Business borrowers aren’t just facing higher interest rates today. The terms of new loans have also become more restrictive. Nearly a quarter of senior loan officers reported tighter standards for commercial and industrial loans in the Federal Reserve’s second-quarter survey on bank lending practices.
As banks rein in their lending practices, it’s important for business owners to put their best foot forward when they apply for credit. Here’s how to position your business in the best possible light on a loan application and negotiate favorable loan terms.
The top tightening measure banks currently are employing is charging premiums on high-risk loans. That measure was mentioned by 20% of respondents to the Federal Reserve’s July 2022 Senior Loan Officer Opinion Survey on Bank Lending Practices. Other tightening measures include raising the cost of credit lines, widening the spread over the bank’s cost of funds and increasing collateral requirements.
In addition, the survey identified the following key reasons for implementing more restrictive lending practices:
Loans officers expect even greater volatility in the second half of 2022. They project borrowers’ debt-servicing capacities could worsen as inflation persists and collateral values fall. However, demand for commercial and industrial loans is expected to remain high, despite rising interest rates and tighter credit practices.
If you need money to grow or maintain your business, it’s important to understand how the loan application process works. It starts with four basic questions:
Your loan officer will also ask about your company’s previous sources of financing. So, you’ll need to explain your business and how it’s been financed to date. This includes your personal cash infusions, forgone salaries and sweat equity, as well as any equity contributions from friends, family members and outside investors.
Banks generally offer two types of financing:
When applying for a loan, lenders want serious borrowers who are invested in their businesses and aware of their financial condition and performance. Don’t go into your lender’s office empty-handed. Instead, bring a comprehensive loan package that includes:
Loan officers have seen all kinds of business plans and financial projections — and they know how to critically evaluate the underlying assumptions. Where possible, support your assumptions with market data and research. It’s important to be realistic about your strengths and market opportunities, while being forthcoming about your weaknesses and potential threats to your growth.
If your lender thinks you’ll make a viable borrower, your application will be given to the bank’s underwriting committee. Underwriters will have greater confidence in your historic and prospective financial statements if they’re prepared by a CPA and conform to U.S. Generally Accepted Accounting Principles (GAAP).
Also, remember that this list is just a starting point. Underwriters may ask for additional information, such as interim financial statements, lease agreements and marketing brochures.
Underwriters don’t approve every loan application, especially when the demand for new loans is high. But don’t give up if one bank turns you down. Ask why the application was denied, fix the problem and try again. Also don’t be afraid to shop around. Viable borrowers could receive multiple offers, allowing them to pick the option with the most favorable terms.
Underwriters will assess the following three key factors when deciding whether to approve or deny your loan application:
Additionally, an owner’s personal credit will be factored into the lending decision for a private business, and the bank will likely require a personal guarantee from the owners. So, expect to share personal financial details and put your personal assets on the line to secure the debt, even if your business is incorporated.
Please contact Mikki Obreja via our online contact form for more information.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.