Jeff Judy

Jeff's Thoughts - October 12 , 2011

Why Character Matters

Looking for the ultimate "put down" when you are in a heated argument with another banker? Try calling them a "character lender."

Many in our industry are almost embarrassed that "Character" remains in the list of "C's of Credit" at most institutions. Oh, sure, the borrower's character was a key decision factor back in the bad old days, before we knew better, but since then, we have discovered that we like other "C's" a whole lot more.

Some banks operate on the principle that if they can find enough Collateral to support the credit, they can reduce the risk to almost nothing. It rarely works out that way (as I discussed in a recent series of articles in this e-zine), but, of course, "at least it's not character lending."

At other banks Cash flow is the C that matters. They generally evolve credit staff who become expert at fudging the spread sheets to "get it to flow," when doing credit analysis.

The reason we teach multiple "C's of Credit" is that no one of them will do the job. If it was misguided to rely almost exclusively on Character in the bad old days, it is just as misguided to replace Character with something else.

Even in institutions that rely on multiple C's, however, there is a tendency, these days, to pretend that Character is not among them. That's a mistake on two levels.

First of all, Character does matter. Just look at our own industry: how many of the problems rippling through our economy, how many of the meltdowns we have seen in recent years, ultimately come back to Character issues?

And given two borrowers who are similar in collateral and cash flow and other factors, doesn't it make sense to go with the one where you have more confidence in the borrower's character? From deliberate fraud to simple mismanagement, character does play a role in any business's success.

The second reason that we need to look explicitly at character is because we implicitly rely on it to some extent. In other words, we are all "Character Lenders" to a degree. We work a little harder to strike a deal with the borrowers we trust more, the ones we feel comfortable with, the ones we think are telling us a straight story. We make judgments about their willingness to do the careful and arduous work of creating a sound business plan and faithfully executing it. We are more likely to say "yes" to a borrower we believe will carry out promises, abide by covenants, and respond to questions, all of which are character assessments.

Every bank has had a bad experience with a borrower who showed great numbers during the credit analysis process. When you wonder if the numbers are too good to be true, that's really a character question.

And it's one you should answer. We do not want to go back to the days when character was, for many banks, by far the most influential factor in a loan decision.

We just want to recognize that in the end, a credit decision is a judgment, and the more realistic we are about the factors that go into that judgment, the better decisions we are likely to make.