Let’s Have An Easter Egg Hunt
Spring has always been a special time to me; it seems to slip by fairly quickly in between winter and summer. Spring usually means the ushering in of nice weather and the greening of lawns, trees, and shrubs. On the flip side, there is the inevitable “last gasp” snow event and, in most years, tax time (big frown!). This time of year, before Summer officially hits, I often find myself reflecting on other things that make Spring so meaningful. I realize we’re long past Easter. But because it’s my favorite religious holiday, it’s always an important part of the entire Spring season for me. I recently caught myself thinking back fondly of a special Springtime tradition when I was a youngster: Easter Egg hunts, so Let’s Have An Easter Egg Hunt!
A wise mentor once made the analogy that quality commercial credit underwriting was quite similar to an Easter Egg hunt. Except that instead of searching for colorful eggs or sweet treats, the prize was uncovering the two or three key credit issues that were the most critical to address in the proposed credit structure. That is, identify the risks and develop specific mitigants to address the risk(s).
Let’s Have An Easter Egg Hunt
Please appreciate that this “hunt” does not negate or reduce the importance of completing a thorough underwriting as guided by the over-arching construct of the Five C’s of credit. Rather, it is the element of critical thinking applied to the credit request which discloses the key credit issue or issues in the request.
What might these issues look like? In general, they would involve “one-time” events or any type of significant change in the operations of the borrower or its operating environment. A few examples may be instructive:
- A “reflag” of an existing hotel may require major renovations and/or change the reservation system. Also, potential changes to services offered. Change from limited service to full service may require capital improvements and changes to staffing levels. External factors such as road repairs or highway re-routing. Loss of a major local hospitality event such as a convention, conference, or golf tournament.
- Auto, RV, motorcycle, or equipment dealers. Addition or loss of a name plate, “badge,” or product line. Changes to OEM floor plan arrangements. Changes in the interest rate environment and general economic strength.
- Churches and non-profits. New pastor or leadership. Loss of one or more significant givers/benefactors (either individual or corporate). Adding a new program such as a church adding a school or mission/program (counseling, homeless program, food pantry).
- Addition of a new product or product line resulting in new equipment, inventory needs for raw materials, work in process or finished goods. Changes in the sales channel and sales closing time. Technology changes.
- Regulatory changes can significantly change sales outlook and performance. New regulations can favor one industry and potentially kill another including federal, state, or local mandates related to alternative energy sources. Also, limiting access to state and federal lands for natural resource access can have a significant impact. Other issues include more restrictive government regulations (zoning, environmental, etc.). Finally, companies undergoing major technology upgrades are prime candidates for all types of operational disruptions.
Since the first step in solving any problem is to discover and define it, so it is with identifying our credit “Easter Eggs.” Once identified, it is necessary to develop a strategy for mitigation. This may mean passing over an opportunity where there are too many unknowns or proper mitigants are not available. Possible mitigants may include enhancement to the credit structure, including more frequent reporting. Covenants can also be useful to track actual performance against projections. Then again, a very strong guarantor with confirmed liquidity can make a real difference.
This approach to supplementing the basic Five C’s underwriting can yield strong results both in terms of establishing your position as a knowledgeable and trusted advisor to your client/prospect, as well as avoiding a potential credit loss. Adding a short summary to existing credit presentations, which discloses key credit issues (two or three) and appropriate mitigants, is an easy way to focus this type of analysis. After all, Easter Egg hunts really are fun.
Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape. This lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133.Tags: Enlighten Financial, Let’s Have An Easter Egg Hunt