M&T Bank : Five Cs of Credit
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Understanding the 5 C’s of Credit
By M&T Bank Staff

Do you ever wonder what magic formula the bank uses to evaluate your small business loan application?

Banks have different underwriting formulas, but many applications are evaluated on some version of what is commonly known as “the 5 C’s of credit.” The criteria include: character, capital, capacity, conditions and collateral.

Understanding these 5 C’s of credit puts you in a better position to successfully approach your bank.

Character is a subjective measure of both the borrower’s willingness and ability to repay the loan. This is where your personal credit history, personal financial strength and relevant work experience are evaluated. The importance of the personal credit report of somebody looking to start a business cannot be overstated. Banks use your personal credit history as a measure of character, and a way to understand how reliable an applicant has been in repaying past loans.

Capital is a measure of the borrower’s investment in the business or project as represented on the loan application. This helps the bank determine the borrower’s ability to overcome financial difficulties. Capital can take the form of initial cash infusion, retained earnings, or other assets of the business owner. Bankers tend to look more favorably on small businesses when the owner has made a personal investment.

Capacity is an evaluation of the borrower’s financial capacity to repay the loan. The bank wants to make sure the business will generate enough cash from daily operations to cover loan payments. The best way for the bank to determine capacity is by analyzing the historical cash flow generated by the business.

Conditions are a little more subjective. This is a measure of the overall economic environment. Bankers need to understand how the economic environment affects the company’s ability to repay loans. For example, how would a quick spike in the cost of oil change your expense projections? Your discussions with you banker about your company’s competitive environment is an important part of this analysis. The bank may also compare your company’s performance with peers’ performances. 

Collateral is the safety net commercial lenders rely on if the company cannot repay the loan. While loans are not intended to be repaid by liquidating collateral, lenders must have some recourse in case the borrower is unable to make loan payments.

When lenders examine collateral offered by borrowers, they place a higher reliance on more easily liquidated collateral. For example, a loan fully secured by a CD or savings account is more likely to be granted than a loan secured by obsolete equipment. Remember that lenders are not interested in taking ownership of the items you pledge as collateral. However, your willingness to pledge personal assets as collateral reinforces your commitment to your business.

Banks have different underwriting criteria and certain banks place more emphasis on one criterion over another. But most banks use the 5 C’s of credit somewhere in the evaluation process. By understanding the 5 C’s, you can do a little self-evaluation in order to better position yourself for a successful trip to the bank.

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