Back in 2011, our CEO, Ed Lette, wrote about the Five C’s of Lending. Given how important these factors are in the lending process, I thought it would be helpful to look at each one of these areas a little more closely.
The five C’s are generally referred to as – Character, Capacity, Collateral, Capital, and Conditions. Just about everyone in banking or finance learns about these terms early on in his or her career. These are the principles that creditors use to help them make sure that they are making a sound decision in lending money, and that there’s a good possibility for getting repaid in a timely manner. Depending on the circumstances of the arrangement, one or more of these areas may be more important than others. Some criteria is more subjective than others, some may be very clear cut and definitive (a credit score for example), while others may require some very complicated and in-depth number crunching and financial analysis.
The first “C” in our discussion is character. When it comes to banking, character refers to whether a person (and their company) is forthcoming, honest and transparent. This is one of the areas that is more prone to interpretation than some of the other “C’s”. Most lenders look for customers that have paid their previous bills on time, have good relationships with other vendors, and are current with the IRS. This applies to your business as a whole, not just the executives working on the deal.
If a banker asks an associate or another banker down the street about you and his reply is “I know him, we used to play on a softball team together and he is really a good guy (or gal),” will that be enough to check off the character line on your loan application? No. The lender will be more interested in how the owners and management of the business have conducted their operations in the past. Have they paid their bills on time? Are they trusted and respected by their customers and vendors? A banker wants to conduct business with and make loans to people they can trust to act in good faith at all times – in good and bad.
However, that doesn’t mean that your business can’t have experienced hardships before. Economic and industry cycles are just a reality. What is most important is how you handled your business during those tough times. Were you proactive and forthcoming in discussing your problems and how you were going to deal with them? Were you timely in taking corrective actions to address problems? Were you cooperative in providing information in the down times as well as the good? Bankers are often more interested in how you dealt with problems than in whether you had them.
A banker will want to talk with previous business contacts to determine how you and your business have conducted business in the past. When character is being assessed, a banker will not be able to point out a FICO score or a number on a spreadsheet to help explain the outcome of your loan request. To sum it up, character gets down to the issue of people. It’s determined aside from all the other considerations of your business. It boils down to “are the owners and management of your business worthy of the bank’s trust to fulfill the obligations of this loan or line of credit?
We’ll be looking at the other C’s used in lending decisions in upcoming articles. Make sure to check back to learn more about how lending decisions are made.
Gary Green is Sr. Vice President, Business Bank of Texas, N.A.