Monthly Archives: December 2012

Lending environment changes, room for a PD Model

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Starting with the financial crisis, there has been a decided shift in the lending environment. Banks and credit unions with commercial lending have turned away from Commercial Real Estate loans (CRE) in favor of Commercial and Industrial Loans (C&I). If the C&I portfolio is well managed, it can be a lucrative opportunity since demand for this type of loan is increasing and due to the risk that was exposed among CRE portfolios during the financial crisis.

Given increasing demand, financial institutions might be tempted to loosen credit terms so that they can remain competitive in the aggressively competitive market. If standards are relaxed, or even if they aren’t, regulators are concerned that financial institutions that enter into or expand their C&I portfolios will do so without ensuring that they have the appropriate credit risk management processes in place. The result could be inefficient covenants or analysis at origination or improper monitoring during loan review.

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Why maintain a healthy business credit relationship?

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Drive down any major road, and at some point you could run into trouble: A wreck that has shut down traffic, construction causing delays, or a dangerous object in your lane you must swerve to miss.

Obviously, your best chances of avoiding a major problem are when you have warning – a “Construction Delays” sign or a radio traffic alert before you get to the trouble spot.

In the same way, businesses can prepare for or even avoid disastrous business credit relationships with suppliers, distributors, customers and other partners when they have warning – when they can predict which of those players are riskiest in a business relationship. While the U.S. economy has been improving slowly, business failures outnumbered business startups as recently as the first quarter of 2011, according to the Bureau of Labor Statistics.

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Why do personal finances and credit scores matter?

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Many business owners are required to submit their personal finances and credit scores for commercial loan applications, but why? In most cases, the owner is the guarantor for the loan and either contributes or receives income from the business. In addition, it is common especially for sole proprietors, to mix personal and business finances. Since most of these transactions do not appear on financial statements, it is difficult to gain an accurate picture of the cash flow. Subsequently financial institutions run a global debt service calculation to understand the flow of cash.
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Credit analysis benefits of a probability of default analysis

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Financial InstitutionFinancial institutions may inject a probability of default (PD) analysis into several steps of their credit risk processes, and each use-case provides a different benefit to the bank that directly impacts its workflow efficiency, credit decision quality, and most likely profitability.

Before any financial statements have been spread, a PD analysis can be an effective way to perform pre-screens. Lenders, for example, can analyze a business in just a few minutes and quickly see if the loan could be worthwhile (yes) or one on which they should quickly pass (no). These pre-screens could reduce strain on the credit department.

It provides management with a tool with which they may perform a deeper and more objective analysis when making credit decisions. Banks or credit unions that may have previously had very small or nonexistent commercial and industrial (C&I) concentrations in their portfolio might be especially interested in tools that add depth and objectivity to the analysis performed on potential borrowers. Whether a banker is used to analyzing private companies or not, a PDM is an accurate and reliable addition to an existing credit analysis process. Read More →