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