Besides being a great family movie for the holidays, “It’s a Wonderful Life” appeals to me in a loan geek sort of way. Central to the story is the near failure of George Bailey’s building and loan business. I began my lending career in 1989 at Sacramento Savings Bank, and while the business of lending money had changed dramatically since the 1940’s one key characteristic still remained at that time – Savings and Loans and other small community banks still lent money directly from their vaults (customer’s savings accounts) to local residents they knew.
The key words were “local” and “knew.” These lending institutions only lent money on real estate within a small geographical radius around their bank branches – therefore their loan officers and managers understood the local real estate market and trends. Often times they even knew the borrower directly, or maybe their employer, or the CPA that prepared the borrower’s tax returns. In other words they could make much more subjective decisions about borrowers due to this intimate knowledge of the borrower’s “four C’s.”
Lending professionals that began their careers before the early 2000’s were carefully taught the “four C’s” in lending - Capacity, Credit, Capital and Collateral. The newer generations of loan originators have too frequently been taught to just “throw it against the wall and see what sticks.” I’m not exaggerating – I know this from direct feedback from Underwriters who review everything the loan officer does.
- Capacity – Does the applicant have the ability to repay the loan?
- Character (substituted with “Credit” in more recent years) – Does this borrower honor their debts? Do they walk away from obligations or do whatever is necessary to repay the debt?
- Capital – How much savings does the borrower have to invest in the property? What liquid reserves do they have to cover the mortgage payment and other obligations if there is an interruption in earned income?
- Collateral – Does the home being financed meet minimum standards of habitability and is the value sufficient to secure the debt?
I vividly remember one conversation with my manager at the S&L that explicitly demonstrated the use of the four C’s. One of our customers had been denied for a loan at one of the big banks due to the fact he was unemployed and had been for a few months. Hence his “capacity” was temporarily zero. My manager reviewed the file and said to “approve it, and add $30,000 in cash to help him get through the next few months.” The extra cash we gave this borrower was sufficient to carry him for at least 6 months. He had zero late payments on his credit report because he’d been drawing down savings to cover them, and the total loan was going to be less than 50% of the home’s appraised value. We knew the borrower’s neighborhood and knew it to be a good location.
In other words, it was extremely unlikely this loan would go into default, and even if it did the bank was sufficiently protected by the large equity position. My manager was adamant this was a worthy borrower and the circumstances made sense.
That loan wouldn’t be made today – at least not by an institutional lender. The “building and loan” companies are virtually extinct, and with rare exceptions all lenders now follow a rigid set of guidelines. Lenders now use money from all over the world to fund loans instead of the money in their vaults.
There’s really no turning back the clock on the switch from local lending to global based funding sources. We don’t put enough money into savings accounts for banks to be able to fund all the necessary real estate loans. Recent news reports have indicated some of the major players don’t even have enough capital reserves to support their current operations let alone additional lending.
The global transfer of excess savings to fund loans across the county is a necessary function. However, with that comes the difficulty of determining the “four C’s” of a borrower and a property that may be a continent away from the lender.