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The 5 Cs of Credit

May 15, 2023

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Co-Written by: Bert Bartle, Opportunity Bank of Montana

If you’ve ever gone to a bank to ask for a loan, your lender more than likely used the 5 Cs of Credit to guide your conversation.

This is a system used by lending institutions to gauge your creditworthiness, evaluate risk, and ultimately set the loan rates and terms. It is important to understand these criteria to better prepare your proposal, provide the necessary information required, and improve your chances of attaining financing.

Bert Bartle, Regional President of Opportunity Bank of Montana in Bozeman, dove into each of these Cs and why they are important, for borrowers and lenders alike.

The Importance of the 5 Cs of Credit

The 5 Cs of Credit are not as cut and dry as you would think. While several of these may appear to reference concrete metrics, our job as lenders is to look beyond those numbers and evaluate the meaning behind them.  We use them to understand the full picture of our borrower and what a partnership may look like.  

The 5 Cs of Credit

Character

Character is really about who the borrower is, their financial or credit history, and their overall trustworthiness and credibility.

We put a lot of emphasis on this area because a borrower’s backstory of where they come from, how they got to where they are, and what they are trying to accomplish can tell us a lot about that person. This is where we may be able to find different opportunities to advocate for our borrower, even when other Cs of Credit are not as strong.

Capacity

Capacity is the area where we start to dive into the numbers and evaluate the borrower’s ability to repay a loan. While all banks do this a bit differently, many use metrics like the Debt-to-Income ratio or Debt Service Coverage to do that.

These metrics may sound intimidating, but it’s not necessarily as much about the numbers themselves as it is the why and how (a.k.a the assumptions) used to get there. It’s important that borrowers know this so they can do research on their own, understand how these numbers might be calculated and what they mean, and be in a good position to talk through them in a proposal.

Capital

This refers to the amount of funds a borrower is willing to put towards a potential project, either of their own cash or from investors, and helps show their level of commitment to the project. Typically, the more capital a borrower can provide, the lower the risk for the bank and the greater the ability to attain financing.

This doesn’t mean you have to be able to provide a specific down payment to get a loan. There are so many programs and resources that exist today to help mitigate a lower capital position and fill in the gaps. While capital can be a large determining factor for a bank, as limited capital position is where the other 4 Cs come into play and your lender may be able to use other stronger areas to balance it out.

Collateral

Collateral refers to those assets that individuals or businesses are willing to pledge to back the loan. In the event of default, the collateral is liquidated to payoff the debt.

Banks often have a difficult time providing a loan without adequate collateral because collateral can be seen as a strong risk mitigant. However, they usually have a lot of flexibility in what that collateral can be. This is another one of those areas that we might look to outside resources to find a way to show their borrower’s commitment and investment into the project.

Conditions

Conditions dictate under what circumstances a bank would be willing to provide a loan. They often look at the overall economy, industry trends, and other contributing factors that impact a borrower’s repayment ability and use those to set up specific terms for the loan.

Like character, conditions can be an area where the bank can compensate for other Cs that may be lacking. Based on the risks of your industry or your proposal, the bank may add additional requirements such as minimum debt service coverage requirements or collateral release covenants.  As market conditions change or your business evolves, those additional requirements may be altered or lifted.

The Bottom Line

While learning about these Cs can sound intimidating, we do not expect borrowers to have all the answers. Instead, we are looking to see if they have the resources and partnerships in place to get those answers so we can work together to find the best solution, for both the borrower and the bank.

Understanding the basics around the 5 Cs of credit and setting up a meeting with your possible lender early on in your project development to discuss them can help you develop a stronger proposal in the end.

For more information about formulating a loan proposal, read our article on “Preparing for ‘Your Ask’”.