By Scott Balfour
Commercial and business lending is different than that of housing. Commercial & Business loans are often held in-house where most residential loans are sold to the secondary market. This fact alone can explain why one bank may turn down a loan and another approves it. Same buyer, same business, yet different results.
Banks write loans expecting a return for their shareholders. To do this and to mitigate risk across the board, many like to have a balanced portfolio. Too many loans in one segment don’t spread out the risk. An example could be one bank has many marinas, another just a few. All things being equal it’s considered less risky for the bank with fewer loans in that segment.
When lending to a business the bank makes its lending decision focusing on two aspects: the person and the business. They are reviewed separately then combined as a package.
A person needs the cash down payment, a good credit score, an appropriate resume showing skills to run the acquired business, Cash Credit, Character, and Competency – often referred to as the first 4 C’s of lending.
The business loan is based on a business plan for start-ups or the history and projections for mature companies. The first two things looked at are Cash Flow and Collateral. Two more C’s – we are up to 6.
Cash flow is the primary source for repayment of a loan. When someone says ‘the numbers work well’, they are often referring to a strong cash flow. When a bank receives a loan request for a small business with a strong cash flow they often will look to further reduce the bank’s risk by getting a Small Business Administration (SBA) loan guarantee. In this case an SBA 7A guarantee. The underwriting relies heavily on a debt coverage ratio. So now in effect, there are two sets of qualification rules, one for the bank and one for the SBA. What does this mean? More documentation, longer processing, and hoops to jump, but what are the alternatives?
If a bank receives a loan request with heavy assets, perhaps with real estate, they look to the collateral should things go bad. This collateral to fall back on protects their shareholders. Again to further protect the interest of shareholders they often look to the SBA for a loan guarantee. In this case, it’s an SBA 504. The underwriting is often based on the asset class(es) for the term and percentage(s) for the amount for the loan amount. And, yes, again a lot of documentation, appraisals, and time is needed to satisfy the bank and the SBA.
I’ll conclude this article by describing a conversation I had with a banker just the other day. He was commenting that the result of a loan application is often tied to how well the loan package is prepared. It’s an old adage but ‘you only have one chance to make a good first impression’. A good loan package demonstrates how thoughtful and knowledgeable the purchaser is regarding the business they are starting or acquiring. Anything less creates doubt.
Magnusson Balfour assists in the preparing of loan packages for its clients and offers this service for individuals looking to refinance, acquire new loans or lines of credit as part of an a la carte advisory services.