Wondering or worrying if you are going to get approved for that line of credit you applied for at the bank is something relatable to everyone. What I have found out in my 15 plus years in the banking industry is that retail, commercial, and private banking customers all want to know what goes into the underwriting process.
The curiosity is rooted in knowing that access to credit, financial capital, determines how one can move in this economy. We don’t have to look any further than what is going on with American businesses during the COVID-19 (Coronavirus) pandemic to see the importance of financial capital.
Businesses are struggling because they lack the cash and credit to keep operations going and, more importantly, the ability to make payroll. They are turning to the government for help in the form of short terms loans to carry them through a looming economic crisis.
Congress has to infuse over two trillion dollars into the U.S. economy in the form of an emergency relief package to support households and businesses because things have become increasingly dire. At least one trillion of those dollars are going to fund federally guaranteed small business loans and a lending program for companies hit by COVID-19.
Additionally, before that, the Federal Reserve dropped interest rates to zero and, The Fed, according to The Washington Post, “is giving more-generous loans to banks around the country so they can turn around and offer loans to small businesses and families in need of a lifeline.”
Credit, if used responsibly, can serve as a lifeline to steady one’s ship in troubled waters just as much as it can be as a catalyst for growing a business.
Having an idea of some of the things that go into the underwriting process can hopefully provide mental relief, even if only for a little while.
Is the loan in alignment with the bank’s portfolio?
Before reviewing the details of a loan application, the first thing that banks are going to consider is if the potential loan is in alignment with their loan portfolio. A loan outside the usual book of business is usually not an automatic cause for denial, but banks tend to be highly risk adverse.
Financial institutions have analysts whose sole job is to understand markets and industries as well as interpret and predict trends.
So if they do not have the analysis to mitigate their perceived risk, it is less likely that the request is funded. In 2018, Forbes wrote an article that broke down the loan portfolios of the largest U.S banks. Click here to check it out.
Be able to articulate your business
In addition to making sure that one is communicating the essential ins and outs of the business on the loan application, a company should make sure that they have a website that can tell the story of the business.
Underwriters peruse company websites to learn about the business, scope of services, and management’s business outlook as much as they leverage Dun & Bradstreet for data and analytics.
Define and articulate what makes the business strategy unique or competitive amongst its peers in the industry. Here is a task every potential borrower can do to prepare their business for the application process. Explore and identify what the potential risks are for the company.
Questions future applicants should ask themselves:
• Are there any operational/governance improvements I can implement to strengthen my business?
• How does my business thrive in my industry?
• How is my industry performing within this economy?
The meat and potatoes of the underwriting process is financial analysis. Underwriters assess the financial condition of the business and evaluate how the loan being applied for will impact it. Banks, at a minimum, will want to review tax returns and business financials for the last two to three years, so make sure that you have those readily available.
In addition to analyzing business financials, personal finances could be considered as well. It is especially true if there will be someone who will serve as a personal guarantor of the loan. A personal guarantor is someone who will agree to be responsible for the loan if the business applying for the loan defaults on their financial obligation to the loan. A personal guarantor will have to submit a completed personal financial statement that dives into the assets (e.g., cash, cash value of life insurance, stocks, notes & accounts receivable).
The personal financial statement will review the liabilities (e.g., notes payable, car notes, mortgage payments, unpaid income taxes) of that individual. Most banks have a company created Personal Financial Statement. If one is not available, I would recommend finding banks that make them publicly available then use it as a guide to putting one together.
Learning more about the underwriting process can help manage expectations after submitting an application. Applying for a loan is a significant step in building a business. Yet, for many across the country, credit still is the barrier that prevents people from turning a passion into a thriving and self-sustaining business. As a best practice, it senses for an entrepreneur to enhance their business acumen by learning about credit from certified, licensed professionals.