Study examines financial statements as loan-monitoring mechanisms
Monitoring the loan portfolio is vital to ensuring loans don’t default, but how much contact with a borrower is enough? And how frequently should financial institutions be asking for financial statements, tax returns or other information?
Every bank or credit union has its own loan administration system and requirements for tracking exceptions and information requests that are based on the institution’s credit policy. But recent research by University of Chicago professors Michael Minnis and Andrew Sutherland sheds some light on the types of information banks request from commercial borrowers and the frequency of those requests.
Minnis and Sutherland analyzed 4,518 bank loans included in Sageworks’ online database. They reviewed aggregate, anonymous statistics for the loans, which were made to 3,148 firms between 2010 and 2012, and they reviewed correspondence associated with the loans. Among their findings related to loan administration and document management:
-Banks made 90,172 information requests related to the loans in the sample, or nearly 20 requests for each loan. These requests could include all types of information, such as financial statements, recorded mortgages, copies of UCC filings and other items that can trigger documentation exceptions.
-Banks requested financial statements for 51 percent of the loans in the sample.
-Of the requests for financial statements, more than three-fourths were for annual financial statements, while roughly one-fourth were for interim statements.
-Banks requested business tax returns for 43 percent of the loans in the sample.
-On average, banks made about 10 non-financial information requests a year from each borrower.
-The sample was predominantly made up of loans to small businesses. The average loan size in the researchers’ sample was $232,835. The market for small commercial loans in the U.S. is huge, exceeding $1 trillion, even though financial conditions of privately held companies are often difficult to determine because of a lack of financial reporting requirements, the researchers noted.
-About 44 percent of the loans were collateralized.
The working paper for the university’s Booth School of Business examined how financial statements are used for monitoring loans. Among other things, Minnis and Sutherland found that firms with credit ratings toward the middle of the spectrum are most intensively monitored. They also found new evidence that banks are more likely to request both financial statements and tax returns, despite the frequent overlap in information, when the stakes are high – for example, for a short or complex lender-borrower relationship or for a borrower with a middle-tier credit rating.
“Considering that the overwhelming majority of the financial statements in the small private firm setting are not audited by an independent accountant (Minnis 2011), this verification role could be particularly pertinent,” the authors said.