The Case for the 7 Cs of Credit


This is an essay by Dennis West, past-president of Northern Initiatives, that is still oh-so-relevant.

As long as I have been involved in this field, there are some guideposts for underwriting.  When you are fairly young, the five Cs of credit are etched into how you think about lending.

The five Cs are cash, credit, collateral, capacity and character.  Underlying each is an objective way to assess a customer and an underlying prediction about their success.

Five Cs of Credit

Capital – Indicates your level of seriousness. What you have personally invested in the company.

Condition – The purpose and details of your loan.

Capacity – How you plan of to repay the loan.

Collateral – A form of security that guarantees repayment.

Character – A look at your credit history, demonstrated responsibility and the integrity of your actions.

For financial institutions these 5 Cs help thread the line of risk, where they have a fiduciary responsibility to depositors and shareholders to assess the amount of risk that is acceptable.  Should they cross that line, they will have regulators, Boards of Directors and shareholders all pulling to bring them back into line.  Losses therefore tend to be less than one half of one percent among regulated financial institutions.

Our world revolves around the same five Cs, we want to know credit scores, what collateral is available, and how much equity can be offered.  These Cs tend to be “cleaner” when one is dealing with people who have means, or family members of friends of means, or “God bless the child that’s got his/her own.”

Why 7 Cs  – It’s Not About Math, It’s About Human Opportunity

However, here is an observation, a community’s entrepreneurial potential is not confined to the limits of those who have means.  A community’s entrepreneurial character is a matter of who participates and how do we as lenders assess those who have the attitude and aptitude to succeed.  So, what that means is to go along with the science of underwriting a Community Development Financial Institution, must also have lenders accustomed to the “art” of the work.  For us, that means that there are seven Cs the five mentioned before, and courage and compassion.

Why the latter two?  We deal in and among the real disparities born of our history.  One disparity is that the average amount of wealth held by white families versus Blacks and Latinos is substantial (over ten times). Another disparity until the last decade was the preponderance of men owned versus women owned businesses. These disparities are historical, but the factors of inheritance make it more likely that those who have will perpetuate.  As Michael Sherraden pointed out in his book, Assets and the Poor, a family who has wealth is able to pass it along from one generation to the next, where a family in poverty passes along their poverty.

Inheritance is not always a clear path.  Anyone who has experienced the need to have a parent get access to Medicaid knows that assets must be liquidated, leaving nothing to be inherited.  Anyone who lives in a declining community also knows that assets held in a home losing value are depreciating assets. There is also data that shows that 60% of American workers have experienced wage flattening since the 1980’s.  The point is, that a long history of wealth disparities, when laws and systems actively discriminated against minorities and failed working class families, making underwriting for many a challenge beyond the view of the five Cs.

Generally speaking, we are going to look at many deals with prospective customers whose credit scores are below or well below 700, do not have 20% equity and do not have the ability to meet collateral requirements exceeding the value of the loan.  And, to leave this group out, undermines that ability to have an “entrepreneurial community,” since attitude and aptitude are not reserved to persons of means.

Compassion and Courage

That brings us to compassion and courage.  A commercial lender is trained in the science of underwriting while those who come over to the Community Development Financial Institutions field, employ the art of underwriting.  That art means:

  • Sometimes taking the time to understand why a credit score that can be sub 600 or even sub 500 is not a disqualifier.
  • It means understanding that not everyone has secondary collateral to pledge and so doing the best that you can, given that which is available.
  • It means that when equity is lacking, you need to employ a structure that supports that reality.
  • It means talking to customers to tease out their goals and ambitions to test sales assumptions, understanding of costs and viably assessing attitude and aptitude.

It is the art of this work, that is about getting it right.  When we get it right we extend opportunity.  We help to overcome disparities and to make communities more entrepreneurial.  The art is the courage and compassion to understand the story and advocate for the customer before work peers and loan committees.  The courage and compassion also sits at times on the side of telling people that they are not ready, and a business loan will not support their meeting of their family needs.

Sometimes there is talk of how do you scale small business lending and I think that is difficult because I don’t think that you can have algorithms for courage and compassion.  And if I am right, then the aim is efficiency because it is not a math problem, it is a human opportunity.

Dennis West, Past President, Northern Initiatives

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