Sometimes an institution will get into the habit of doing whatever is necessary to bring in the business. This is most often seen with loan officers who are on an incentive program that has no qualifier for credit quality or loan profitability. It is also common with financial institutions that are opening up new business lines and believe they need to “buy” the business. The areas that are most often compromised are (1) price and (2) loan covenants and structure.
The price issue can come with an abnormally low rate inherent to the risk associated with the credit. An example is taking a higher risk credit facility, such as a revolving line of credit for a manufacturer, and pricing it similar to what you may an auto loan, which traditionally has a lower amount of risk. It can also come in the form of locking in a rate for a longer time frame than the risk associated with the cost of funds. An example of this would be locking in a rate for a year on a revolving line of credit. The cost of funds on those draws can change every day, and you do not know if your margin will remain intact. Other concessions on prices come with closing loans with no financial compensation to the institution for its time in underwriting, documenting, and booking the loan. In some cases, institutions may even pay for third party costs associated with the loan on behalf of the borrower.
So is there any case that justifies a price concession? Sure there is. But the lender should go into the situation with a strong case as to why prices were lowered to do the loan, and make sure the concession makes financial sense.
Covenant concessions can be even more dangerous than price concessions. This is where the lender will deviate from standard covenants on a loan in order to just get the deal. Some examples of compromised covenants could be accepting a DSCR that is below your standards for the type of credit, allowing collateral (such as in a line of credit) to be sold and not require funds repaid to the loan, or accepting a highly leveraged company as an acceptable credit when this would not normally be done so. I would contend that each covenant concession should have a mitigating factor defined that explains why the increased risk for the covenant waiver is OK.
It is also a double-whammy when both price and covenant concessions are done only to win the business. If that is the only way you can win the business, why would you want to do that? It does give you the reputation of being both cheap and easy. Last time I checked, those are not good qualities to look for in people! The problem with being cheap is that there will eventually be some fool who will undercut your rate. If your borrower is willing to leave for 0.005% of savings, just how loyal is he to you? The problem with covenant concessions occurs if the performance of the company or farmer deteriorates into a problem credit status. The first question that would be asked by an auditor or regulator is why such low credit standards were accepted and championed in the requirements just to get the business? In this case, the deal may become so bad that a “greater fool” may not be able to be found to offload the loan.
I contend that a long term strategy of price and covenant concessions is not the way to grow your commercial portfolio. You must move to a place where these issues can be taken off the negotiation table. You cannot beat Walmart, nor do I know many institutions whose goal is to become Walmart and compete solely on price. Some bank that is bigger will eventually beat you.
When I think of good covenants, I think of my Aunt Lill. Lill was a gardener. Once, when I was just a lad, I asked her why she took so much time putting stakes and cages around her tomatoes. It seemed like such a waste of time to me. She showed me that if she just left the tomatoes grow on the ground, she could only plant one plant in the same space that she could plant five with good cages. The tomatoes on the ground also grew wild and tended to rot easier, and more of the critters under the ground would get to them. Her tomato yields were down substantially.
In the same way, good covenants are just like tomato cages, allowing the company to grow with structure and understand how the lender views and manages risk. This also allows the institution to grow with more loans to more institutions. The large loan that is un-covenanted is like the un-caged tomatoes. They will cost more time and money, hindering you from growing your portfolio.
I always say that you know you have won the relationship when the borrower comes to you for advice that does not immediately involve a financing request. The time this happens is when the borrower views you as what your goal is to become, a trusted financial advisor. Again, the ultimate goal for the lender is to become the trusted financial advisor to the client.
When you look for an attorney, doctor, accountant, or investment broker, you do not look for the cheapest and easiest. You want the best. You want someone who will make you better. In the same way, once you become a trusted financial advisor, your good clients will come back to you, because they realize you make them better by being your member or customer.