Capacity, collateral, capital, conditions and character are important points when seeking a loan

When I first started in the banking industry, almost 13 years ago now, I was an intern of sorts, working in that institution’s lending area. One of my responsibilities was to help the commercial loan officers write their credit memos, which basically outlined a loan request and the reasons for approval. A couple years later, I became a credit analyst whose job it was to compile all the data our lending committee and others needed to approve a request put forth by the lenders. Now, as a lending officer myself, I put that past knowledge to use in my own loan approvals and requests.

Through it all, there has been a set of guidelines the very first loan officer I assisted provided me that has always stuck. They were the five Cs of credit, and maybe you’ve heard of them: Capacity, collateral, credit or capital, conditions and character. As I help guide new farmers, new borrowers and transitioning businesses, these have remained my mainstays in decision making.

When a new request crosses my desk, there is a list of documents I ask for to help me make a decision. Typically, they’re financial statements, tax returns, collateral information and sometimes others, depending on the request and the customer.

1. Tax returns and credit bureau reports help determine cash flow or repayment capacity – this is the first “C.” 

Does the customer make enough to cover their debts and living expenses? Bare minimum, this should be a one-to-one ratio: For every dollar going out, there should be a dollar coming in. Many institutions take it a little further and look at a 1.20x base ratio, which provides a cushion should something untoward occur.

2. Secondly, we look at credit, or capital, through balance sheet analysis. How much capital does the borrower have to invest in the project themselves? Current ratios – current assets to current liabilities – and debt to net worth are the main ratios examined. If it is a new business, or a young client with little net worth yet, does it make sense to look at a government guarantee program through the FSA, SBA or USDA to compensate for the lack of capital?

3. Collateral is another guideline. Hopefully, a lender will never have to foreclose, but that is a consideration of a prudent lender. Collateral serves as a secondary source of repayment. This is also why a lender will rarely lend on a piece of collateral’s full value. Aging, wear and tear, and expected discount at foreclosure must all be considered.

4. The fourth test is conditions, otherwise known as an industry analysis. What are commodities markets doing? Is this customer affected by global dynamics, i.e., overseas soybean sales? Does the customer have any experience in this business? When are crops and calves sold? These questions help the lender guide the customer and set up repayment to coincide with sales receipts.

5. Lastly, but perhaps most important, is character. Does the credit bureau indicate a good or poor repayment history? How has the customer handled past adversity? Are there any foreclosures or court cases out there against the customer? How are they viewed in the community, what is their reputation? Just as customers expect to do business with a reputable and honest institution, those institutions have the same expectations of their customers.

To some, whether new to lending or well-seasoned, this may seem like overthinking the situation. But you also take many of the same things under consideration when forming a new relationship, whether it be a new business partnership or investment, changing suppliers, or even switching banks. Remember, it is the job of your loan officer to make sure that you and your agribusiness continue to succeed, and the 5 Cs are just one of the tools that can help ensure that happens.

Jessica Allan is an agricultural lender and commercial relationship manager at Guaranty Bank in Carthage and Neosho, Mo. She may be reached at [email protected]


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