Managing Commercial Loan Underwriting

Managing Commercial Loan Underwriting

When To Use

• Underwriting a new commercial loan request (term loans, revolving lines, CRE loans, construction facilities)
• Performing annual or periodic credit reviews on existing borrowers
• Spreading borrower financials for credit analysis and trend identification
• Assigning or updating internal risk ratings
• Preparing a credit memo or underwriting package for credit committee approval
• Evaluating trade finance facilities, letters of credit, or working capital lines

Inputs To Gather

• Borrower financials: 3 years of audited/reviewed financial statements (balance sheet, income statement, cash flow statement); interim statements for YTD period
• Tax returns: Business and personal (guarantors) for 3 years
• Loan request details: Amount, purpose, term, proposed structure, collateral offered, pricing expectations
• Business information: Entity type, ownership structure, management bios, industry/NAICS code, years in operation
• Collateral documentation: Appraisals, environmental reports (Phase I/II), UCC search results, title reports for real estate
• Personal financial statements: For all guarantors with >20% ownership
• Existing debt schedule: All outstanding obligations with terms, balances, and lender names
• Industry benchmarks: RMA Annual Statement Studies or comparable data for the borrower's NAICS code

Workflow

1. Spread financials

   • Normalize 3 years of financial statements into a standardized spreading template
   • Adjust for non-recurring items, owner compensation above market, related-party transactions
   • Calculate key ratios: current ratio, quick ratio, debt-to-worth, debt service coverage ratio (DSCR), leverage ratio, operating margin, return on assets
   • Compare ratios against RMA industry medians and flag significant deviations

2. Analyze cash flow

   • Prepare a Global Cash Flow analysis (UCA or traditional method) covering all related entities and guarantors
   • Calculate DSCR using both EBITDA-based and cash-flow-based methods
   • Minimum acceptable DSCR: typically 1.20x–1.25x for most commercial credits [VERIFY against institution's credit policy]
   • Stress-test cash flow under adverse scenarios (revenue decline of 10–20%, interest rate increase of 200 bps)

3. Evaluate collateral

   • Determine advance rates by collateral type: A/R (80–85% of eligible), inventory (50–65%), equipment (70–80% of NOLV), CRE (75–80% of appraised value) [VERIFY against institution's lending policy]
   • Confirm collateral perfection requirements (UCC filings, mortgage recordings, title insurance)
   • Identify environmental risk for real property collateral
   • Calculate loan-to-value (LTV) ratios

4. Assign risk rating

   • Apply the institution's internal risk rating scale (typically 1–10 or Pass/Watch/Substandard/Doubtful/Loss) [VERIFY against institution's rating system]
   • Document the primary risk rating drivers: financial performance, industry conditions, management quality, collateral coverage, guarantor strength
   • Dual risk rating: assign both a borrower risk rating (probability of default) and a facility risk rating (loss given default)
   • Flag any rating that triggers enhanced monitoring, concentration reporting, or regulatory thresholds

5. Structure the credit facility

   • Recommend loan structure: term, amortization schedule, rate type (fixed vs. floating), pricing spread
   • Define financial covenants: minimum DSCR, maximum leverage ratio, minimum tangible net worth, capital expenditure limits
   • Specify reporting requirements: frequency of financial statements, compliance certificates, borrowing base certificates (if applicable)
   • Identify conditions precedent to closing and ongoing conditions

6. Prepare the credit memo

   • Executive summary: borrower overview, request, recommendation
   • Financial analysis section with spreading output and ratio trends
   • Industry and market analysis
   • Risk assessment with mitigants
   • Collateral analysis with LTV calculations
   • Proposed terms and conditions
   • Exceptions to policy with justification (if any)

Output

A complete underwriting package containing:

• Standardized financial spreads with 3-year trend analysis and industry comparison
• Global cash flow analysis with DSCR calculations and stress test results
• Collateral analysis with advance rates, LTV calculations, and perfection checklist
• Risk rating assignment with documented rationale and dual rating (PD/LGD)
• Credit memo formatted for credit committee review with clear recommendation (approve, approve with conditions, decline)
• Covenant and structure summary with proposed terms, monitoring triggers, and reporting calendar

Quality Checks

• All financial spreads tie back to source documents — totals must reconcile with submitted statements
• DSCR calculated consistently (confirm whether using EBITDA, EBITDA–CapEx, or UCA cash flow) and method is disclosed
• Risk rating supported by quantitative metrics, not solely narrative judgment
• Collateral values based on current appraisals (within 12 months for CRE) [VERIFY appraisal age requirements per institution policy and regulatory guidance]
• Guarantor analysis completed for all individuals with >20% ownership
• Policy exceptions explicitly identified and justified — never buried in narrative
• Stress test assumptions are reasonable and documented
• All [VERIFY] items confirmed against the institution's current credit policy manual before submission