Navigating the 4 C's of Credit Risk; Is the next perfect storm Coming?
Getting your bearings straight.
To state it simply the 4 C’s of credit are Character, Capacity, Capital, and Conditions. All of these factors are used in the evaluation by a prudent loan officer to develop an extension of credit from a lender to a borrower to reduce the risk of default. Character is the hardest of the factors to accurately measure. Capacity refers the borrower’s ability to repay the loan. Capital evaluation measures the financial strength of the borrower by determining his or her Net Worth. Finally, the economy, national security, and unemployment rates are all Conditions that may affect a borrower’s ability to secure a loan. Therefore the conditions should be more favorable now for securing a loan.
In Irons – to head in the wind and refuse to fall off Character evaluation is the single most difficult measure of a person’s ability to repay a loan. Has the person been bankrupt before, has their car ever been reposed, have they attended college, have they begun to pay back those loans, do they own a home? These are factors that a loan officer must use to determine if a person is of good character for a loan consideration. In my opinion character must be developed at a rather young age. When morals, ethics, and values are instilled in a child, he or she will have the ability to make the tougher choices when they are older.
Waterline -the line along the hull at which a boat floats. Capacity to repay a loan is the second factor in a loan evaluation. How much does the borrower owe, own, and earn? Ten years ago in the October 13th 2008 issue of Time Magazine Niall Ferguson wrote“when families and banks tip into bankruptcy, more assets get dumped on the market driving prices down further and necessitating more deleveraging This process now has so much momentum that even $ 700 billion in taxpayer money may not suffice to stop it.” It was during this time, the financial crisis, that charecter and capacity converged and plunged the stock market, loans defaulted and the economy was on the verge of failure. Ferguson stated the cause “Much of the increase in debt was used to invest in real estate. The result was a bubble….as bubbles always do- it bursts” All of the mortgage telemarketers, Di-Tech commercials and snail mail loan offers in the world will not fix the storm that we have created for ourselves. How will the government fix it, sorry to tell you but they can’t. We have seen that the“Live Now Pay Later” mindset from pre-2008 was really the downfall. Refinance deals positioned the value of the principle mortgage more than the home was worth. Are some people sinking in another mortgage crisis, will they consume more than their boats can safely operate within, are we seeing the same mistakes?
True Wind -the direction and speed of the wind felt when stationary, at anchor or on land. Capital has been for years been based upon the value of one’s home, as collateral. Today though, one’s net worth is really based upon liquid assets, stock, bonds, and securities. It was for that reason that the credit market froze . With a dead housing market of 2008-2014, diminished holdings, the price of gold and cryptocurrency have been perceived as measurements of capital.. Investors have been hungry for opportuntiy and greedy for quick returns which is why the market has been volatile this past year. Smooth and steady calcuations is how the race is won.
Jibing – changing direction with the wind aft; to change from one tack to another by turning the stern through the wind; also spelled gibing. Conditions affected the credit market as does speculation. During the midst of this crisis nn AP Economics Writer quoted Federal Reserve Chairman Ben Bernanke “Only if that is the case, in my view there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery,” we know now that it took 6 years longer than Bernanke expected. Its now been 5 years since the last major finacial crisis. Big banks did not fail, well they did not sink.
What will be the next storm? If we have learned how to navigate and observe the warning signs of the past perfect storm. Hopefully the next crisis will be averted. Will the next crisis be the result of reverse mortgages, a market slide of 20%, decreased value in precious metals, the increase in national debt this past decadeor a combination of all four.
It's now 6 weeks before the mid-term elections. So just when the wind picks up, the seas are getting a little rough, the sails are trimmed and we have a new helmsman, gibe ho. We can continue to hope for the best, but be mindful that a storm is coming in the next two years, one that will change the way we all live, work, and transact. Will you be ready?
So what is the most important thing to remember about the 4 C’s of credit Concerning Consumer Credit- Common Sense
1. Fox, Elizabeth. “BASIC SAILING: Sailing Terms.” 1997. Rutgers University School of Communication
2. Ferguson , Niall. “The End of Prosperity.” Time Magazine 2008: .
3. Jeannine Aversa . “Bernanke: economy suffering ’severe contraction’.” Associated Press
4. Rosland Capital