Broker Success: Looking at Borrowers Through the Eyes of Lenders By Don Cosenza, CLFP
Article originally published in Monitor and is being reproduced by NEFA with permission.
As the chief marketing officer for an equipment finance lender that generates volume solely through third-party referral agents, I’m often asked how to maximize approvals and closing rates. Brokers who tend to have higher customer satisfaction levels and repeat business — along with stellar performance indicators — are those who adopt a consultative and educational approach to equipment finance transactions. As a conduit, brokers collect data on the customer and use it to package deals with a specific lender in mind.
Even for the most seasoned brokers, however, the process of qualifying for small business financing can sometimes seem shrouded in mystery. Although nobody can predict outcomes with pinpoint accuracy, brokers can lessen uncertainty by becoming familiar with the credit parameters that lenders use to assess risk and make underwriting decisions.
By looking at a borrower through the eyes of a lender, brokers can exclude institutions that are unlikely to approve a request and spare customers the disappointment of a declined transaction. As a broker level-sets borrower expectations, they can also offer insight on how to improve crucial scores and strengthen relationships with lenders as they pass along more qualified applicants.
Why Lenders Assess Risk
A good place to start is with a quick look at how lenders assess risk. The quantification of credit risk is the process of assigning measurable numbers to the likelihood that a customer will be approved and be able to make the required payments on a debt obligation.
It stands to reason that a higher default risk leads to a higher required return, and as such, a higher interest rate.
“There are a number of factors that impact credit risk, ranging from borrower-specific criteria to industry-related factors to worldwide events,” Bob Dion, senior vice president of North Mill Equipment Finance, says.
A discussion on credit risk would be incomplete without mentioning the “five C’s of credit,” otherwise known as capacity, capital, conditions, collateral and character. Together, they help formulate a picture of a borrower’s eligibility to obtain financing and probability to repay. They’re also fundamental in determining interest rates and credit limits. “Capacity” is a borrower’s ability to repay the debt, “capital” is their net worth, “conditions” are external factors like the economy, “collateral” is the asset being pledged and “character” embodies the borrower’s moral integrity.
While the vast finance landscape is far from heterogenous, there are some basic credit tenets that go along with the five C’s that many lenders use when assessing an equipment finance transaction. There are no steadfast rules used to scale these attributes, as lenders operate differently; however, these parameters are worth knowing, as they provide a window into a customer’s credit history. This information, much of which is available through the credit bureaus, helps predict outcomes.
Credit Parameters That Influence Lenders’ Decisions
Length of time in business and industry experience
Statistics published by the U.S. Bureau of Labor Statistics reveal that nearly half of all businesses1 established in 2016 failed within five years, so it is understandable why some lenders prefer established businesses over startups. Managing debt effectively and ensuring predictable revenue takes experience.
“Time in business” is what lenders use to weed out newbies from established enterprises. If a company has not been in business for long, some lenders may consider previous work experience in the industry, aptly called “industry experience.” While these two terms are often used in tandem, there is a clear distinction. “Time in business” refers to the amount of time that has lapsed between the date that a business was established (e.g., by referencing its articles of incorporation) and the date of the loan application. “Industry experience,” on the other hand, is the number of years of experience that the borrower has worked in a particular field.
North Mill, for example, considers “startups” as entities with fewer than two years in business and has rate cards specifically for this category. All applicants, however, must have at least three years of industry experience to be eligible for financing. This reference point is not limited to startups at North Mill, as the company requires all applicants to bring three years of experience to the table. Knowing an industry and working in an industry are two very different concepts and being intimately familiar with a particular type of business — having worked in it for three years or more — improves the chance for success.
Lending is a practice completely dependent on reciprocated faith and trust. Therefore, it is vitally important that a broker communicate thoroughly with a lender regarding a client’s background. It behooves both parties to share past mistakes and any potential challenges that may face the business or the personal guarantor in the future.
“Our brokers represent the lifeblood of our organization,” Dion says. “We’ve worked hard to develop deep-seated, meaningful relationships founded on reciprocal trust.”
Recently a long-time North Mill broker partner included a comprehensive write-up with an application explaining in detail why the borrower had a series of late payments on their credit report.
“We are very appreciative when we receive explanations with a submission. I would rather learn of a stain on an applicant’s report from the broker at the time of submission than to have one of my analysts uncover it during the review process,” Dion says. “Transparency is often what expedites the processing of a transaction.”
While it depends on the lender, character issues such as fraud and embezzlement or as profane as sex crimes and murder have no time limit, while other less serious incidents may be forgiven once a certain number of years have passed. Looking at a more specific example, some lending institutions consider child support payments a serious matter, so missing and/or late payments result in an immediate decline. If the borrower is not making a requisite payment to support a family member, there is a good chance the lender’s debt will be treated similarly.
Cash Flow, Revolver Availability and Comparable Debt
Cash Flow: It is likely no surprise that lenders consider cash flow, or the amount of money coming in and going out of a business, a crucial element during a credit analysis. By assessing liquidity arrangements, a lender ensures a borrower has a steady influx of cash to cover the costs of any current debt in addition to the costs associated with any new loan that it underwrites.
Depending on the size of the transaction, some lenders have an “application-only” solution whereby a borrower doesn’t need to submit financial documents like bank statements or tax returns. These programs are typically for small-ticket transactions of less than $250,000, while larger sized transactions may require a full financial package. For example, North Mill looks for the last two years of tax returns and the last three months of bank statements for its mid-ticket transactions of up to $1 million. A detailed write-up offering additional insight on the borrower is also required.
Revolver Availability: A revolving credit facility is a line of credit based on a continuous cycle of withdrawals and repayments. As payments are made on the balance, money becomes available again to borrow. Lines of credit, credit cards and home equity lines are classic revolvers. While analyzing a customer’s credit profile, some lenders consider the type of revolver, the credit limit, the utilization ratio and the repayment history. Keeping revolving balances at or near the limit may signal that a borrower is having a difficult time making ends meet and will not be able to repay an additional loan. A high utilization ratio may also indicate financial distress, particularly when the credit limit is “maxed out.” Missing and/or late payments may also have negative consequences. Lenders often feel more confident with a borrower who has an alternative source to pay its debt, which is why they like to see an unused portion, or “revolver availability,” in a report.
Comparable Debt: When a borrower is looking to finance a piece of equipment, some lenders turn to credit history to identify comparable debt. As its name implies, comparable debt is an obligation for approximately the same amount of money with a similar maturity and similar payment terms, usually via installments. Lenders consider comparable debt and payment history a vital benchmark on which to base additional debt service, as past behavior is often an indication of future behavior. Some lenders “stack” debt to meet the requirement, meaning individual obligations are added together to arrive at a comparable loan request while payment histories are assessed for timeliness and regularity. As a borrower’s consultant, a broker should be sure to share any interruptions in debt service at the time of submission. Honesty and transparency go a long way.
Credit Depth and Minimum Tradelines
Depth of credit: Lenders often take a 360-degree view of a client’s credit history. They assess all types of financing arrangements, from revolvers to working capital solutions to mortgages to other equipment loans. Depth of credit relates to the amount of time over which credit has been established, the noting being the larger the number, the more experienced the borrower. In other words, the depth of credit measures the scope, accessibility and quality of credit information available, with higher values indicating more time and more information. Typically, lenders favor borrowers with a “deeper” credit profile to qualify for optimal buy rates.
Minimum Tradelines: Part and parcel to credit depth is the number of open tradelines a borrower has. Borrowers with a small number of credit accounts are considered to have a “thin credit file” and pose a greater credit risk given their lack of experience in the credit markets and dearth of reference points for the lender. It is usually in a borrower’s best interest to have generated a more expansive credit history before applying for financing. In some cases, a lender may require that a borrower to find a co-signer or produce a larger down payment, or the lender may even suggest that the transaction be held in abeyance until enough time has passed for the borrower to build up a substantive credit file.
Navigating the Risk Assessment Process
Brokers are at the top of the pyramid forming the financing triumvirate, a relationship comprised of the broke, the borrower and the lender. Brokers can alleviate the challenges associated with equipment financing by being informed and informing the other members of the funding triangle. Some things to remember when submitting a transaction to a lender include:
Get a clear picture of your customer: At North Mill, we ask our brokers to provide a write-up with an application. Some brokers have their customers complete a ‘pre-application’ to solicit as much information as possible on their credit background. For a reasonable fee, a broker can arrange a “soft” credit pull to avoid impacting a customer’s credit score. Some services offer a “three-in-one” product in which data from TransUnion, Equifax and Experian are bundled into one report. A broker’s customer interview, along with the data from its credit report, will supercharge the write-up a broker provides to a lender.
Set realistic expectations: If a borrower’s creditworthiness is an issue, a broker should explain the challenges in a candid manner. Not disclosing facts will only lead to frustration and disappointment for the borrower. A broker should examine a borrower’s credit history for derogatory and/or questionable information to avoid surprises while also facing challenges head-on and advocating for the borrower rather than denying or deflecting. This may even unveil errors in the credit report that need to be disputed prior to application.
Know Your Lender: Finally, brokers should make it a point to know their lenders by understanding their credit boxes, ascertaining the type of equipment they have an appetite for and becoming familiar with their processes and policies. Some of this information can even be found in a lender’s manuals and online tools. When determining if something should be included with an application, a broker should err on the side of caution and include it with the submission. And finally, a broker should call the lender they are unsure about something related to a customer’s credit history.
Don Cosenza, CLFP, is North Mill Equipment Finance’s chief marketing officer. He is responsible for leading the company’s sales and marketing efforts with a primary focus on devising and implementing its promotion and third-party distribution strategy. Leveraging his more than 25 years as a marketing leader, Cosenza manages all branding, social media, business development, broker and customer relations and product marketing initiatives for the company.