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Photo: David W. Coulter, License: N/A, Created: 2015:09:16 14:22:44


By Joe Bonsick

Obtaining a loan from a bank might seem like a complicated, confusing and convoluted process — three “C” words that any business owner looks to avoid.

On the contrary, bankers use a relatively straightforward standard called the “Five Cs of Credit” to determine the creditworthiness of a borrower. Knowing these can help improve a borrower’s chances of getting approved for credit.

The “Five Cs of Credit” are character, capacity, capital, collateral and conditions.

Banks view character as the most vital aspect that a borrower can have. That may seem counterintuitive. After all, character is a subjective measure. It doesn’t have a line on a pro forma or tax return.

But demonstrated character breeds trust. It reflects the reputation and integrity of the business and its management. To assess character, bankers must step out of the electronic world of emails and texts and meet with borrowers face-to-face. They talk with the management team. They talk with community and civic leaders. They might even talk with your employees and customers. Bankers want to know you are true to your commitments and have high ethical standards. In our marketplace, it’s nearly impossible to get a loan without this all-important first “C.”

The next most important “C” is capacity, or the ability to pay back a loan in good time. Capacity is a more objective measure. You can typically determine it from the borrower’s historical financial statements, namely the income statement and statement of cash flows. Bankers will work with you to examine how the loan will affect both your income and your expenses.

Character and capacity are by far the most significant and least flexible of the “Five Cs of Credit.” Generally speaking, if you are cleared in these two areas, you will likely be approved for a loan. The remaining three “Cs” are still important, but often are viewed as being more flexible.

The third “C,” capital, refers to a borrower’s net worth. This is a quantitative measure bankers use as a secondary indicator of financial health. It is used to determine if a borrower is becoming overleveraged or financially strained with too much debt.

The fourth “C,” collateral, is another quantitative measure. Collateral is the asset (or assets) pledged as security for the loan’s repayment. It’s what the bank receives if the loan goes into default.

Collateral, and to some extent capital, are evaluated to protect the bank from financial loss. If the borrower takes off or heads south after the loan is made, the lender still needs to be repaid; after all, it must look after the interests of its depositors and stockholders. Collateral and capital ensure that. Collateral is a backup measure in case the borrower is unable to make the loan payments.

The final “C,” conditions, looks at external forces that could affect the business, both on a micro and macro level. “Conditions” have been receiving more attention since 2007, when the nation’s economy plunged into a recession. In some instances, borrowers were making smart decisions, yet poor economic conditions prohibited them from reaching the financial forecasts on which loans were based.

Since the recession, the banking industry has reassessed the large impact the economy can have on good borrowers and is doing its best to adapt to the post-recession realities.

For many of the Cs, quality financial statements are critical. But equally important is the personal relationship between the business owner or top executives and the bank management.

A strong, long-term relationship can provide unparalleled insight into the borrower’s character. The relationship will provide useful information beyond balance sheets and statements of cash flow, potentially reducing the bank’s perception of risk and increasing the likelihood of approval.

Bankers need to be transparent with their clients, and the “Five Cs of Credit” approach helps borrowers understand where they stand when applying for a loan.

Moreover, knowing the Five Cs up front can compel a borrower to strengthen one or more of them in preparation for a future loan.

A good banker will work closely with potential borrowers far in advance of their application to help them navigate as many of the Cs as possible.

In the end, the Cs are not only good for obtaining credit from a bank, they’re good business practices. A company that’s constantly attuned to character, capacity, capital, collateral and conditions is a company that is fundamentally strong and has a foundation for growth — with or without bank credit.

Consistency is ultimately what each bank strives for, which is why most financial institutions use the “Five Cs of Credit” principle. It provides an easy-to-follow framework for both parties. By sharing this concept, bankers can work more closely with borrowers to achieve the results that both parties desire.