The credit cycle: origination to workout — Credit Module 2

Every loan, regardless of size, follows the same life cycle inside a lending institution. Different banks call the stages different things, but the structure is universal. Understanding the full cycle is the difference between a credit analyst who can underwrite and one who can also recover a loan when it goes wrong — and they're different muscles.

The six stages

Origination: customer requests a loan or a relationship manager pitches one. Application captured.
Underwriting: credit analyst evaluates risk, runs models, recommends terms or rejection. Sometimes splits into pre-screen (low effort) and full underwriting (high effort).
Approval: credit committee or designated approver signs off. For larger amounts, this involves multiple levels of approval and often a board credit committee.
Disbursement: the loan is documented (covenants, security agreements, guarantees), funded, and the customer receives the money.
Servicing and monitoring: payments collected, financial covenants tested quarterly, customer's business monitored for deterioration.
Collection or workout: if the loan goes sideways, recovery activities begin. Mild delinquency goes to collections; serious distress goes to workout.

Where each stage typically fails

text

Stage          Common failure                                    Cost
────────────────────────────────────────────────────────────────────────
Origination    Misrepresentation by borrower at application       High
Underwriting   Optimistic forecast; wrong industry view            Highest
Approval       Pressure from RM to approve marginal credits        High
Disbursement   Bad documentation; missed security perfection       Medium
Servicing      Late detection of covenant breach                   Medium
Collection     Wasted effort on non-recoverable accounts            Low

Most credit losses (~70%) trace back to underwriting decisions made years before the loan defaulted. Servicing rarely creates losses on its own.

The 'lookback' culture

Mature banks do a 'lookback' on every defaulted loan: was there evidence at underwriting that this would default? If yes, the underwriter is held accountable; if no, the credit policy is updated. Junior banks blame the borrower and move on. Lookbacks are how lending organisations learn — and the absence of a lookback culture is a major leading indicator of future credit problems.

Information loss between stages

The relationship manager who originates knows things about the borrower that don't end up in the application file. The underwriter sees the file but never meets the customer. The collections officer who calls about a missed payment three years later has neither the relationship nor the file. Every handoff loses context. The best lending shops have systems that capture qualitative judgements (relationship history, character observations, industry context) and surface them at every later stage.

Where to look first in any credit

If you're handed a non-performing loan and asked 'how did we get here?', go to the original credit memo from underwriting. Read it. The answer is almost always in what was missing — the optimistic projection that didn't have a downside case, the covenant that should have been tighter, the industry assumption that didn't acknowledge a known risk. The fix for the next loan is in those gaps.

Exercise

A bank has just written off KES 200m on a single corporate loan that defaulted after 18 months. The relationship manager argues it was an act of God (industry downturn). The collections team argues the borrower hid information. What additional evidence would you ask for to decide where the actual failure was?