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How Commercial Banks Get to "Yes"

What happens behind the curtain of a business lender's underwriting decision.
Scott Bergquist, CFO.com | US
July 2, 2012

What happens once your loan-application package — complete with business summary, historical financial statements, projections, etc. — is submitted to your bankers for recommendation and approval? From the outside, the apparent black box of decision making can confuse and frustrate finance chiefs, as two seemingly comparable opportunities can yield conflicting results. Understanding why and how banks arrive at their answers will greatly improve a company's chances of success when seeking a loan. By no means exhaustive, consider the following an overview of the context and construct of commercial bank decision making.

"It's Not You, It's Me"
Despite how attractive a borrower or transaction is, external macro and internal micro considerations can, and do, have an impact on bankers' decisions. The most obvious macro issue influencing underwriting has recently been general economic uncertainty, particularly for traditionally targeted commercial industries such as manufacturing, retailing, and distribution.

While some specific sectors, such as technology, are showing greater immunity, they still are caught in the macro trend, as enterprise buyers defer their projected spend. In a low-interest-rate environment, banks have focused all attention on portfolio management, versus growth, to preserve earnings. Why? Simple break-even bank math says when the bank is lending at a 5% coupon, it needs to lend an additional $20 for every $1 lost from a defaulting loan.

While most institutions are now asset-hungry (bank-speak for actively making loans), internal agendas within a bank can challenge even the best deals. For example, in the pursuit of return on equity and to optimize earnings and capital, financial institutions set a target composition for their loan portfolios. Similar to any asset allocation, a well-balanced portfolio is a hedge. So financial institutions create targets for their portfolio of loans that can include limits on specific industry sectors, geographies, and structures. If your loan application falls within a currently overweighed bucket, you may be out of luck. Ask your banker about its general appetite for your industry and deal type to help manage your expectations.

A Multilayered Process
Most all debt providers employ some semblance of a consistent written and verbal recommendation and approval process. So-called one over one approval governance implies that your primary point of contact (likely a relationship manager) is recommending, while another person or body is approving.  Length and depth of the recommendation will vary, but at some level, analytics and story-telling must marry. The best bankers are skilled at both, able to expand the narrative beyond simple numbers or, conversely, draw tight conclusions hidden in dense financial presentations.

The importance of relationship banking is layered, and CFOs should be confident that their representative will defend and advocate for their proposals with appropriate preparation, knowledge, and enthusiasm. If not, proposals will be viewed as a commodity (i.e., buying paper), and decisions will be based primarily on price and structure.

Banking done right is a team sport. While the best bankers are implicitly empowered to deliver on behalf of a client, material explicit decision making is done by committee. Relationship managers have division managers, credit officers have senior credit officers, sector experts have industry heads, and so on. Companies should know the bankers who are participating directly with their loan application and be aware of others who are tangentially involved.

Delighting Your Banker
Well-managed bank portfolios will lose less than 1% per year of total loans or assets. There is little room for error when you must be repaid 99 cents of each dollar loaned. Accordingly, bankers analyze the strength of multiple repayment sources from the income statement and balance sheet. Banks like businesses that provide a repeatable, even contractual, and arguably mission-critical product or service to enterprise clients. Translation: high gross profit margins, predictable working capital cycles, and strong enterprise value to insulate the company and debt against predictable threats.

While the strength of the borrower's proposed capital structure and business model correlate to probability of approval, there remains a good deal of interpretive art, science, and experience that goes into any underwriting decision. For example, we have found in lending to technology companies of all sizes that debt fits well in development stage and later-stage technology companies, but can test the best financial engineering (and fortitude) when start-up firms reach commercialization and revenue early.

It may be counterintuitive to some CFOs, but a company's development-stage milestones and the new equity it anticipates from investors are easier underwriting variables for the bank than the vagaries of lumpy, concentrated revenue and unproven expense structures in a fast-growing business. For companies in this high-paced stage of development, fixed-payment term debt as growth capital is a challenge. As a rule, if the proposed debt structure would influence how you run the business, the company is undercapitalized: neither banker nor client should let the "tail wag the dog."


There is good news about banks' decisions to lend. Most deals are done with terms and conditions reasonably consistent with those proposed. This is because the best bankers have already separated the wheat from the chaff by screening, filtering, and structuring against bank risk and return targets. They are empowered as an institutional proxy because they understand the portfolio strategy of the financial institution and can anticipate how receptive the underwriters will be.

Still, CFOs should ask their banker to explain the decision-making process up front and to provide regular status updates to manage their expectations as they seek and acquire the financing their companies need to operate and grow effectively.

Scott Bergquist is the central U.S. division manager for Silicon Valley Bank, overseeing business development and client relationship activities with 2,000 companies and managing more than $1 billion in committed capital. He specializes in financing solutions for high-growth technology and life-science companies.




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