Credit Culture – make it dynamic!

January 11, 2019

By Phil Marsden

While Commenda is a merchant bank that is a source of Capital, both equity and debt, today we are focusing on the debt piece. 

Over time, all providers of credit have developed a way of evaluating and reaching credit approval decisions for the business/commercial loans that they make. The process can seem a bit mystical and unscientific, but it isn’t.  The review and decision process include a “check-the-box” set of tangible criteria – principally involving historical financial information and recent appraisals of assets pledged to support the loan request — while much of it is much more “gut feel” and tends to rely upon intangible factors. Nonetheless, all of these factors tend to come into play, as the lender attempts to fully evaluate the credit risk and the likelihood/possibility that the borrower may not be able to repay the loan in accordance with the terms of the loan. The particular weighting given to each of the various factors defines the “credit culture”, which tends to be unique for each lending institution. In this process, Commenda attempts to guide its clients to provide the most comprehensive, accurate and timely information to facilitate the debt financing.

Potential lenders receive, analyze, and assess a number of different data points. The lending officer in charge prepares an internal loan approval memo and presents the opportunity to the “credit committee” for approval. Once approved, closing documents are prepared and signed and the funds dispersed to the borrower. Thus, begins borrower’s obligation to make monthly loan payments for the next 3, 5, 7 or 20 +/- years, depending upon the terms. During the term of the loan, the primary, on-going “communication” between the business borrower and lender is the loan payment history.

One limitation of this approach is that it tends to over-emphasize a static view of the borrower at the point in time when the loan is originally made. Clearly things change over time.  For example, the borrower’s ability to generate on-going cash flow sufficient to make the loan payments over a long period of time is based on various dynamic market conditions and economic factors.  Frequently such market changes lead to an uncomfortable and ineffective disconnect when borrower lacks enough operating cash flow to make loan payments on a timely basis. Under these circumstances, both lender and borrower are trying to play catch-up.  In this case, the lender is typically driving the “loan modification” process to suit what is “easiest” or most expedient to get approved. This might lead to the extension of additional credit (to cover the cash flow shortfall) or to other modifications in the loan that typically do not address the core issues underlying a cash flow shortfall.  In this situation, Commenda also tries to assist and advise its clients on the most efficient way to meet cash flow needs to service the debt.

In these situations, a very effective approach is a dynamic credit culture that establishes meaningful, consistent financial reporting and promotes on-going constructive dialogue between the borrower and the lender. Often the borrower needs to generate timely financial reporting to the lender. This results in a far better, more reliable and current information sharing on business operations.  This process helps to identify both existing problems or any potential problems related to cash flow.  As a result, both the borrower and lender can be proactive, solving any issues in advance of a loan payment coming due.  Since there is already on-going business/financial dialogue taking place between borrower and lender, there are few if any surprises for either party and such potential problems can be mitigated quickly and efficiently.

Commenda Capital offers many highly seasoned professionals, experts who can help establish or improve dynamic credit cultures for lenders.  They can also generate a dynamic playbook to effectively address the core operating and cash flow issues. The bottom line:  Commenda can help you and your company take the problems out of problem loans.

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