How Can A Bank Limit Risk In Commercial Lending?

Commercial lending involves a level risk no matter who the borrower is, but banks do have ways in which they can minimize risk.

Borrowers are always confident their idea can’t miss. They always think that their idea is the one that will make millions and that the bank would be foolish not to approve. If a borrower didn’t exude some level of confidence in their business model the bank would be foolish to approve them. If they don’t believe in it how can the bank?

But when you are in the business of commercial lending you can’t get caught up in the confidence and emotions displayed by the borrower. You have to remain detached and objective—but how?

Five C’s Of Credit Used In Commercial Lending

It is impossible to know beyond the shadow of a doubt whether someone is going to honor their loan agreement and pay it off in a timely fashion. People in the commercial lending industry just have to do the best they can when judging the level of risk that lies with approving a particular borrower.

How do they judge it? The apply the Five C’s of Credit:

- Character: Does the borrower have a track record of paying his or her bills in a timely fashion or do they have a lot of outstanding debt?

- Capacity: Will the borrower have sufficient income to pay his note every month? Are they entering a market with a lot of competition and not enough demand to go around?

- Capital: How much equity do they have in the venture? Is it enough to convince the bank they will do whatever it takes to succeed or will someone else be the big loser if the business fails?

- Collateral: an alternative source of payment for the lender should the borrower fail to abide by the terms of the loan.

- Conditions: also known as the loan structure; this will include whatever interest rate is being charged as well as any other things the lender feels are necessary in order to minimize their risk (i.e. loan-to-value ratio, debt service coverage ratio, financial covenants, the subordination of officer debt, borrowing base).

It All Starts With The Relationship for Commercial Lending

Commercial lending can be a nerve-racking business. You want to believe in people and help make their dreams come true, but at the same time, you have to be responsible to the bank's investors too. But you hate to be the one that has to crush someone’s dream. Does this mean you have to be ruthless?

Not at all! In fact, the best bet is to get to know the borrower as much as possible. Establish a relationship with the borrower, and you are more likely to “accidentally” discover red flags that they inadvertently let slip. It sounds dirty, but at the same time you can find out if they are a crazy dreamer with their head in the clouds are a practical and responsible business person.

 

Dennis Dahlberg Broker/RI/CEO/MLO
Level 4 Funding LLC  Private Hard Money Lender
Arizona Tel:  (623) 582-4444
Texas Tel:      (512) 516-1177
Dennis@level4funding.com NMLS 1057378 | AZMB 0923961 | MLO 1057378
22601 N 19th Ave Suite 112 | Phoenix | AZ | 85027
111 Congress Ave |Austin | Texas | 78701
 
About the Author:  Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 42 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.









          

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