The credit analyst is charged with identifying risks and mitigants associated with the repayment sources on a loan. The credit analyst must understand the borrower’s business and borrowing need to start with the analysis. The best way to start the process is to have a conversation with the borrower. A general idea about the feasibility of a loan request can be obtained from the conversation. Financial analysis and modeling techniques can then be used to test the feasibility of the request.
The borrower will be the best source of information related to internal factors affecting cash flows such as marketing, sales, business operations, management, etc. The borrower can also identify its direct competitors for the analyst and provide some direction on good sources for market information. The main takeaway from the conversation is the identification of the principals and details on their background, experience and involvement with the day to day activities, planning and management of the business as well as an initial indication of the financial position of the borrower. The analyst should be able to determine the level of collateral dependence for the loan request and have some idea about the market environment for which the borrower operates and understand other influences such as the economy, political environment, industry and competition that would affect the borrower’s ability to repay the loan.
The analyst collects financial information from the borrower to perform financial analysis using various financial modeling techniques such as spreading the financial statements in Excel, Moody’s Risk Analyst, Financial Tools, or Buker’s Taxanalysis to determine the financial position of the borrower from a historical and forward looking perspective as appropriate. The feasibility of the loan is determined mainly by cash flow as a lender would not make a loan to a borrower with cash flow that is insufficient to repay the loan. Other important factors that are identified in the analysis are borrower liquidity, leverage, and sustainability. Market data should provide an indication of how strong the borrower’s performance has been relative to the market. Strong performance indicates good management and business sustainability and lower probability of default on the subject loan. I am preparing a series on spreading financial statements that will cover the modeling techniques I use in my analysis.
One final note is that the level of detail in the analysis should be guided somewhat by the lender’s attitude towards risk and appetite for specific types of loans, borrowers, and financial strength. Lower risk tolerance environments will require a higher level of details. At any rate the analysis should be comprehensive. Calculation methods should be easy to follow and duplicate and it is good practice to reference sources and methods. Management may not find errors or inconsistencies in the analysis. Check your work. You do not want your auditors or examiners catching errors that you should have.
Tools-The document under tools labeled Checklist is a checklist of financial information to collect from the borrower to start your analysis. An important item on the list to note is the Debt and Maturity Schedule. This will enable the analyst to determine if there are going to be any upcoming liquidity events that could adversely affect cash. If you look under the Tools section there is a link to an Excel file titled Debt and Maturity Schedule that you can use.
