Sorting the Good Prospects From the Bad
Many lenders consider some form of pre-underwriting or executive summary as a way to help lenders sort out good prospects from the less desirable prospects. If your institution hasn’t implemented a customer selection process what can you do? Read on for our recent client experience for two we collaborated to enhance this process.
To screen or not to screen?
Recently, a client reached out to us regarding some internal struggles surrounding client selection. Our client believed that the diverse professional background of the loan officers, limited internal underwriting expertise and the lack of established procedures was impacting the customer selection process. They wondered: were they chasing after deals that did not fit in the definition of acceptable risk?
Why is customer selection important?
Customer selection is important for several reasons. First, the customer’s time is valuable. If they are clearly not qualified for a loan, don’t waste their time asking for all the pieces of a complete application. Second, your loan officer’s time is valuable. There are enough trees to shake in most markets to find viable prospects. Filling the pipeline with viable clients is far more likely to result in a growing portfolio then focusing on every possible client.
Our client faced an additional consideration regarding customer selection. As a CDFI, the client felt they owed it to each applicant to run the application process to its completion. After all, the client was serving the needs of a community and the community benefit of each and every loan they approved was highly visible within the community. Therefore, turning away a customer would be turning away the chance to improve their community.
How can your institution improve customer selection?
Together with the client we created a framework for improving customer selection. Specifically:
- Obtain critical information from each client as soon as possible and pause the process until this information is in hand. With these four items in hand, the loan officer should be able to ascertain the credit risk profile this customer represents to the institution. They would be able to assess the primary, secondary and tertiary sources of repayment with these items in hand. What is the critical information? We recommended to our client that they obtain:
- 12 month income statement projection,
- Description, estimated value and documentation to support the estimated value of the collateral,
- Personal Financial Statement of each owner including documentation to independently verify liquidity and
- A business plan for the Borrower.
- Implement a new customer screening approval process. The goal of this step was to involve the credit approval chain in the customer selection process without completing a full blown underwriting document. We discussed with the client what information was needed to give a full picture of the credit risk profile of each customer. We recommended the document include:
- Transactional information (customer name, address, industry, loan amount requested, term requested, etc.),
- Personal information on the owners (name, address, ownership percentage, expected responsibilities in the operations of the Borrower, etc.),
- Abbreviated EBITDA cash flow analysis and a determination that the DSCR exceeds policy minimums
- A summary collateral analaysis,
- A PFS analysis with a focus on verified liquidity of the the owners and
- Rationale for moving forward with a complete underwriting including any rationale for policy exceptions for DSCR, FICO minimums and collateral coverage.
With the critical information in hand and an enhanced internal process for screening potential customers, the client expects rapid improvement in the credit risk profile of their prospect pipeline. The loan officers will have more time to focus on getting the best prospects approved. Meanwhile, potential customers that don’t quite meet the credit risk profile will be able to revise their growth plans or seek other avenues of funding. Furthermore, once loans do reach the approval stage the credit signers will have some familiarity with the credit. This, in turn, reduces the time an approval decision can be made.
