The 6Cs Banks Consider When Reviewing Your Loan Application

Here’s the hard truth: applying for a business loan or line of credit from a bank right now is difficult. Knowing the 6Cs that banks consider when reviewing your loan application can make the process a lot smoother.

We are not in usual circumstances. The criteria that banks use to consider your loan application is now more stringent than ever. Some banks are even only lending to clients they know.

Before you submit your application, review these 6C’s that lenders typically use to assess whether or not your business is credit-worthy. They are:

#1.  Capacity

#2. Character

#3. Capital

#4. Collateral

#5. Conditions

#6. Communication

Granted that every bank has their own assessment process and every business’s situation is unique, here is some general insight into how banks are assessing clients during this time.

#1. Capacity: Your ability to repay bills as well as the loan

Bankers typically collect a financial package from the borrower which can include – 2-3 years of business tax returns, year to date financial statements, accounts receivable & accounts payable reports, personal financial statements and a business debt schedule. These numbers give them a strong understanding of historical performance, trends and a client’s ability to repay the proposed debt.

Normally, they want the borrower to have at least $1.25 in cash for every $1 borrowed. This is called a debt service ratio. However considering the COVID-19 pandemic, bankers will most likely lend to clients who have a much larger cushion than this.

#2. Character: Work experience, industry experience and personal credit history

The biggest determinant of character is a business owner’s or majority stakeholder’s personal credit history.  It’s a good indicator of how you will treat your business obligations. Most lenders do a hard inquiry to get your credit profile and FICO credit score. Your FICO score is determined by five differently weighted categories:

§ 35% Payment History – consistent, timely payments; no delinquencies.

§ 30% Credit Utilization – measured individually by revolving account and across multiple revolving accounts.

§ 15% Average Length of Credit History – the length of time each account has been open divided by total number of accounts.

§ 10% New Credit – opening too many new credit lines at the same time indicate financial trouble.

§ 10% Credit Mix – historically, borrowers with a good mix of revolving credit and installment loans or other forms of credit represent less lending risk.

TIP: If you plan to access debt to fund your business, check and proactively manage your personal credit profile and score. Go to annualcreditreport.com at least once a year for a free credit report from TransUnion, Equifax and Experian.

Your company’s credit is just as important as your personal credit standing. It takes about 10 years to build a business’s credit record that’s independent of the owner. When your business has a strong credit record, you are more likely to:

§ Borrow from lenders at favorable rates

§ Receive better terms from suppliers

§ Secure a loan without giving a personal guarantee

If you are establishing business credit for the first time, check out this article for 8 steps to establish your business credit.

Another big character issue that has become even more important during COVID-19 is discretion. When the government approved the CARES ACT and PPP loan funds became available through banks, business owners flooded banker’s voicemails and call centers with all kinds of questions and follow ups because there was very little guidance coming from the SBA.

Bankers also had little guidance but still had to field client calls. A few banker friends said they received 10x their usual number of client-calls. They had to make conscious decisions about helping a client who had not yet been helped vs. a client who had already called 20 times.

Yes, we as small business owners can feel like fishes out of water in a sea of unknowns. But by overcalling or panic calling, you are signaling fear and implying that your business is in a high risk or desperate situation. Banks don’t prefer to lend to clients that have a high probability of little to no repayment, so use a bit of discretion when reaching out for information. Maybe reach out once a week or every other week instead of everyday. Your banker will likely be more responsive.

#3. Capital: What’s in it for you?

Lenders want to know if the owner/majority owner has “skin in the game” with a personal investment in the business.  This makes complete sense.  Think about it. Would you invest in a business or idea if the owner or person presenting the idea hasn’t invested in it? I think not.

#4. Collateral: The ability to provide valuable collateral assets

Loan terms and rates can be improved if you have valuable assets such as equipment, real estate or accounts receivable that can be used to secure financing.

In addition, lenders will consider how much outstanding debt is already attached to that collateral. Right now, real estate serves as valuable collateral. But, as more people continue working from home, the need for commercial spaces may decline. It will be interesting to see what collateral becomes most valuable in the future.

#5. Conditions: External factors

The state of the economy, industry trends and pending legislation relative to your business are all external factors that can affect a business’s ability to repay lenders.

COVID-19 is a the perfect example of an external factor. Given the impact of this pandemic on different industries and business types, bankers are requesting business updates more often than ever from their clients. Expect to speak to your banker at least once or twice a month.

#6. Communication: A two-way relationship

Lenders want to ensure a strong two-way relationship with their borrowers. This is especially important if your business is not doing well during a crisis and is at risk of default. A banker will likely make regular calls to check in and find out the status of your loan. If an owner does not cooperate and is unresponsive, it could trigger proceedings to call the debt.

One of the first indicators a banker uses to gauge how communicative a client will be is the client’s level of responsiveness during the initial application period. Bankers often lament about having to wait many weeks to receive financial documents from business owners because the owners are waiting for their CPAs to prepare the financial information.

If businesses had a financial expert like The Art of Money Matters on their team to make sure the financials were complete, up to date and readily accessible, they would be prepared to submit a loan application in no time. It is much easier to optimize your loan application according to the 6Cs that banks consider when you have a financial expert on your team.

We update and review our clients’ numbers on a regular basis so they know how their business is doing, can make important business decisions and take action (e.g. access credit from a bank) quickly. Having a virtual CFO on your internal team to respond quickly to lender’s requests is integral to increase your chances of being approved for a loan. If you have been in business for a while and you’re now preparing to apply for a loan, contact us to walk you through the process.