The C's of Good and Bad Credit Analysis

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October 30 2012 23:39
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1. The Ten Commandments of Commercial Credit: The 'Cs' of Good and Bad Loans

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The Ten Commandments of Commercial Credit: The 'Cs' of Good and Bad Loans

Author: Golden, Sam; Walker, Harry M

Publication info: The RMA Journal 94. 9 (Jun 2012): 42-46,13.

http://search.proquest.com/docview/1039695514?accountid=27932

Abstract: One of the first things examiners and lenders learn is the Five Cs of Credit. They are the tried-and-true rules of good loan making, consisting of character, capacity, conditions, capital, and collateral. The Five Cs represent the "Thou shalt" commandments of lending, the core of sound commercial banking. Then there are the Five Cs of Bad Credit: complacency, carelessness, communication, contingencies, and competition. These are the "Thou shalt not" commandments. Only by following the Five Cs of Good Credit and the Five Cs of Bad Credit can bankers be sure of not falling into the same traps that have tripped them up for years.

Full Text: Headnote This article first appeared in the January 1993 issue of The Journal of Commercial Lending, forerunner of The RMA Journal. The authors, in their introduction, stated their eagerness for bankers "to learn from the problems of the past few years; for unless bankers learn from history, they will be doomed to repeat it." In the following article, they add their current views, noting that "the relevance and applicability of what we outlined in the 1993 article remain unchanged." One of the first things examiners and lenders learn is the Five Cs of Credit. They are the tried-and-true rules of good loan making, consisting of character, capacity, conditions, capital, and collateral. The Five Cs represent the "Thou shalt" commandments of lending, the core of sound commercial banking.

The Traditional Five Cs of Credit
I
Character
Thou shalt make sure that the company or person you are lending to is of upstanding character. Bankers want to get some sense of how their borrowers will react once times get tough. They hope to never find out how the borrower will respond to a real emergency, but if they have favorably assessed the borrower's character, at least they have some sense of assurance. Character also includes such traits as honor and trustworthiness. II

Capacity
Thou shalt be sure that the company you are lending to has the capacity to repay the loan. If a company is not making money or generating a positive cash flow, odds are there will not be enough money to pay offits debt. Remember, bankers are in the business of getting repaid for the loans they make. III

Conditions
Thou shalt underwrite all loans with the understanding that business and economic conditions can and will change. Bankers cannot predict the future, but being alert will allow the bank to react to deteriorations in the market quickly, rather than reacting at the bottom of a downturn. IV

Capital
Thou shalt make sure that the company borrowing money is adequately capitalized. This provides a cushion for any losses that may occur and helps keep the bank from ending up in bankruptcy court, haggling over the remains of a dead company.

V
Collateral
Thou shalt make sure that collateral does not drive lending decisions.Credit factors should always be the primary consideration. Having a tangible (that is, "seizable") asset backing up each deal (collateral) means that if something goes wrong, the bank is covered. But if asset values fall, as they have in real estate, it means that banks move into the real estate management business. The Five Cs of Bad Credit

The Five Cs of Credit should be thought of as commandments: Do this, check...
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