By name: underwriting-analysis description: Credit underwriting analysis patterns for alternative lending. Covers borrower analysis, financial spreading, and risk assessment methodologies.
Underwriting Analysis Skill
Comprehensive credit underwriting methodologies for alternative lending and investment.
Borrower Analysis Framework
Entity Structure Review
Key Questions:
1. What is the legal entity type?
- LLC, Corporation, Partnership, Other
2. Where is it organized?
- State of formation, foreign qualifications
3. Who are the owners?
- Beneficial ownership down to 25%+ holders
4. What is the management structure?
- Officers, managers, board composition
5. Are there related entities?
- Affiliates, subsidiaries, parents
Management Evaluation
Scoring Criteria (1-5 scale):
Experience in Industry:
5 = 15+ years, multiple successful ventures
4 = 10-15 years, proven track record
3 = 5-10 years, some success
2 = 2-5 years, limited track record
1 = <2 years, unproven
Financial Management:
5 = Excellent controls, timely reporting
4 = Good controls, minor issues
3 = Adequate controls, some gaps
2 = Weak controls, reporting issues
1 = Poor controls, unreliable data
Personal Credit:
5 = 750+ FICO, clean history
4 = 700-749 FICO, minor issues
3 = 650-699 FICO, some derogatory
2 = 600-649 FICO, significant issues
1 = <600 FICO, recent bankruptcy/foreclosure
Financial Statement Analysis
Spreading Standards
Income Statement Adjustments:
Revenue Recognition:
- Verify timing of revenue recognition
- Identify non-recurring revenue
- Adjust for related-party transactions
Expense Normalization:
+ Add back owner compensation above market
+ Add back one-time expenses
+ Add back non-cash expenses (if appropriate)
- Subtract understated expenses
- Subtract non-recurring income
= Adjusted EBITDA
Balance Sheet Adjustments:
- Mark assets to fair market value
- Identify related-party receivables/payables
- Verify inventory valuation method
- Assess intangible asset values
- Identify off-balance-sheet liabilities
Key Ratio Analysis
Liquidity Ratios:
Current Ratio = Current Assets / Current Liabilities
Benchmark: >1.5x
Quick Ratio = (Current Assets - Inventory) / Current Liabilities
Benchmark: >1.0x
Cash Ratio = Cash / Current Liabilities
Benchmark: >0.2x
Leverage Ratios:
Debt/Equity = Total Debt / Total Equity
Benchmark: <2.0x
Debt/EBITDA = Total Debt / Adjusted EBITDA
Benchmark: <4.0x
Senior Debt/EBITDA = Senior Debt / Adjusted EBITDA
Benchmark: <3.0x
Coverage Ratios:
DSCR = EBITDA / Total Debt Service
Benchmark: >1.25x
Interest Coverage = EBIT / Interest Expense
Benchmark: >3.0x
Fixed Charge Coverage = (EBITDA - CapEx) / Fixed Charges
Benchmark: >1.15x
Profitability Ratios:
Gross Margin = Gross Profit / Revenue
Industry dependent
EBITDA Margin = EBITDA / Revenue
Cannabis: 15-35%
Net Margin = Net Income / Revenue
Cannabis (post-280E): 5-15%
Cash Flow Analysis
Quality of Cash Flow Assessment:
Cash Flow from Operations (CFO):
- Compare to net income (CFO should approximate NI)
- Identify working capital manipulation
- Assess sustainability of cash generation
Free Cash Flow Quality:
- CFO - CapEx = FCF
- Recurring vs. one-time CapEx
- Maintenance vs. growth CapEx distinction
Cash Burn Analysis (for growth companies):
Monthly Cash Burn = (Beginning Cash - Ending Cash) / Months
Runway = Current Cash / Monthly Burn
Minimum: 12 months runway for new loans
Risk Assessment Methodology
Credit Risk Matrix
| | Low Impact | Medium Impact | High Impact |
|--------------|------------|---------------|-------------|
| High Prob | Monitor | Mitigate | DECLINE |
| Medium Prob | Accept | Monitor | Mitigate |
| Low Prob | Accept | Accept | Monitor |
Risk Categories to Assess:
1. Credit/Financial Risk
2. Industry/Market Risk
3. Operational Risk
4. Regulatory Risk
5. Key Person Risk
6. Collateral Risk
7. Legal/Documentation Risk
Industry Risk Assessment
Cannabis Industry Risk Factors:
Regulatory Risk (HIGH):
- Federal illegality
- State licensing requirements
- Banking access limitations
- Tax implications (280E)
Market Risk (MEDIUM-HIGH):
- Price compression
- Oversupply in mature markets
- Competition from unlicensed operators
- Consumer preference shifts
Operational Risk (MEDIUM):
- Product recalls
- Crop failures
- Employee theft
- Compliance violations
Mitigation Strategies:
- Diversified state exposure
- License renewal monitoring
- Enhanced reporting requirements
- Cash management controls
- Third-party compliance audits
Collateral Risk Analysis
Collateral Quality Assessment:
Accounts Receivable:
Quality Factors:
- Age of receivables (% current vs. aged)
- Debtor credit quality
- Concentration risk
- Historical collection rates
- Dispute/offset exposure
Inventory:
Quality Factors:
- Turnover rate
- Obsolescence risk
- Storage conditions
- Market price volatility
- Regulatory compliance
Equipment:
Quality Factors:
- Age and condition
- Useful life remaining
- Specialized vs. general purpose
- Secondary market liquidity
- Maintenance history
Advance Rate Adjustment:
Base Rate: X%
- Concentration adjustment: (X%)
- Age adjustment: (X%)
- Quality adjustment: +/- X%
= Adjusted Advance Rate: X%
Underwriting Decision Framework
Credit Score Calculation
def calculate_credit_score(factors: dict) -> float:
"""
Calculate weighted credit score.
Weights should sum to 100.
"""
weights = {
'management': 15,
'industry': 15,
'financial_performance': 25,
'cash_flow': 20,
'collateral': 15,
'guarantor': 10
}
score = sum(
factors[factor] * weights[factor] / 100
for factor in weights
)
return score # Range: 1.0 - 5.0
Decision Matrix
Score Range | Decision | Conditions
------------|----------|------------
4.5 - 5.0 | Approve | Standard terms
4.0 - 4.4 | Approve | Enhanced monitoring
3.5 - 3.9 | Conditional | Structure enhancements required
3.0 - 3.4 | Committee | Requires credit committee approval
2.5 - 2.9 | Decline | Unless significant mitigants
< 2.5 | Decline | Hard decline
Structure Enhancement Options
For Borderline Credits (Score 3.0-4.0):
Pricing Enhancements:
- Higher interest rate (+200-500 bps)
- Larger origination fee (+0.5-2.0%)
- Minimum interest provisions
Structural Enhancements:
- Lower advance rates (-10-20%)
- Additional collateral requirements
- Stronger guarantor requirements
- More restrictive covenants
- Shorter loan term
- Faster amortization
Monitoring Enhancements:
- More frequent reporting
- Field exams/audits
- Lockbox arrangements
- Reserve requirements
Due Diligence Checklist
Complete Package Requirements
Borrower Information:
- [ ] Application and summary
- [ ] Organizational documents
- [ ] Good standing certificates
- [ ] Ownership/beneficial ownership
- [ ] Management bios/resumes
- [ ] Business plan (if applicable)
Financial Information:
- [ ] 3 years financial statements
- [ ] 3 years tax returns
- [ ] Current year-to-date financials
- [ ] Projections (3-5 years)
- [ ] Accounts receivable aging
- [ ] Accounts payable aging
- [ ] Inventory reports
- [ ] Bank statements (12 months)
Collateral Information:
- [ ] Asset schedules
- [ ] Appraisals/valuations
- [ ] Title reports
- [ ] Environmental reports
- [ ] UCC search results
- [ ] Insurance certificates
Third-Party Reports:
- [ ] Background checks
- [ ] Credit reports (business and personal)
- [ ] Reference checks
- [ ] Site visit report
- [ ] Independent market analysis
Red Flags Checklist
Immediate Concerns (Require Explanation):
- [ ] Declining revenue trend
- [ ] Negative or declining EBITDA
- [ ] DSCR below 1.0x
- [ ] Recent management changes
- [ ] Legal or regulatory issues
- [ ] Tax liens or judgments
- [ ] Related-party transactions
- [ ] Guarantor credit issues
- [ ] Inconsistencies in financials
- [ ] Resistance to providing information
Deal Breakers (Likely Decline):
- [ ] Fraud indicators
- [ ] Active litigation (material)
- [ ] License suspension/revocation
- [ ] Recent bankruptcy
- [ ] Federal violations (cannabis)
- [ ] Criminal background (principals)
- [ ] Negative net worth
- [ ] Cash flow insufficient for debt service