Borrowers/lessees often do not -- and cannot be expected to -- understand the credit underwriting process and requirements that banks and equipment finance companies need to follow. This often leads to a prolonged underwriting process that could potentially be avoided if borrowers/lessees more readily understood the risks and issues that lenders/lessors typically address during the adjudication process. 

The sharing of this knowledge by the lender/lessor may increase a borrower’s/lessee’s chance of expediting the approval process and may also assist in establishing a closer relationship to facilitate future financing requests. Regarding this point, in the current economic environment credit quality continues to be of paramount importance, and both lenders and borrowers have found it to be advantageous to establish credit relationships rather than continue to approach the business on a transaction-by-transaction basis. The extent both parties can become more familiar with each other’s needs as well as better understand the makeup of the other organization will help make the ongoing relationship more efficient and rewarding.

Exchanging Accurate Information

The burden of providing the most efficient means to exchange detailed information does not fall solely on the lessee/borrower but is shared with the lender/lessor. The ability of the lender to adequately address this responsibility and its organizational needs will most likely come from a foundation built well prior to the discussions with the respective borrower/lessee. 

Advance training of business development/sales personnel regarding what is required within their respective organization, what questions should be asked and what information should be obtained is critical to the successful adjudication process. It benefits both sides to proactively provide as complete a description as possible of the financial health of the borrower as well as any other factors that might influence the credit decision.  

There is, of course, the prerequisite financial statement package that forms the nucleus of information necessary to provide a clear picture of the borrower’s overall health. Typically the package will include three fiscal year-end reports as well as comparative interim reports as appropriate. This chronology is intended to point to trends happening within the business, positive or negative. The quality of the reports is also important, with third-party accountant-prepared information thought to provide the most objective and accurate picture.

Negative information is not always the death knell, and it may provide insight on how the proposed financing should be structured for the benefit of the borrower and the lender. Well-trained sales/business development personnel can often assist the borrower in constructing a financing product that addresses the needs of both sides. However, it is also important to recognize that not every borrower’s credit profile will fit the lender’s risk appetite; while this may lead to a credit decline, the ability to identify that early in the process will save time and resources for both parties. Lenders cannot be all things to all borrowers and neither side should have false expectations.

It may be helpful to provide some examples of the other types of questions and/or information requests that most lenders will want to address in their approval process to provide borrowers with a better understanding of the need to furnish a detailed and comprehensive oversight of their business. For the most part, the items covered will serve a twofold purpose for the lender. 

The first is to gain further insight into the current request of the borrower, and the second is to help contribute information for the benefit of adding more depth to the overall risk perspective of the lender’s portfolio as it pertains to aggregate exposure in categories such as customer industry, geography and risk rating. In most equipment finance organizations, all clients with borrowings above a certain threshold will be assigned a risk rating that is reflective of overall financial strength. Using this information, the organization can effectively obtain a risk assessment of its entire credit portfolio. For these reasons, certain industry-specific information is helpful to the lender. 

Understanding Industry Risk

Highlighting specific industries as examples, it is helpful to understand the need to obtain, in some detail, information regarding critical aspects of that industry. The first example is the construction industry: Information requests covering the status of current contracts in progress, including the status of billed receivables relative to costs, should be expected. In this same business it is also important to obtain contact information for the borrower’s bonding agent. This entity usually has the responsibility of insuring its clients for performance risk, a protection that is normally called for by the builder’s clients and which, in many cases, is likely to expose the bonding company to potential dollar loss greater than the borrower’s exposure to the lender. For this reason, the bonding company will usually have detailed information about the borrower that could be very helpful to the lender.

Looking to the transportation industry as another example, some of the areas to explore between the borrower and lender would include customer concentration, terms of major customer contracts, less-than-truckload issues, deadhead inefficiencies, the age of the borrower’s fleet, and cost to convert to government-mandated more-fuel-efficient vehicles vs. absorbing rising fuel costs. 

Healthcare can be provided as yet another example and needs to be further segmented by facility type – e.g., hospitals (which also need to be subdivided), surgery centers, clinics, etc. In addition to reviewing the operating statistics of the individual provider, a more global focus of critical importance is on the regulatory influence with respect to reimbursement rates, pending/potential regulatory changes and the overall governance of the industry.

One additional example is the emerging alternative energy industry in which issues such as financing costs relative to investment recovery timeframes should be explored. Rapidly evolving technology also plays a role, especially in the case of the solar industry, where both the cost and efficiency of solar panels need to be addressed as these two components have continued to move in opposite directions over a short time period. 

There are also more generic issues for the lender to cover – issues that bridge many industries and also serve multiple purposes. A discussion regarding some detail about the borrower’s industry would help to not only better understand the borrower’s business but, as previously mentioned, would also be factored into ongoing periodic review of the lender’s portfolio customer concentration by industry and geography. More specific to the borrower’s financial condition: Its liquidity, ability to service current and projected debt, profitability, quality and breadth of reporting information, as well as the quality of management, are items that should be addressed.

Internal and External Factors Affecting Businesses

In addition to the issues enumerated above, many of which capture a historical perspective of the borrower, most lenders will also want to explore other areas that help them gain some insight into the possibility of a borrower’s potential future challenges/opportunities. As such, the following five important questions are provided as introduction to areas of discussion that the borrower’s CEO, president, COO, CFO or owner should be prepared to discuss when requesting a new equipment finance facility:

• Have there been or are there expected to be near-term changes inexecutive management?
• In what direction is the future financial condition of the company headed?  If it is a continuation of the current trend, what are the drivers that have contributed to that and why are they expected to remain? If it is a reversal of a prior trend, what is changing to make that happen?
• What are the outside early warning indicators in the business – i.e., the external factors such as housing, unemployment, weather problems and global economic issues – that most affect the business, and have these been identified and considered in strategic decisions?
• Without disclosing proprietary information, what are the elements of the business that help to distinguish this borrower from its competition, and can this borrower maintain any competitive advantage/edge it has been able to establish?
• If the borrower is not a known entity to the lender either through prior experience or other information, what additional knowledge can be shared that will help the lender get comfortable with the makeup of the organization – i.e., going beyond the financials?

Conclusion

Certainly, the information contained in this article is not meant to be or thought to be all-inclusive. However, it is hoped that at the very least it will help to facilitate robust discussion between borrowers/lessees and lenders/lessors that will help make the credit approval process better understood and, perhaps, even more efficient for the benefit of all parties involved.

Andrew G. Mesches
Andrew G. (“Andy”) Mesches is currently consulting in the area of credit risk management, having retired in April 2010 after 15 years as Executive Vice President and Chief Risk Officer for Key Equipment Finance (KEF), one of the largest bank-held equipment finance companies in the United States.

Before joining Key, Andy served in various management roles at Banc One Leasing as well as US Leasing. Andy has more than 40 years of experience in the financial services industry. A native of upstate New York, he received a bachelor’s degree in economics at the State University of New York - Buffalo and also did graduate work at the State University of New York - Albany.

Andy has been an active member of the Equipment Leasing and Finance Association, serving on the association’s Credit/Collections and Basel II Advisory committees and he serves on the Dean’s Advisory Council for the College of Arts & Science at the University at Buffalo, as well as being a member of the Advisory Board for the Center of Human Capital located at the University at Buffalo.

Andy has published and/or contributed to articles in various financial services periodicals including Equipment Leasing & Finance Magazine, The Monitor, The RMA Journal, and American Banker Community Banking. Andy can be reached at a.g. mesches, llc. – (720) 323-3246 or agmesches@gmail.com.