The 3 Cs of Commercial Credit

Banks and other lending institutions make sure that each credit officer knows the three Cs of lending. It’s important to know the criteria for commercial credit and the role it plays in funding a business loan.

The 3 Cs summarize the elements that the financier uses to underwrite the loan. This technique of assessing the client comprises both qualitative and quantitative measures.

Character

This is the most important of the three. It refers to the borrower’s reputation. The shareholders who are going to guarantee the loan and the management of the business will all come under scrutiny to determine if they are reliable and will repay the funds.

• The lender will usually look at the credit history of the business owner to gauge honesty and reliability. Considerations may include:
• Whether or not they pay bills on time
• Whether or not they’ve used credit before
• How long they’ve been in business, and what positions they held before starting the business
• How long they’ve lived at their respective addresses

Lenders might also look at the credit scores of the principals of your business. This score is numeric, typically between 300 and 850, gleaned from the info in your credit report. High scorers generally have a lower risk. Each lender has its own standards, but many of them use credit scores to assist them in making their evaluations. It all depends on the level of risk they find suitable for a particular credit product.

Credit scores are weighted as follows: 35 percent payment history, 30 percent amount owed, 15 percent length of credit history, 10 percent new credit, and 10 percent types of credit in use. Around 60 percent of people have credit scores of 700 or more. A person is considered a secure risk at 720, and can usually obtain a loan at a low-interest rate without trouble.

Collateral

Savings, real estate, inventory, accounts receivable, and equipment are the asset classes of the borrowers that fall under the umbrella of collateral. These assets help to secure the loan.

The lender is concerned only with these asset classes, because in the event of insolvency, they can be sold or collected to generate funds to pay the loan. Since in the experience of most lenders asset classes such as prepaid amounts, goodwill, and investments will not raise any significant amounts, they are generally not considered for collateral.

Commercial lenders will place a lot of weight on the loan-to-value ratio, just like with residential loans. Collateral is especially important for private lenders. If you’re using a property as collateral, its location and quality, and its adaptability are some of the features your future lender will look at.

The bank wants the loan amount to be surpassed by the amount of the business’s collateral in most cases.

Capacity

Most commercial credit officers refer to capacity as cash flow, and it represents the ability of the company to repay debt. Since a big down payment will reduce the risk of default, the lender will consider any capital the borrower puts into a potential investment. In short, the lender is looking at how much debt the borrower can comfortably handle. The following are usually requested from the borrower in order for the lender to evaluate cash flow/debt service:

• Business tax returns
• Historical financials, such as the balance sheet and profit & loss statements, interim financials, and/or projections
• Personal financial statements for each guarantor
• Rent rolls for leased property

Your business may not have the required capacity in kind, but it could be latent and hidden in another form. For example, your business plan might be solid, and you may have a clear blueprint as to how you’re going to achieve success. Imagine refusing a loan to a startup that has the potential to become a world dominator like Amazon or Uber. You, therefore, should not worry if your startup doesn’t yet meet all the criteria of the three C’s. Once you locate a lender who believes in your ideas, you will still be able to procure financing.

Beyond the 3 C’s

There is one other element that will come into play when lenders are evaluating who will get a loan and who will not. That element is how much business you will bring to that lender. Someone who will be sending out a large number of SWIFT (wire) transfers, setting up a merchant account to take credit and debit card payments, and using instruments such as letters of credit will be more attractive to the lender. Remember, lenders are businesses like any other, and they may even be willing to overlook some elements of the 3 C’s if they think you will contribute significantly to their profits.