that are doing poorly and are a drain on cash-flow. If a commercial loan borrower does not have good global cash-flow, a traditional lender is likely to take a pass on a strongly performing asset that itself has strong cash-flow due to concern about the borrower’s overall capacity to service all of their obligations. Many private lenders will look beyond global cash-flow and will lend money against solid performing assets despite other troubled assets that borrower may own.

4) Construction Loans. Traditional banks are very hesitant to fund construction loans in this market, whether it is ground up construction or just rehab construction, due to the increased level of risk associated those projects and the increased capital requirements Banks have put into place for those projects. Private lenders do not have additional capital requirements, so as long as they can mitigate much of the risk, many private lenders are willing to fund construction loans.

5) Transitional properties. Often time borrowers have properties that are in transition and may have a high vacancy rate or are in need of some work. Traditional banks often do not want to take on the risk of a property that is not producing strong cash-flow today and is not fully improved. Private lenders are willing to take on that improvement risk and are willing to fund many of these projects.

6) Special-Use properties. Many Banks have restrictions of the amount and types of financing they will provide to special-use properties such as car washes, restaurants, gas stations, hotels/motels, etc. Although some private lenders do have similar restrictions, there are many private lenders that actively welcome the opportunity to finance these assets so long as the cash-flow and loan to values are reasonable.

7) Lack of Historical Cash-Flow. In this market many borrowers are purchasing transitional properties or paying cash for properties and then improving cash-flow. Most traditional banks want at least one year of seasoning if not two or more years to evidence on-going cash-flow support for transactions. Some private lenders will provide financing on properties with very limited cash-flow seasoning.

8) Cash-Out. Most traditional bank lenders are hesitant to give commercial loan borrowers cash-out on commercial properties, specifically investment real estate. They do not want the Borrowers getting over-leveraged like what happened to partially get us into the current economic crisis, and cash-out is often frowned upon by regulators. However, many private lenders are willing to provide cash-out so long as the collateral value and cash-flow are strong enough and justify the cash-out the commercial loan borrower is requesting.

As can be seen, there are many reasons for which the use of private lenders makes sense in this market. With so many private lenders offering conforming fixed rates, many times the products these lenders are offering are just as competitive as many banks programs, but are available to a larger percentage of commercial loan borrowers. Although not all borrowers will qualify for the most aggressive of private lending funds, even hard money costs have come down quite dramatically with so many new private lenders in the market today with capital raised they need to deploy. If you have not found a traditional financing option for your project or property, you should consider exploring private lending options. Here at CLX we work with close to 50 private lenders offering both conforming / bank competitive fixed rates as well as higher risk hard money rates, and can often times find borrowers the right solution when the traditional bank markets are not offering any solutions.

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