Credit Evaluation Process
Posted by Derek O'Doherty on 16th August 2017
At Linked Finance, we understand that the long-term success of a platform like ours depends heavily on our lenders being able to make attractive and steady returns.
To achieve this, and to ensure we continue offering an attractive way to make your money work harder, we believe it’s paramount to our long term success that we comprehensively, consistently and accurately measure the creditworthiness of each loan application we receive before a loan is launched on the platform.
While all lenders understand that there is a level of risk involved in any form of lending, and that some defaults are to be expected individually and through an economic cycle, we work very hard to minimise the default rate and maximise the returns our lenders earn.
With this mutual goal in mind, we have developed a comprehensive credit evaluation process for lending to Irish SME’s which ensures we minimise the time it takes to process an application, but still ensures we accurately reflect the creditworthiness of any business who makes it on to the Linked Finance platform.
Our success in this area is well demonstrated by our low default rate, which was holding steady at 0.86% as of Q2 2017.
Generating a Linked Finance Credit Grade
As all lenders will know, we provide a short form Profit & Loss and Balance Sheet for each potential borrower such that you can get a snapshot of the financial results and the health of the business
However, we also conduct a detailed and comprehensive credit analysis of each loan application in order to derive a credit score and credit grade.
Due to a number of data protection, confidentiality and IP factors, we do not publish every aspect of the scoring and grading system. But to help lenders understand what goes on under the bonnet, we’ve outlined below a summary of each step of the credit analysis process…
The Linked Finance Credit Process
- Initial Application: This process usually starts with a business owner completing a 2-minute form online or talking to a member of our team. They provide Business Name, Annual Revenue, Years Trading, Loan Amount requested and contact information.
- Minimum Criteria: On receipt, we check that the business meets our minimum criteria for turnover levels and the numbers of years trading.
- Documentation: If the business ticks the necessary boxes, we ask the business owner to provide the most recent set of financial accounts, the last 6 months bank statements, and the most recent tax clearance certificate – this is what we call the Initial Information.
- Initial Analysis: The Initial Information is then input into our credit template. The model evaluates over 30 qualitiative and quantitative metrics and more than 200 key data points from the information provided in order to generate a LF Credit Score between 1 and 100.
- Scoring and Pricing the Credit Risk: The score is weighted heavily towards the debt servicing ability of the business, which is measured using a combination of standard credit scoring metrics such as the level of existing debt or financial obligations laying claim to the cash flows of the business (either secured or unsecured), but also a detailed analysis of the credit balances within the bank account, other monthly creditor payments and monthly and seasonal cash balances etc. Whilst this is not summarised for lenders, it is crucial to the overall credit score. The model also analyses a number of wider metrics such as exposure to Brexit, working capital indicators, management assessment etc. to derive the final score.
- 3rd Party Checks: We will also use third-party resources to verify personal information, the ownership structure of the business, the credit history and to check for any previous judgements or liquidiations, which are also factored in to the final score.
- Further Information: Our credit team may request additional information (such as an accountant’s reference, recent management accounts, copies of key contracts etc.) and/or discuss queries from the initial analysis with the borrower, their accountant or their financial advisor, so as to complete the credit template and generate a final credit score.
- Credit Commitee: Depending on the final score or any other exceptional aspect to the business, the loan application may be brought to the LF Credit Committee. The credit committee meets daily to discuss any loan requests which warrant additional discussion. This process is designed to ensure we debate the salient points as soon as we can, so as to generate a decision for the prospective borrower as quickly as possible.
- Loan Offer: Following the final analysis, or the decision of the Credit Commitee as required, if the application gets a sufficient score then a loan offer is made. Too low a score and the loan request will be declined with the applicant being informed as to the key reasons why.
- Continuious Upgrading: the current credit template is the seventh iteration of the original model used by Linked Finance in 2013, and it is constantly being amended and upgraded due to macroeconomic factors and changing market conditions. For example, a Brexit metric was introduced over the past year to measure Irish SME’s exposure to the UK market etc. We will continue to evolve this model to ensure that it remains a highly effective way to assess the creditworthiness of Irish SMEs.
Depending on the final score derived, a credit grade is awarded. Until recently these were A, B, C, D, E or Y. Following the introduction of new rates on 12th September 2017, an A+ grade will now be shown. This will be reserved for the very top tier of those loan requests which would have previously been awarded the A grade.
Borrower & Sector Caps
It should be noted that our credit evaluation process looks at each loan request on a case by case basis. As such, if a borrower is requesting their second or third loan, we will incorproate the existing debt into the credit score and may introduce a borrower cap if we believe it is warranted.
Similarly, we regularly monitor our exposure across all sectors of the economy and at times have introduced limits to the % exposure of the entire portfolio to a specific sector, so as to protect the overall default rate on the book.
Quick but Disciplined Lending
Whilst we are delighted to have completed our 1,000th SME loan recently, we are just as happy that our credit evaluation process is continuing to ensure low default rates.
Essentially, the loan requests we decline are just as important as those 1,000 loans we have completed.
We have invested a lot in developing a rigorous yet responsive credit decision process. We are happy that we have a very robust method for identifying creditworthy businesses, and we can do all of this in a fast and friendly way that business owners appreciate.
While we are committed to providing Irish SMEs with a fast, fair and afforable source of finance, our overriding pricincipal when evaluating loan requests is, and always will be, providing our lenders with the opportunity to make fair returns by lending to creditworthy local companies.
Topics: P2P Lending