RETIRE ON TRACK: Can you trust your bonds? Understand the 'Four Cs' of credit (2024)
In last week’s column I showed how to gauge the risk of changing interest rates on your fixed income holdings. Broadly speaking, I showed how falling interest rates are good for bond prices and vice-versa, if everything else stays the same.
But that’s only part of what drives bond prices. They’re also driven by the market’s perception of the bond’s safety. Companies with growing cash flow and low debt are more likely to repay their loans, while companies with falling sales, growing costs and high debt are more prone to default on their bonds or, worse, go bankrupt.
Luckily for us, we don’t need to be bond wizards to know if our bonds are crazy risky. Credit rating agencies like Moody’s and Standard &Poor’s grade bonds for creditworthiness. Agencies each have their own rating scales, divided roughly into three categories: default, speculative and investment grade. Speculative bonds, otherwise known as “high yield” or “junk,” are best left to experts.
The agencies evaluate bonds on four dimensions, but they’re equally handy if your brother in law asks to borrow money from you, too, so let’s have a look.
Bond analysts and investors want to know borrowers will be able to make the required payments over the life of a loan. Mortgages may be for thirty years. Some corporations, such as Disney, have issued “century bonds” that will repay the original principal in 100 years. Before loaning anyone your hard-earned money, remember the 'Four Cs' of credit: character, collateral, covenantsand, the most important, capacity.
Character refers to the borrower’s willingness to repay the loan as originally agreed. President Putin’s threat to pay dollar denominated Russian bonds in depressed Russian rubles made it clear Russia regards adhering to its financial obligations as optional. Though Russia has, so far, made good on its payments, its character is now questionable simply by issuing the threat.
Collateral is what a lender can recoup if a borrower defaults on a loan. Just as someone who takes out a mortgage pledges the property as collateral, corporations may pledge factories as collateral for their bonds. Though borrowers usually just want their interest and principal on time, ample collateral can make a loan to a teetering company far safer.
Covenants list the requirements borrowers need to follow for them to avoid default. A bond covenant might prevent a company from borrowing more money until the firm has grown beyond some point or issuing any new debt that must be repaid before the original debt.
Capacity is the borrower’s financial ability to make payments and repay principal. Companies need cash flow to pay lenders back. Firms with shrinking income, rising costs and a big debt burden are risky. That’s true of your brother-in-law, too. The old days of “neither a borrower nor a lender be” have been replaced by “letting your money work for you instead of you working forever.” Just make sure your money is safe while it works, or at least is getting paid well enough for the risk.
Evan R. Guido is the founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or eguido@aksalawealth.com.Read more of his insights atheraldtribune.com/business. Securities offered through Avantax Investment ServicesSM, member FINRA, SIPC.Investment advisory services offered through Avantax Advisory ServicesSM, insurance services offered through an Avantax affiliated insurance agency.8225 Natures Way, Suite 119, Lakewood Ranch, FL34202.
The criteria often fall into several categories, which are collectively referred to as the five Cs. To ensure the best credit terms, lenders must consider their credit character, capacity to make payments, collateral on hand, capital available for up-front deposits, and conditions prevalent in the market.
Capacity refers to the borrower's ability to pay back a loan. This is one of a creditor's most important considerations when lending money. However, different creditors measure this ability in different ways.
This review process is based on a review of five key factors that predict the probability of a borrower defaulting on his debt. Called the five Cs of credit, they include capacity, capital, conditions, character, and collateral.
Some corporations, such as Disney, have issued “century bonds” that will repay the original principal in 100 years. Before loaning anyone your hard-earned money, remember the 'Four Cs' of credit: character, collateral, covenants and, the most important, capacity.
Do you know what they are? Communication, collaboration, critical thinking, and creativity are considered the four c's and are all skills that are needed in order to succeed in today's world.
Students classify those characteristics based on the three C's of credit (capacity, character, and collateral), assess the riskiness of lending to that individual based on these characteristics, and then decide whether or not to approve or deny the loan request.
Capital. While your household income is expected to be the primary source of repayment, capital represents the savings, investments, and other assets that can help repay the loan.
Mark owns his own house with a monthly mortgage payment of $1,200. He also has a car payment of $600. He has no other debt payments since he pays off his credit cards every month. If Mark earns $8,000 each month, his DTI is ( $1,200 + $600 ) / $8,000 = $1,800 / $8,000 = 0.225 = 22.5 percent.
1. Character. Character refers to your credit history, or how you've managed debt in the past. You start developing that credit history when you take out credit cards and loans.
Capacity includes the ability to pay current financial commitments, repay any new debt, provide for replacement allowances, make payments for family living and maintain reserves for adversity. One key factor in determining whether an applicant has the capacity for the loan is sufficient cash flow into the business.
A quadruple bond is a type of chemical bond between two atoms involving eight electrons. This bond is an extension of the more familiar types double bonds and triple bonds.
Character refers to the borrower's reputation. Capacity refers to the borrower's ability to repay a loan. Capital refers to the borrower's assets. The lenders want to know if the borrower's assets could be used to repay credit debts if income is unavailable.
The three main types of credit are revolving credit, installment, and open credit. Credit enables people to purchase goods or services using borrowed money. The lender expects to receive the payment back with extra money (called interest) after a certain amount of time.
Although ranges vary depending on the credit scoring model, generally credit scores from 580 to 669 are considered fair; 670 to 739 are considered good; 740 to 799 are considered very good; and 800 and up are considered excellent.
“While every lender has their own approach to making lending decisions, credit data — often represented by the FICO score — is likely to be a bigger driver of the approval decision,” Dornhelm says. But he notes that your income still has a pivotal part in the approval process.
* Collateral--If you fail to repay the loan, is there something of value that you agree to forfeit? For example, if you're buying your first car, it would be collateral to ensure that you will repay the loan. If you default, you lose the car. * Capital (accumulation)--What are you worth?
What is Conditional Sale? A Conditional Sale (CS) agreement is similar to Hire Purchase (HP). These are different from ordinary credit agreements because under CS and HP agreements you do not own the car until you have paid off the agreement.
An underwriter can deny a home loan for a multitude of reasons, including a low credit score, a change in employment status or a high debt-to-income (DTI) ratio. If they deny your loan application, legally, they have to provide you with a disclosure letter that explains why.
There are many different forms of credit. Common examples include car loans, mortgages, personal loans, and lines of credit. Essentially, when the bank or other financial institution makes a loan, it "credits" money to the borrower, who must pay it back at a future date.
Concept 86: Four Cs (Capacity, Collateral, Covenants, and Character) of Traditional Credit Analysis. The components of traditional credit analysis are known as the 4 Cs: Capacity: The ability of the borrower to make interest and principal payments on time.
Students classify those characteristics based on the three C's of credit (capacity, character, and collateral), assess the riskiness of lending to that individual based on these characteristics, and then decide whether or not to approve or deny the loan request.
* Collateral--If you fail to repay the loan, is there something of value that you agree to forfeit? For example, if you're buying your first car, it would be collateral to ensure that you will repay the loan. If you default, you lose the car. * Capital (accumulation)--What are you worth?
A comprehensive credit risk management program will address at least four areas: (i) establishing an appropriate credit risk environment; (ii) operating under a sound credit-granting process; (iii) maintaining an appropriate credit administration, measurement, and monitoring process; and (iv) ensuring adequate controls ...
The types of collateral that lenders commonly accept include cars—only if they are paid off in full—bank savings deposits, and investment accounts. Retirement accounts are not usually accepted as collateral. You also may use future paychecks as collateral for very short-term loans, and not just from payday lenders.
In lending, collateral is typically defined as an asset that a borrower uses to secure a loan. Collateral can take the form of a physical asset, such as a car or home. Or it could be a financial asset, like investments or cash. Lenders may require collateral for certain loans to minimize their risk.
Lenders ask for collateral while lending, as a security for the loans they give to the borrower. They keep it as an asset until the loan is repaid. Collateral is an asset or form of physical wealth that the borrower owns like house, livestock, vehicle etc.
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