I have often been asked over the years what I look for when analyzing a market loan. While all market loans are not the same and well there is no magic box to decree the fate of a market loan, there are some very easy secrets that all market lenders and credit analysts look for to decree the credit worthiness of a Borrower. One such method, and a great beginning point, is known as the 5 C's of market Lending.
1) Cash Flow - This is the most foremost of the 5 C's as that is how my loan is going to be repaid. Historical cash flow is a good indicator of future cash flow just as the history of anyone is a good indicator of any future event. My Detroit Lions are historically a bad team and indications are that they will be bad in the future. A enterprise that has historically struggled in cash flow often will struggle in the future as that may be an indicator of miss-management, lack of desire for a product, or an excessive number of fixed expenses to name a few. Conversely, strong historical operations often, but not always, bodes well for future earnings. Simple cash flow is often calculated as: Net wage + Depreciation + Amortization + Interest cost divided by 12 months of loan payments on the field loan plus any other debt obligations of the company. The rule of thumb is that this ratio should be 1.20 times or greater.
2) Character- Many banks may have this ranked in a distinct spot, I have all the time felt this was the second most foremost "C" and in some cases equally as foremost as Cash Flow. Character represents the strength, ability and desire of a Guarantor to withhold the debt if called upon to do so. credit history of a Guarantor, like historical cash flow noted above, is a good indicator of a Guarantors propensity to pay. A loan team will look at assets and liabilities of a Guarantor exclusive of the field loan. Moreover, Guarantor's personal cash flow exclusive of the wage derived from the field enterprise is analyzed. These three factors: credit History, Personal Assets, and Personal Cash Flow are vital facets in determining the character of a Guarantor.
3) Collateral - In event of default, collateral is often times the only way a bank can recover some or all of the loan proceeds and hence is commonly the secondary source of refund on a loan (cash flow is first). Collateral can contain a myriad of item such as cash (my favorite), various forms of real estate and land, assets of a enterprise such as accounts receivables, inventory, equipment, vehicles, and many, many other choices. Other than cash, banks will margin the number that they will lend on a type of collateral. For example: for a market apartment complex the b ank may lend 75% of the value versus 50% of the value of inventory. This is the hedge in case the loan goes sideways that may allow the bank to recover most, and hopefully all, of the vital superior on the loan.
4) Capital - A bank is a partner in an attempt with a borrower. The loan officer wants to make sure that a borrower has some skin in the game so as to lose something if they walk away from the loan. Capital is the number of equity or money that is put into a transaction or has been built up by a enterprise through historical profits (retained earnings). The number of equity in or vital retained wage differs based upon the type of market real estate, the situation in the shop (today you need more equity in), or the type enterprise you are lending to. No magic secrets here but a bank should not have to take on all of the risk. Look at the mortgage industry today to see what happens when the Borrowers take no risk - they well can walk away from their house and not lose their down payment, because they never had one!
5) Conditions - This "C" is commonly such things as competition, administration succession, and most importantly today shop conditions which you lend in. Some lenders can well remember to the turning of the century and all concerns over whether businesses were Y2K ready from their computer and operational standpoint. inescapable fellowships were deemed to be more susceptible to Y2K concerns than others. In today's market, inescapable businesses or real estate are more likely to perceive cash flow concerns or failures than others. In my market, fellowships tied to the automotive operations, or Tier 1 suppliers, will likely perceive cash flow concerns and hence should be evaluated tougher when analyzing the credit worthiness of a Borrower.
As noted heretofore, market lending is not done in a box and is not an exact science. Much goes into determining whether a Borrower is credit worthy. distinct banks have distinct criteria but all market banks use the 5 C's of market Lending as a tool to support with that process.
What You Need to Know About the 5 C's of industrial Lending