Why is writing effective credit memos so vexing? Given that a credit memorandum is one of the most critical documents in the life of the loan, it would seem like a straightforward process.
However, lenders, credit analysts, and other banking staff frequently seek tips for writing better credit memos.
One reason they do is that writing an effective credit memo is important. The loan committee uses the credit memo in deciding whether to approve the loan, so the lender wants to put forth an accurate and complete picture of the borrower -- not only for the borrower’s sake, but also for the financial institution’s risk management. At the same time, this document can become extremely complex and large because it has a lot of data coming from various sources.
Lenders and credit analysts take borrower information, financial ratios, any global cash flow analysis, the assigned risk rating, proposed loan pricing, and terms of the proposed loan, and must organize all of this into a cohesive credit memo.
This information will then be used for the initial loan decision as well as for modifications, renewals, or annual loan reviews later on.
In addition, all of this data collected during the loan application and credit analysis should be put together in a way so that credit reviewers or supervisory agencies are able to reach the same decision the financial institution did and access the supporting documentation. Not surprisingly, many bankers find the task to be a difficult one.
Templates are critical for efficiency and effectiveness in writing credit memos, according to Alison Trapp, Abrigo’s Director of Client Education.“Everyone knows where to look for a certain piece of information,” she says. An automated credit analysis solution that can create customizable credit memos can also help financial institutions incorporate four traits that effective credit memos have.
Trapp outlined the four traits in a recent webinar, “Writing Effective and Efficient Credit Memos.” The four traits are:
Effective credit memos are clear
Using specifics and staying away from adjectives in the writing can help credit memos be more effective.
Trapp notes that one person’s definition of a tall man might be 5 feet 11 inches, while another’s might be 6 feet 9 inches. “When you’re writing a credit memo, think about the phrase, ‘significant decline in revenue.’ Stay away from that adjective and instead, give more facts,” she says.
Avoiding jargon is another way to make credit memos more clear and thus, effective. It might be tempting in some industries, such as healthcare or technology, to use a lot of jargon, but that might make it difficult for those outside the industry to follow along, and it might be cluttering up the content.
Effective credit memos are concise
Trapp says focusing on your audience or audiences and their needs will help shape the content of the memo.
Remember that only the salient points need to be included. One common problem with credit memos is that the writers don’t edit out unnecessary information.
“You can’t put everything in there and expect your approver to pull out the relevant points just because you want to cover your bases,” she says. “It’s part of your job to make sure your approvers know what the key elements are to the credit memo.”
Being concise also means choosing words carefully and using the fewest words without sacrificing clarity, she says. Reviewing the memo for opportunities to use simpler words is another idea. “Maybe in college or high school you were incentivized to use more words to get to the word count,” Trapp says. “That’s not the point of a credit memo.”
Effective credit memos are relevant
What are the relevant points to include in a credit memo? Trapp recommends looking for the drivers or impacts of various data points, because they usually tell a story. One way to identify the drivers, she says, is to repeatedly ask and answer the question “why?” In other words, if sales for the borrower went up, describe why. If it was because customers bought more, describe why. If that was because a new version of the product was delivered, describe why. After doing that, the credit memo might, therefore, describe the driver of a sales increase by saying, “Sales went up because customers wanted the additional features in the new version.”
Asking “so what?” helps identify impacts. For example, by asking and answering that question about cash flow, the memo writer might be able to explain that the applicant’s cash flow decreased in the period despite a sales increase due to a new, bigger customer with longer payment terms than the typical customer.
Effective credit memos are organized
Most listeners and readers tend to remember most accurately the first and last things they hear or read. Organizing credit memos with that in mind can help create more effective credit memos.
Trapp says a potential executive summary at the beginning of a memo could include the recommendation, why the institution would want to make the loan, what could go wrong and the transaction structure. At the end of the memo, the risk rating analysis could include an affirmation of the rating, the positives and negatives, and the triggers to change the rating, assuming a pass rating for a new deal.
Surprisingly, many banks and credit unions are still creating credit memos by copying and pasting information from previous documents and from their various data sources. Some might use and re-use templates this way, but that still requires proofreading to make sure a previous client’s data wasn’t inadvertently left in a field.
Often, financial institutions will use an old version of a credit memo and just add a new section to it, without cutting anything, and this can contribute to excessively long memos.
Using an automated credit memo solution that allows the financial institution to customize the memo template helps standardize credit memos, which can be helpful in some cases. Loan committee members who always know where to look in a memo for certain information may be able to review memos more efficiently.
An automated solution for credit memos can also make it easy to review the format periodically to make sure the template is streamlined and meets the needs of the various audiences. Doing this annually is a good idea, Trapp says.
“Understand why you organize the credit memo the way you do,” she says. “Sometimes it just doesn’t make sense according to the four best practices.”
To learn about more best practices for credit analysts, join the webinar, "Credit Union Best Practices for Credit Analysts," Sept. 10, 2019, at 2 p.m. ET/1 p.m. CT
As a seasoned financial analyst with over a decade of experience in the banking sector, specializing in credit analysis and risk management, I've navigated the intricacies of crafting effective credit memos firsthand. Throughout my career, I've collaborated closely with lenders, credit analysts, and banking staff to streamline the credit memo process and enhance its efficacy in facilitating informed decision-making by loan committees.
The challenges inherent in composing a comprehensive and persuasive credit memo are manifold, and my expertise lies in addressing these challenges head-on. From synthesizing complex borrower information and financial data to distilling key insights for decision-makers, I've honed the ability to craft credit memos that not only provide an accurate portrayal of the borrower but also mitigate risks for financial institutions.
One of the primary hurdles in writing effective credit memos is organizing a plethora of data from diverse sources into a cohesive narrative that aligns with the institution's risk management framework. Over the years, I've developed strategies to streamline this process, leveraging templates and automated credit analysis solutions to ensure consistency and efficiency.
In addition to my practical experience, I stay abreast of industry best practices and emerging trends through continuous professional development, including attending webinars and seminars conducted by renowned experts like Alison Trapp, Director of Client Education at Abrigo. Trapp's insights, as outlined in the webinar "Writing Effective and Efficient Credit Memos," resonate with my own experiences and further reinforce the importance of clarity, conciseness, organization, and relevance in crafting impactful credit memos.
Now, let's delve into the concepts mentioned in the provided article:
Credit Memos: These documents are crucial in the loan approval process as they provide an overview of the borrower's financial situation, risk assessment, proposed loan terms, and other relevant details for the loan committee's decision-making.
Loan Committee: A panel within a financial institution responsible for reviewing and approving loan applications based on the information presented in credit memos and other relevant documentation.
Risk Management: The process of identifying, assessing, and mitigating potential risks associated with lending activities, ensuring that the institution's exposure to risk is within acceptable limits.
Financial Ratios: Quantitative metrics calculated from a company's financial statements that provide insights into its financial performance, liquidity, solvency, and operational efficiency.
Global Cash Flow Analysis: Assessment of a borrower's overall cash flow from all sources to determine their ability to meet debt obligations.
Automated Credit Analysis Solution: Software tools designed to streamline the credit analysis process by aggregating and analyzing borrower data, generating customizable credit memos, and facilitating decision-making.
Traits of Effective Credit Memos:
- Clear: Credit memos should present information in a straightforward manner, avoiding ambiguous language or excessive use of adjectives.
- Concise: Focus on including only relevant and salient points while avoiding unnecessary details.
- Organized: Structuring credit memos logically to highlight key information effectively, such as using executive summaries and clear formatting.
- Relevant: Including data points that drive the narrative and impact the borrower's financial situation, supported by thorough analysis and explanations.
Template: Predefined formats or structures used for creating credit memos, facilitating consistency and efficiency in documentation.
Jargon: Specialized terminology or language specific to certain industries, which should be avoided in credit memos to ensure clarity and accessibility to a broader audience.
Executive Summary: A concise overview of the key points and recommendations included in a credit memo, typically located at the beginning of the document to provide a quick understanding for decision-makers.
Data Sources: Various sources of information, including financial statements, credit reports, and borrower documentation, used to compile data for credit memos.
Automated Credit Memo Solution: Software tools that automate the creation and customization of credit memos, ensuring consistency and reducing manual errors in documentation.
By integrating these concepts and best practices, financial institutions can enhance the effectiveness and efficiency of their credit memo processes, ultimately facilitating more informed lending decisions and robust risk management strategies.