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Due diligence drives sound lending

Balance skepticism, curiosity, and awareness

Due diligence drives sound lending

Due diligence is something that all lenders do. But we probably don’t think critically enough about what we’re doing or how we’re really doing it.

Yes, we have to do our independent “look.” But how detailed is that? How dirty do our hands really get in this process?

Those who regularly exercise loan authority know that once in a while there’s a dishonest loan applicant. Lending is based largely on trust, but we also have to verify and double check what we’re told.

Errors and omissions can be honest ones. But both honest errors as well as sins of commission can cost our banks money and erode our own credibility.

When due diligence isn’t diligent enough

I have two war stories illustrative of what I learned about the due diligence process—the hard way.

• Loan request that went bad on the vine

The first case concerns an SBA loan candidate applicant who wanted to borrow money to hydroponically grow tomatoes.

Today hydroponics is a big business, but years back it was new to me when I was banking in Orlando.

The applicant, who was a walk-in, brought along elaborate projections on volumes and costs. Not surprisingly, his story made compelling sense as he told it. But, frankly, I didn’t have a clue.

I eventually, artlessly, turned down the loan by saying, “I’m sorry, I just don’t believe your projections.”

The applicant grew furious.

He retorted, “Then what do you want the projections to say?”  (This is reminiscent of “Turn on the blue lights Charlie, the man wants a blue suit.”)

The would-be tomato farmer created a bit of a scene in the lobby and I wasn’t a very good poker player in those days. It was embarrassing.

What I didn’t understand then is the value of building contacts among banks and business people, folks I could turn to try out the logic of some of the ideas and concepts I was being asked to evaluate.

I could be forgiven for not knowing much about hydroponically growing produce. But of what use am I to the bank or to the community if I have no idea of how to develop an independent understanding of the basic concepts and a base for understanding the economics of the various business loans I was evaluating? 

If I’d paid more attention to this simple concept early on, I’d have made a much better lender at an earlier age.

Metal bender who bent the truth.

The second instance was an applicant who ran a “metal bending” shop in New Jersey. The company was a metal fabricator and there was nothing at all proprietary to the business. But it could be a very lucrative enterprise with repeat business of a high-quality, high-service nature.

The applicant had found his way to us at The Bank of New York through a customer. The proposed deal came to me on the basis of size of the request (not very big) and my significant lack of seniority among the members of the metropolitan lending department.

I was formally trained in accounting and experienced at spreading statements in the bank’s credit department. The basic trick in those days (frankly, I still do it) is to reconcile surplus. If surplus doesn’t reconcile and rounding errors are easy to spot, then there’s a defect in the accounting.

There was a discrepancy in this case, but I didn’t have the smarts, or perhaps the patience, to figure it out—or to obtain the help of someone who could finger the problem more definitively.

Fortunately for me and the bank, the deal never got done. But I wasted a lot of time and energy by being unfocused on the process.

It turned out that the prospective borrower was a flake. Somehow I didn’t tune in on the irony of the man’s nickname: “Zoom.”

Zoom was as apt a name that anyone like him could have appropriately had and I played it like his straight man. We ultimately learned that the man had an unsavory history with a New Jersey lender and finding out such facts is another obvious product of the due diligence process.

Remember what “due diligence” means

The point of due diligence is to evaluate the riskiness of a deal. Due diligence is not just an item on a checklist. Rather, it’s a process to follow on every C of credit—Character, Capacity, Collateral, and Conditions.

Sometimes we get distracted with other Cs of Credit—like Charm and Charisma. But it’s our job to separate the sheep from the goats and to do so efficiently and thoroughly.

In today’s environment, we all work hard at our jobs. If we don’t, we are shunted aside and while we may not necessarily be fired, we’ll never make it to the top.

Due diligence is a definable skill, and one of the hallmarks of really good lenders. But to do it properly and consistently takes a well-developed sense of curiosity.

If you’re not at least curious, then you don’t belong at a lender’s desk.

Curiosity is to some degree inherited, in the DNA, so to speak. It’s also the mark of an inquiring and informed mind. It can be cultivated and enhanced with practice.

Find the middle way

Think about the lenders you’ve known and respected over the years. I’ll bet they all share a short list of attributes. These include being well read, well met, and having an interest in human activity and interrelationships.

These are probably characteristics that are shared by successful people in most any occupation. But in banking, they seem almost universal among the best lenders.

I’ve known bankers who were brilliant conversationalists while others were boring as could be. Neither personality type is necessarily the better banker/lender. Without a healthy curiosity (and the healthier the better), we’re dealing with ordinary people who probably don’t have a lot to teach us.

Paralysis by analysis is the norm in some banks and some of that may be time frittered away. We want men and women who can figure out the essence of opportunities and risks and do so quickly and responsibly.

Pick your own models

If you would learn this business right, go and carefully observe those who seem to ask the right questions. Figure out why they think the way they do.

Be curious, look for incongruities, and be alert to opportunities to confirm what we’re being told as well as to question it.

Yes, skepticism is a necessary part of our business—but only a part. Chronic skeptics don’t usually get many deals done.

It’s time we figured out how to work smarter and not just harder.

Due diligence is probably the best possible place to start.

Ed O’Leary

Banking Exchange Contributing Editor Ed O'Leary, a veteran lender and workout expert, spent nearly 50 years in bank commercial credit and related functions, working with both major banks as well as community banking institutions. His last job before retiring was as the CEO of a regional bank headquartered in Alburquerque, N.M. He earned his workout spurs in the dark days of the 1980s and early 1990s in both oil patch and commercial real estate lending. O'Leary began his banking career at The Bank of New York in 1964, and worked at banks in Florida, Texas, Oklahoma, and New Mexico. He served as a faculty member and thesis advisor at ABA's Stonier Graduate School of Banking for more than two decades, and served as long as a faculty member for ABA's undergraduate and graduate commercial lending schools. Today he works as a consultant and expert witness, and serves as instructor for ABA e-learning courses. You can e-mail him at [email protected]. O'Leary's website can be found at

In mid-2016 O'Leary's "Talking Credit" blog received a bronze excellence award for the Northeastern Region from the American Society of Business Publication Editors.

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