Behind the scenes on debt finance – a free guide for ICAS Members
When your clients are seeking debt finance, it can help their chances of success to understand what lenders look for, and why. Although each lender may operate with different assessment styles, they all examine the same important components of a borrowing proposal.
For a rare behind-the-scenes lender’s perspective on the application and assessment process, LendingCrowd has produced an exclusive guide for ICAS Members:
What lenders assess
When appraising a loan application, lenders will seek to answer the following questions:
- Who is the borrower and what do they do?
- What is the proposed debt amount and structure?
- What is the borrowing purpose?
- How will the debt be repaid?
- What is the secondary source of repayment?
- What is a fair return for the risk?
Lenders will usually seek a route to two repayment sources:
- The primary source of repayment (PSOR), which is the borrower’s ‘plan A’ and anticipated route to repaying the proposed debt, and
- The secondary source of repayment (SSOR), or ‘plan B’, which is usually some form of security that can be realised to repay the debt if the PSOR partially or wholly fails
Each repayment source will be tested separately and, understandably, lenders prefer both to be strong and reliable.
All lenders will undertake their own appraisal, challenging and stress testing the information provided to ensure it is valid. Bear in mind that lenders must also look out for potential fraud and other criminal activity, so they have internal policies and legal requirements to meet in this regard. They will test the proposal’s integrity to ensure it is honest and legitimate, while assessing the overall business opportunity.
Duncan Cassidy, Director of Credit at LendingCrowd, says: “It’s important to remember that, from a lender’s perspective, there’s no such thing as bad news, the communication of developments in a timely manner assists with the options a lender will have to assist. If a business has lost a big contract and needs some short-term funding, be honest. On the flip side, perhaps some competitors have gone out of business, which could lead to an upturn in trading for the borrower. Lenders have been through these cycles before and understand the journey is never smooth.”
The assessment will usually include initial application checks to ensure the proposal is fit for further consideration. These might include eligibility, regulatory, profile and credit checks. If these checks are successful, the proposal would then usually be passed to the underwriting team for the credit assessment, to analyse the ability of the borrower to repay the debt over the proposed term.
Financial statements and management information provide visibility over recent earnings and, along with financial forecasts, are the main references as the lender forms a view of the movement in the borrower’s operational performance over time, and its capacity for debt.
Trading affected by lockdown
In the current economic climate, lenders will want to know how your clients have been affected by the coronavirus pandemic. Details of their impact management and strategies for exiting lockdown are useful, ideally supported by up-to-date management information and forecasts to show the financial outputs of key management decisions.
Duncan adds: “When it comes to assessing financial records covering the period affected by the pandemic, lenders will be as sympathetic as possible. They know that accounts are likely to show a downturn in trading, but they’ll also want to see what the next 12 months will look like from the directors’ point of view. Be realistic with the assumptions – lenders won’t be taken in by talk of a ‘hockey stick’ recovery unless there is very clear information to back this up.”
The debt market
Lenders operate with different risk appetites and use various mechanisms to ensure their loan portfolios are maintained accordingly. For example, stricter lenders may complete ‘deep dive’ analyses rather than use assumptions during their assessments, favouring more comfort and flexibility around the borrower’s ability to repay and the supporting security package.
The market for debt finance is extremely vast and varied. However, research has shown that half of SMEs that have their loan application declined by their bank choose to look no further, believing there are no other options available. However, non-bank lending is growing in stature as it delivers a track record of providing significant finance at reasonable costs and with a keener appetite to lend than the banking industry.
LendingCrowd is a non-bank lender that has invested substantially in its financial technology (fintech) platform to help bridge the SME funding gap, but a human always makes the final lending decision.
“For us, fintech is all about the efficient capture, processing and delivery of information to the decision maker,” explains Duncan.
“The data going into the process has to be up to date and of the best quality possible, because the underwriters rely on that data to make a decision. The human approach is still important – every SME is different, so having an experienced individual looking at the deal benefits the borrower.”
The debt market is very competitive and there is often an opportunity to negotiate with the lender around price and structure to ensure the terms are suitable and you are happy with the deal. Don’t be afraid to ask as lenders will expect it. This is a good time to build rapport and build the working relationship between the borrower and the lender. Ideally, perhaps with a little compromise on both sides, the lender and borrower will reach agreement around the debt proposal and proceed towards completing the deal.
LendingCrowd, the trading name of Edinburgh Alternative Finance Limited, was founded to help SMEs thrive by giving them access to non-bank lending. To find out more about LendingCrowd, call 0345 564 1600.