A bank has received an application for an INR 30 lakh home loan from an individual. Another bank has received an application for the issuance of a credit card. A non-banking lending institution has been approached by a firm for a loan of INR 1 crore for expansion purposes. A Credit Rating agency is deciding which of Country A and Country B is more creditworthy.
What is common between all these? A Credit Analyst will be required to work on each of these cases to find out if it’s safe to lend/issue credit (cards) to these entities.
Credit Analysis entails researching and analyzing the debt profile and debt servicing abilities of individuals, companies or even sovereigns (i.e. countries). A Credit Analyst, therefore, is someone who finds out the creditworthiness of an entity (either an individual or company or country) depending on the demands of the situation. In the case of issuing loans, companies / individual borrowers are appraised to see if they have the ability to service the debt and also if it is safe to give out the loan. In the case of a credit card application, income streams and previous defaults etc. will be analyzed. In the case of countries, although more complex to analyze, the end result is the same – an assessment of risk – also called a ‘Credit Rating’. Below is a chart with rating categories used by 3 leading global Credit Rating Agencies.
Credit Analysts are hired across several types of firms:
1. Commercial Banks: These firms need to assess the risk involved in lending debt or issuing credit cards. They may check credit scores of borrowing individuals or scrutinize a company’s books to understand the credit risk.
2. Credit Rating agencies: These firms are responsible for rating companies (or even countries) on the basis of their riskiness/creditworthiness. Investors and analysts all across depend on these ratings for debt-related transactions.
3. PE firms and Investment Banks: These firms either invest/advise their clients on investing in debt instruments and hence often have their own Credit Analysis teams
4. Non-banking financial institutions: These are non-banking lending firms and often they lend to a riskier band of customers. Hence, Credit Analysis for them is essential.
5. KPOs servicing the above companies: These firms are third-party vendors providing Credit Analysis services to the companies mentioned above.
Credit analysis attempts to implement a fundamental view of a company’s financial capacity to repay its debts. While factors such as operating margins, fixed expenses, overhead burdens, and cash flows might be the equivalent in equity and credit analyses, the emphasis is distinctive for each. Below are the Fundamental components of a credit analysis,
At times there are some factors which might have simply an implied impact on a company’s financial situations, but they might still contribute notable dimensions of a credit analysis.
- Country risk is an evaluation of how the company’s business activities might get skeptically affected by alterations in the social, legal, political, regulatory, and tax climates in the countries where it does significant amounts of business.
- Industry risk recognizes how the industry’s business dynamics, legal and regulatory climate, and market factors could impact the production of the individual company.
- Currency risk in the comprehensive insight recognizes not just the next balance sheet impact of adverse foreign exchange movements but also how changes in currency value might help or hamper the ability of the company to sell products and raw materials.
The financial evaluation of a borrower surveys at its revenue and cost structures, both in confinement (using a cross-section of significant ratios and metrics) and in association with peer-group and industry benchmarks.
A company can be considered strong for credit purposes when it has a cost structure that enables it to produce usually higher-than-average profits throughout all stages of its business cycle. Such companies should show near-optimal potential in utilization at peak times and will also tend to produce above-average returns even following the financial stress of a business downturn.
A company can be considered weak for credit purposes when it can only generate better-than-average performance during the peak of its business cycle when it has strong demand. A company is also considered weak when it can be regularly hobbled by burdensome fixed costs and has a limited track record of successful cost reduction, especially if its costs are already higher than its peers.
Credit Analysis is about delivering conclusions based on past, present, and the future situations. The role of credit analysis offers a plenty of opportunities to discover and experience different types of businesses as one retains with a number of clients from different sectors. The career is not only monetarily worthwhile but also helps an individual to improve along with rendering good opportunities to build one’s career.