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Commercial Lending

The 5 Cs of Credit Still Reign

Richard Owens
Aug 10, 2018


In recent years, fintech-style lending has focused a lot of attention on the concept of automated approval of smaller commercial loan requests. While it may seem as though lenders have moved away from the traditional “Five Cs” of credit toward a more digital path, they still reign supreme in the modern age of fintech.

For those of you unfamiliar with the Five Cs concept, perhaps a review is in order. The Five Cs of credit have been part of the fabric of commercial lending for more than five decades.

They are:

  • Character
  • Capacity (Cash Flow)
  • Capital
  • Collateral
  • Conditions

Starting in the early 1990s, large financial institutions began experimenting with automated credit scoring models to shorten approval times on small commercial loan requests. In more recent years, fintech lenders have pushed the science further, deploying fully automated credit scoring models that approve loans in seconds. Despite these technological advances, the Five Cs are still relevant. Let’s examine each as they relate to the current digital environment of automated credit scoring.

Character – While some small dollar loans are currently being approved via a digital-only path, they still consider personal credit score as a key factor in the decisioning process. In fact, it is weighted very highly in most models, and is usually the number one reason for a declined request. While a digital approval process does not afford the lender the opportunity to meet the applicant, the credit score does serve as the primary test of how applicants handle their other obligations. For small businesses, this is essential, since personal finances are often intertwined with the business itself.

Video: Is your LOS focused on the borrower relationship?

Capacity – This is still measured when using a digital path. It is the basis for many fintech lenders who only look at checking account history. They are using a digital means to calculate cash inflow and outflow and to weigh the results against potential credit obligations. In most credit scoring models, going back to the mid-1990’s, debt service coverage calculations also play a key role.

Capital – Traditional business scoring models almost always include leverage ratio calculations as well as some measurement of total owner equity. This may be absent for fintech lenders who are more focused on cash flow. Still, it is possible to construct scoring models that weight this data point heavily. Since this factor is often the subject of credit policy exceptions, it is a necessity to weigh it in every case.

Collateral – Fintech models are primarily focused on cash flow analysis for smaller, unsecured obligations. As the size of the obligation grows, lenders place more reliance on collateral type and value. This is one reason why financial institutions will set a cap on digital approvals. Some institutions may only go as high as $25k before moving to a traditional underwriting standard. Others might go to $100k or higher depending on the model. In almost all cases, though, facilities that exceed $250k will require a higher level of due diligence as it relates to ongoing collateral valuation. This is the point where the personal assets of potential guarantors tend to be stretched, and a reliance on business assets comes into play.

Conditions – When using digital approval methods, conditions are measured using NAICS code analysis as well as independent scores from sources such as Experian or Cortera. Another key data point used is time in business. This data can help determine whether economic conditions within an industry might be detrimental to the proposed facility. They can also be used to catch at-risk industries the financial institution has determined for its credit policy, as well as industrial concentrations.

While the Five Cs are represented in most scoring models and digital approvals, each financial institution must weigh its own risk appetite against its need to offer timely and efficient credit approvals. It’s likely in the years to come that more institutions will begin using some form of fully automated approval, though the size of the facilities approved will vary widely. It’s nice to know that tried-and-true methods such as the Five Cs still play a role.

Please be on the lookout for our upcoming white paper, The Psychology of Credit Risk Management, in mid-August.

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