Don’t Get Stung…

October 01, 2008 ABF Journal

In these challenging economic times, financial institutions must be more vigilant than ever before. If Bear Stearns and Lehman Brothers have taught us anything, every financial institution is at risk from a portfolio of bad loans. This recent experience has made it crystal clear that smaller finance companies must be even more attentive to customer selection and management in order to avoid future problems. Simple techniques can help minimize the risk of a bad financial relationship and avoid common pitfalls and problematic client conduct.

Initial Due Diligence

As a result of the fallout of the subprime loan market, the financial industry will undoubtedly strive to improve the client intake process by requiring, among other things, greater fact gathering from new borrowers. The best and most detail-oriented client intake process will do nothing if lenders employing it do not take a more discerning approach regarding who they want as clients. In this highly competitive industry and tight monetary supply, all too often the desire to close a transaction results in turning a sharper eye away from certain red flags of potential trouble.

One of the biggest pitfalls is what can be characterized as the free-agent Client. This is the type of client who has worked with a number of different financial institutions over a short period of time before coming to you. Although it is not uncommon for a borrower to shop around for better terms, hopping from one potential lender to another over a short period of time may be indicative of a borrower who can never be satisfied or one that may have improper motives. Indeed, these may be clients that are shopping for less scrutinizing lenders so that they can literally "take the money and run." Such red-flag raising conduct is all the more reason for heightened due diligence.

Putting aside the "standard" due diligence documents that a borrower must complete as part of any transaction, the age of instant information has provided financial institutions with a plethora of resources to conduct additional due diligence through publicly available resources. All federal courts (including bankruptcy courts) and many state courts, for example, make information publicly available over the Internet. Alternatively, there are services that you can use that will assimilate this information into one report similar to what you can obtain about the corporate world from Dunn & BradstreetSM.

In either case, you can search by company or individual name to determine whether your potential borrower or its principals are or have been the subject of litigation or bankruptcy. These research tools generally come with relatively little to no real costs because, among other things, you do not need to hire anyone with an advanced degree to conduct such inquiries. The breadth of publicly available information is limited only by the imagination of the person conducting the search; the days of blind reliance on the representations of a borrower are no more. Opting against performing a simple public records inquiry only exposes you to a borrower who may have a checkered past.

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