WELL BEFORE THIS latest economic crisis, bankers have employed The Five Cs of Credit as an analytical tool to evaluate their borrowers' willingness and ability to repay their obligations. The Five Cs are character, capacity, capital, conditions, and collateral, and four of them--capacity, capital, conditions, and collateral--measure ability to repay
It is the fifth C, character, that assesses willingness to repay, and borrowers are not equal in this area because some are weak at the outset and others weaken under adversity. (1) Playwright Oscar Wilde admitted, "The only way to get rid of temptation is to yield to it .... I can resist everything but temptation." The German philosopher Goethe advised, "You can easily judge the character of a man by how he treats those who can do nothing for him." And Abe Lincoln observed, "Nearly all men can stand adversity, but if you want to test a man's character, give him power."
So how do we ensure that our borrower's character is not undercut by the temptation of power, money, or personal aggrandizement? Is an ounce of prevention against temptation worth the pound of cure for the consequences?
Character: Able and Willing?
Character can be defined as the combination of mental and ethical traits marking and often individualizing a person, group, or nation. Its synonyms include decency, dignity, nobility, quality, reputation, worth, honesty, and integrity. (2)
Typically ranked first among The Five Cs in evaluating creditworthiness, character is a banker's judgment of a borrower's willingness to pay. Unfortunately, a borrower's resolve and determination to repay is often tested by hard times, poor business conditions, declining revenues, falling income, and cash shortages. The other Cs have their places, but if the borrower is tentative or hesitant in his promise to repay the debt, the lender is taking a risk at the outset of the credit extension so great that the other Cs are unlikely to mitigate it.
History is replete with examples of broken promises: Nazi Germany invaded the Soviet Union in 1942, despite Hitler and Stalin's 1939 Nonaggression Pact. Henry II imprisoned his wife Eleanor of Aquitaine for 16 years, from 1173 to 1189, for failing to love, honor, and obey him, especially after she supported their son Henry's revolt against him. Imperial disregard for promises seems to be an occupational hazard, and Napoleon summed it up royally: "If you wish to be a success in the world, promise everything, deliver nothing."
These examples of how power tends to undermine character suggest that bankers ought to expand character analysis to include a review of which controls a borrower has in place to remove temptation and shield the firm and its employees from other corruptive influences. The borrower may be willing to honor the firm's obligations, but in order to preserve the value the borrower puts on reputation, honesty, and integrity, it may be necessary to help others in the firm stay resolute.
Questions of Character: Don't Count Them Out
One way to communicate the importance of character to the bank's evaluation of creditworthiness is to tactfully integrate the following 12 questions into the loan interview or search for the answers through secondary sources and references.
1. Financial information: Is the firm or its principals unwilling to provide financial information?
2. Support from the principals: Are the principals unwilling to offer personal guarantees, provide collateral, or accept any conditions or covenants?
3. References: Are the principals unwilling or unable to provide references from colleagues, competitors, suppliers, lenders, customers, lawyers, accountants, etc.?
4. Communication: Are verbal, phone, or electronic communications difficult to establish and maintain? Does the borrower pass on only good news and pass over bad news? …