Know Your Borrower

September 29, 2017
Martha Lehman
SmithAmundsen Financial Services Alert



In the 1980s, President Ronald Reagan introduced the American population to the concept of “trust, but verify.” President Reagan was actually quoting an old Russian proverb, useful during his negotiations with Mikhail Gorbachev. While the phrase created great political theater for Reagan, the catchphrase can readily be applied to financial services, providing a road map of sorts for loan officers and credit committees who are considering new credits.

 As part of the due diligence process, a lender will frequently request a large amount of documentation from a prospective borrower. This documentation includes internal financial statements, audited financial statements, tax returns, and personal financial statements from either the organization’s principals or any guarantors. While tax returns and audited financial statements can have certain indicia of real liability (although they are not always free from error), personal financial statements present unique challenges.

If the borrower defaults, a workout officer – acting in conjunction with outside counsel – frequently pours through personal financial statements, looking for assets available to satisfy the debt and/or fraudulent statements, which can be used to pursue a principal or a guarantor. Finding assets available to help satisfy the debt is a victory of sorts; however, pursuing a fraud claim can be cold comfort.Investigate documents

This is where “trust, but verify” can be applied. Loan officers would be well advised to trust, but verify when reviewing personal financial statements. Here are several frequent areas which can lead to problems:

Obviously, asking some of these questions during the loan intake process could inspire a potential borrower or guarantor to clean up any issues. On balance, understanding the true picture of the guarantor’s financial health, presents the lending institution with the opportunity to verify the information, while trusting that the credit will work out to the benefit of both parties.