Making the Most of Asset-Based Field Exams
By Ronald G. Barber
Field exams are conducted for various reasons – to satisfy regulatory requirements, to comply with loan covenants or just to keep the borrower in line. Whatever the reason, the field exam should be approached with the idea of giving the lender the best and most concise information possible.
Prior to getting into any detail as it relates to performing asset-based field exams, we first need to identify the reasons field exams are performed. Many times, field exams are performed to simply satisfy regulatory requirements, current loan covenants or just to keep the borrower in line. Although these may be acceptable reasons, the field exam should be approached with the idea of giving the lender the best and most concise information possible. Using this information, the lender can make sound credit decisions to both protect the collateral, and to minimize potential losses to the financial institution.
Technology Benefiting the Exam Process
Technology plays an important role in the life of an asset-based field examiner. A key tool used in the field by all asset-based field examiners is the laptop computer. Due to the constant changes and updates in spreadsheet programs and various data manipulation programs used in conjunction with asset-based field exams, an examiner’s laptop needs to be replaced frequently (normally every 2-3 years). The laptop must be equipped with the necessary speed and memory availability so the examiner is not slowed during the exam process.
For loans to companies with various sets of books and records or voluminous A/R and A/P agings, data manipulation programs should be utilized. These programs enable the examiner to take a tremendous amount of data and segregate it into useful and understandable information. For instance, what used to take an examiner days to calculate ineligibles when working with a 10,000 page accounts receivable aging, may now only take a few hours. Obviously, proper training must be provided to the examiner for effective use of such programs.
The Internet has become an invaluable tool in many ways for the asset-based field examiner. Information can be retrieved from the borrower prior to the actual start of the field exam to facilitate a timelier completion of the field exam process. Data from remote subsidiary locations can be accessed and transferred via the Internet to save on travel costs and time. While in the field, workpapers and various schedules can be sent to audit managers and others for review. It is very important to ensure the field examiner’s work is reviewed prior to returning to the office. Communication of key or sensitive exam issues can be relayed to various individuals (account officers, relationship managers, audit managers, underwriters, etc.) at the same time ensuring all that need to be informed and updated receive the information in its purest form. There are currently numerous other exam procedures and functions that can and should be completed by the field examiner via use of the Internet.
Technology Hampering the Exam Process
Technology has sometimes made the field examiner’s duties increasingly difficult. With some borrowers implementing more sophisticated accounting systems, the examiner must spend more time fully understanding the general ledger transaction flow. For example, the examiner must ensure they are identifying all dilutive A/R items, including hidden and/or netting accounting transactions. It is easy to hide various entries with some accounting systems. The examiner must not only understand the physical flow of the inventory, but the accounting flow and determine its appropriateness. Unfortunately, the use of technology by a borrower can also be used to hide collateral deficiencies, misstate collateral values and deceive the field examiner and lender. If adequate time is taken and the proper procedures are performed during the due diligence process, an experienced examiner will most likely uncover such problem areas.
Communication, Communication, Communication
Even with the diverse technology available to an asset-based field examiner, a good examiner knows that nothing makes an exam go more smoothly than continual communication. As stated previously, the best exam that can be performed is the one that gives the lender as much information as possible to make a good, sound credit decision. This cannot be accomplished without good communication. Whether you are looking at a new business survey, a recurring exam that has been in the portfolio for years, or a problem credit, communication is a necessity. At the outset of the exam process, communication must be free flowing, Whether you are using an outsource field examination firm or your own internal staff, there must be a clear understanding of what you want the final exam product to look like. Every institution has its own unique culture. Even within the same group, loan officers, underwriters and audit managers may have different needs when it comes to field exam procedures being performed, information being gathered and the report presentation. All of these needs should be communicated to the examiner prior to the start of the field exam process, during the exam and after completion of test work. When using an outsource firm, the audit manager responsible for the engagement should be included in these communications as well.
The examiner must not only understand the physical flow of the inventory, but the accounting flow and determine its appropriateness.
Communication is also important with regard to the borrower. The borrower needs to be made aware of the information to be examined. A required list of information should be sent by the examiner to the borrower prior to the start of the field exam. The importance of having information pulled prior to the arrival of the field examiner should be communicated to the borrower by the lender. The borrower needs to be informed that company personnel should be made available to answer questions and provide requested information during the exam process.
Few lenders have to be told of the increasing competitive environment when it comes to securing new business deals and the challenges of retaining current loans in the portfolio. No matter the situation, borrowers want lower rates, fewer fees and limited constraints – At the same time, lenders want more assurances when it comes to their collateral.
The challenges for the field exam function is performing due diligence exams that have increased procedures, creating more information for the lender, yet taking less time to complete the exam. To some degree, this can be accomplished provided an experienced examiner is equipped with the proper tools and incorporates many of the ideas previously discussed. In short, the examiner must have full access to the latest technology, proper training on the use of manipulation and conversion programs, a clear understanding of the exam priorities through constant communication with loan officers, audit managers and underwriters, knowledge of the loan structure and the exam format being used, and the complete cooperation from the borrower.
More financial institutions are finding it increasingly difficult to hire and maintain a competent, experienced field exam staff. Therefore, many institutions are looking to outsource the field exam function to supplement its own internal staff. Some institutions have had so many problems retaining its own audit staff; they are now outsourcing the entire field exam process. When looking to engage a due diligence firm, there are some key characteristics you will want the outsource firm to have.
- The firm’s field examiners should all have solid accounting and audit backgrounds, coupled with asset-based field exam experience in a multitude of industries. With sufficient industry overlapping, the field examiner will be well prepared to handle the diverse situations encountered while performing an engagement.
- Due diligence field exams should be the firm’s prominent source of business, not a supplement to its core business or used as filler work.
- The firm should have a formal policy in place to ensure its examiners are continually updated on any industry changes and its examiners possess the technical skills needed to perform their assigned engagements.
- Proper firm structure – Every engagement should have a manager assigned to it no matter the experience level of the examiner. The manager on the engagement should be updated frequently on the progress of the exam and should be involved with any problems noted by the examiner during the engagement.
- The firm should promote open communication between all firm members (partners, managers, field examiners and the financial institution (team leaders, loan officers, audit managers, underwriters, members of the deal team). The firm should be viewed as an extension of your own department.
- The firm should be open and flexible to the financial institution’s specific needs. The firm needs to be receptive to both compliments and criticism. This will allow the organizations to work to the common goal of producing a field exam product that is beneficial to the financial institution.
- The firm must have the proper interpersonal skills needed to work effectively with the borrower. Professionalism from both the managerial levels and the field examiners is vital.
Some Things Never Change
Although there are continual changes occurring in the asset-based lending field, there are still many constants when it comes to due diligence field exams. Both the outsource field exam firm and internal exam staffs must remain responsive to the changing needs of the lender. The field examiner must continually remember that no matter how many procedures they perform, there is no guarantee that all defalcations will be uncovered. The examiner must continually be on the look out for things that do not seem right or make sense (auditor intuition) while walking through the borrower’s offices, manufacturing facilities, warehouse, offsite inventory facilities, etc. When the only two choices that a borrower is faced with are going into default on the loan or over reporting its collateral, the borrower will often times choose the latter. Sometimes, the most insightful information the field examiner may procure from the borrower is through conversations with an individual who is not part of the accounting staff (such as the forklift operator in the warehouse. One of the things that continually makes asset-based lending such an interesting field of work, is that no matter what industry you may be lending to, no two borrowers are the same. Every engagement must be approached with this in mind, ensuring that all exam procedures being performed are tailored to the uniqueness of the borrower being examined.