Bar Napkin Analysis for Member Business Loans

As a CUSO that helps smaller Credit Unions with the startup of their Member Business Lending departments, after drafting a loan policy, the next thing I hear is ‘What now?’ This is a loaded question, because every member and his or her request is going to be different, but there are some basic steps that you can follow to help you determine the credit worthiness of a member’s request before too much time is wasted.

Step 1: Don’t start out quoting rates!! Starting out quoting rates before you know the details of the loan request is setting yourself up for failure. First, a member that is shopping for the best rate isn’t likely to be with your Credit Union for the long haul. Smart business owners know that there is value to a good relationship with their lenders, and if that comes down to an extra .5% on a loan, they will be willing to pay it. If they walk, you will likely see them back in a year when they find out their bargain basement interest rate wasn’t all it cracked up to be. Second, interest rates should be reflective of the structure and general risk of the loan. Quoting the same interest rate for a 5-year single family residential rental loan as a 12-month term line of credit that is tied to a borrowing base makes no sense. The latter is going to require significantly more time to monitor and service, and inherently carries more risk.

Step 2: Have your member complete an application. Pactola’s website,, has applications available to download for both commercial and agricultural loans, and each include a complete checklist of the items that your member will need to provide. These items will get you started on your bar napkin analysis of the credit request. If your credit union is a subscriber of Pactola, shoot us an email with your logo and we can get these applications customized for your Credit Union as well.

Step 3: Evaluate the collateral. Depending on your Credit Union’s loan policy, you will want to evaluate the collateral to make sure it is within your loan policy’s limits and is readily marketable. If it is equipment, do you need to discount the estimated value due to age or condition? You will then want to look at the maximum loan term, amortization, and LTV your policy will allow. Let your member know these terms so they know how much equity they will need to bring to the deal, and that those terms are how you will initially analyze the loan, but are not guaranteed. These terms are relatively fluid until closing.

Step 4: Time to analyze. Now that you have received the historical (or proforma, if a start-up) financials on the business, it’s time to analyze. Ideally, the primary source of cash flow is going to come from the gross revenues of the business. This can be rental income, sales of goods, cattle sales, etc., but this is how we want our debt to get repaid. Starting with the Net Income, add back any Depreciation expense, Interest expense, and Amortization expense. You have now calculated the business’s Net Operating Income (NOI), or EBIDA. This is the cash the business has to service its debt. Again, this is a bar napkin analysis just for you to see if there is merit to the request; these calculations can get much more complicated depending on the business. You will then calculate the estimated Debt Service Coverage Ratio, or DSCR, which is the NOI divided by the proposed debt service. Ideally, you want to see this above a 1.20x. If they are in that gray area of 1.10x and 1.20x, it may be worth looking at further; however, if it is below the 1.10x level the primary source of cash flow starts to be put into question.

Step 5: Look at the Guarantor’s resources. The secondary source of cash flow after the business revenue is likely going to be your guarantors’ cash flow and resources. Do they have a strong equity position or are they highly leveraged? Do they have liquidity to help supplement any cash flow shortages? What are their assets? Do they have diverse income sources, or are they solely reliant on the business for cash flow? Although a full personal tax return spread is not necessary at this stage of evaluation, you can usually get a good feel of the guarantor strength by answering these questions. Having a strong guarantor to backstop a loan is especially important when the cash flow from the business is weak or erratic.

Step 6: Underwriting. Once you have a signed term sheet and all of the necessary items from your borrower, it’s time to dive into underwriting. Business loans are evaluated based on the 5 C’s of Credit: Character, Capacity, Capital, Collateral, and Conditions. If you have a new business lending department or just don’t have enough staff resources to do underwriting in house, Pactola can act as your third-party underwriter.

Whether your Credit Union is just starting its member business lending department or you have found yourself struggling with initially evaluating a loan request, these steps can help get a good conversation going with your member and prevent wasted time on poor requests. Pactola is here to help in making your lending department great!