| I have often been asked over the years what I look | | | | and land, assets of a company such as accounts |
| for when analyzing a commercial loan. While all | | | | receivables, inventory, equipment, vehicles, and many, |
| commercial loans are not the same and certainly there | | | | many other choices. Other than cash, banks will margin |
| is no magic box to decide the fate of a commercial | | | | the amount that they will lend on a type of collateral. |
| loan, there are some very easy secrets that all | | | | For example: for a commercial apartment complex the |
| commercial lenders and credit analysts look for to | | | | b ank may lend 75% of the value versus 50% of the |
| determine the credit worthiness of a Borrower. One | | | | value of inventory. This is the hedge in case the loan |
| such method, and a great starting point, is known as | | | | goes sideways that may allow the bank to recover |
| the 5 C's of Commercial Lending. | | | | most, and hopefully all, of the principal outstanding on |
| 1) CASH FLOW - This is the most important of the 5 | | | | the loan. |
| C's as that is how my loan is going to be repaid. | | | | 4) CAPITAL - A bank is a partner in an endeavor with |
| Historical cash flow is a good indicator of future cash | | | | a borrower. The loan officer wants to make sure that |
| flow just as the history of anything is a good indicator | | | | a borrower has some skin in the game so as to lose |
| of any future event. My Detroit Lions are historically a | | | | something if they walk away from the loan. Capital is |
| bad team and indications are that they will be bad in | | | | the amount of equity or money that is put into a |
| the future. A company that has historically struggled in | | | | transaction or has been built up by a company through |
| cash flow often will struggle in the future as that may | | | | historical profits (retained earnings). The amount of |
| be an indicator of miss-management, lack of desire for | | | | equity in or necessary retained earnings differs based |
| a product, or an excessive amount of fixed expenses | | | | upon the type of commercial real estate, the situation |
| to name a few. Conversely, strong historical operations | | | | in the market (today you need more equity in), or the |
| often, but not always, bodes well for future earnings. | | | | type company you are lending to. No magic secrets |
| Simple cash flow is often calculated as: Net Income + | | | | here but a bank should not have to take on all of the |
| Depreciation + Amortization + Interest Expense divided | | | | risk. Look at the mortgage industry today to see what |
| by 12 months of loan payments on the subject loan | | | | happens when the Borrowers take no risk - they |
| plus any other debt obligations of the company. The | | | | easily can walk away from their house and not lose |
| rule of thumb is that this ratio should be 1.20 times or | | | | their down payment, because they never had one! |
| greater. | | | | 5) CONDITIONS - This "C" is usually such things as |
| 2) CHARACTER- Many banks may have this ranked | | | | competition, management succession, and most |
| in a different spot, I have always felt this was the | | | | importantly today market conditions which you lend in. |
| second most important "C" and in some cases equally | | | | Some lenders can easily remember to the turning of |
| as important as Cash Flow. Character represents the | | | | the century and all concerns over whether businesses |
| strength, ability and desire of a Guarantor to support | | | | were Y2K ready from their computer and operational |
| the debt if called upon to do so. Credit history of a | | | | standpoint. Certain companies were deemed to be |
| Guarantor, like historical cash flow noted above, is a | | | | more susceptible to Y2K concerns than others. In |
| good indicator of a Guarantors propensity to pay. A | | | | today's market, certain businesses or real estate are |
| loan team will look at assets and liabilities of a | | | | more likely to experience cash flow concerns or |
| Guarantor exclusive of the subject loan. Moreover, | | | | failures than others. In my market, companies tied to |
| Guarantor's personal cash flow exclusive of the | | | | the automotive operations, or Tier 1 suppliers, will likely |
| income derived from the subject business is analyzed. | | | | experience cash flow concerns and hence should be |
| These three factors: Credit History, Personal Assets, | | | | evaluated tougher when analyzing the credit |
| and Personal Cash Flow are essential facets in | | | | worthiness of a Borrower. |
| determining the character of a Guarantor. | | | | As noted heretofore, commercial lending is not done in |
| 3) COLLATERAL - In event of default, collateral is | | | | a box and is not an exact science. Much goes into |
| often times the only way a bank can recover some or | | | | determining whether a Borrower is credit worthy. |
| all of the loan proceeds and hence is usually the | | | | Different banks have different criteria but all |
| secondary source of repayment on a loan (cash flow | | | | commercial banks use the 5 C's of Commercial |
| is first). Collateral can comprise a myriad of item such | | | | Lending as a tool to assist with that process. |
| as cash (my favorite), various forms of real estate | | | | |