4 Ways industry data can improve your commercial credit analysis
Commercial lending can be a large source of credit risk for any bank or credit union, especially for institutions in which commercial analysts are unfamiliar with the companies being analyzed or their industries. In that scenario, it’s like trying to read a book but not knowing the language. Or, at the very least, it’s like being unfamiliar with the dialect or the regional vocabulary.
A tool that commercial lenders can use to reduce credit risk and make better lending decisions is quality industry data, including up-to-date financial benchmarks for the relevant industry. With this added context, analysts are better prepared to interpret financial performance and know, for example, the average and above-average growth and profitability rates for the loan applicant’s NAICS or industry code.
Here are four ways that industry data can improve a commercial credit analysis process.
Expanding C&I or Member Business Portfolios
After the financial crisis, institutions are looking to mitigate risk through portfolio diversification, and oftentimes that propagates an expansion of the bank’s commercial and industrial (C&I) or credit union’s member business lending concentration. But these new lines of credit and types of customers could increase risk if not approached or analyzed carefully. For both originations and annual reviews, industry comparisons can be an important part of the institution’s credit risk model for business loans.
“The majority of community banks are looking to grow their commercial loan portfolios as well as diversify the portfolio profile,” according to Joe Hill, President and CEO of CEIS Review. “Comparative industry data is valuable in the underwriting process in identifying the more desirable borrowers.”
Make more informed lending decisions.
Understanding Diverse Commercial Portfolios at Small Institutions
Industry data can be especially helpful at community banks, where analysts are expected to evaluate businesses across a wide variety of industries. “Unlike at a very large bank where the lending officer may be able to focus on one type of business, at community banks they often have many different types of businesses that lenders lend to,” said Linda Keith, a CPA with a niche practice in credit analysis training for banks and credit unions.
“Especially when you have a new business client that you’re considering lending to, there needs to be a quick way for the lender to come up to speed with what those numbers should look like if this is a healthy business,” according to Keith. Even before completing a full financial analysis or “spread” of the numbers, an analyst at a community bank or credit union can use benchmarks for a few key metrics to see if the business deserves a closer look.
Supporting Loan Decisions
Even after the financial data analysis is complete and the analyst has made a recommendation, the documentation for that credit file is more defensible if it includes a benchmarking analysis for the company. “You’re demonstrating to loan committee, to regulators and to anyone else in the lending decision process the basis for your understanding of the underlying business. You haven’t just taken numbers kicked out of accounting or tax software and used them in credit analysis without gaining a familiarity with that type of business or industry.”
This extra analysis can also lead to better preparedness for exams in the event examiners choose to open that credit file.
Increasing Objectivity with Current Clients
Credit unions and banks can benefit from using industry data in existing commercial banking relationships, too. That’s especially the case if it’s possible local clients might have been given preference at underwriting because they are ‘just down the road’ or are longstanding clients. Boards and regulators may be more comfortable that such a practice isn’t endangering the credit risk profile if a standardized process has been used to evaluate all clients.
Industry data can provide quantitative support for lending limit decisions, risk ratings and loan pricing changes. “Especially coming out of the Great Recession…it would be great to be able to use the benchmarking data to show that the business has returned to industry norms for profitability,” she adds. “Whether you’re making the [loan] decision in the first place, or in the area of ALLL, when deciding to upgrade a loan back up to performing status so that you can reduce your allowance for loan and lease losses.”
In these cases, objective industry benchmarks bolster loan and impairment documentation. “It simply adds a dimension to their analysis and their decision making…so that anyone else in that decision-making chain can have a greater reliance on the conclusion that the lender has reached,” according to Keith.