UNIT-1
CREDIT ANALYSIS
Presented by
VIKASH BARNWAL
Assistant Professor
KIT, Varanasi

CREDIT ANALYSIS
 Credit analysis is the method by which one calculates the
creditworthiness of a business or organization. In other words, It is the
evaluation of the ability of a company to honor its financial obligations.
The audited financial statements of a large company might be analyzed
when it issues or has issued bonds. Or, a bank may analyze the
financial statements of a small business before making or renewing a
commercial loan. The term refers to either case, whether the business is
large or small. A credit analyst is the finance professional undertaking
this role.

 Credit analysis is a type of financial analysis that an investor or bond
portfolio manager performs on companies, governments, municipalities,
or any other debt-issuing entities to measure the issuer's ability to meet
its debt obligations. Credit analysis seeks to identify the appropriate
level of default risk associated with investing in that particular entity's
debt instruments.

 Credit analysis is the method by which one calculates the
creditworthiness of a business or organization.
 The objective of credit analysis is to look at both the borrower and the
lending facility being proposed and to assign a risk rating.
 The risk rating is derived by estimating the probability of default by the
borrower at a given confidence level over the life of the facility, and by
estimating the amount of loss that the lender would suffer in the event of
default.
 Credit analysis involves a wide variety of financial analysis techniques,
including ratio and trend analysis as well as the creation of projections
and a detailed analysis of cash flows.

IMPORTANCE OF CREDIT ANALYSIS-
1. Credit is an integral part of the modern economy and the global financial
system. The expansion of credit has been a major contributing factor to
global economic development and is often described as the lifeblood of
the economy.
2. Access to credit has facilitated GDP expansion through an increase in
consumption and the allocation of resources to productive purposes.
3. It has also helped to improve the efficiency and profitability of the
business by enabling access to funding for things like expansion, capital
expenditures, research and development, and staffing.
4. In this environment, investors are inevitably faced with tremendous
amounts of potential bond offerings from companies seeking funds to
perform various activities.
5. Before purchasing corporate bonds, savvy investors typically undertake
credit analysis to determine whether the company has the financial
ability to meet its obligations.

7C OF CREDITWORTHINESS IS
Capacity,
Character,
Capital,
Cash,
Control
Collateral
Conditions,

7`C
 Creditworthiness measures how deserving a loan applicant is to get a loan
sanctioned in his favor. In other words, it is an assessment of the likelihood
that a borrower will default on their debt obligations. It is based upon factors,
such as their history of repayment and their credit score.
 Lending Institutions also consider the availability of assets and extent of
liabilities to determine the probability of default. The 7’Cs of creditworthiness
indicates the characteristics or features of creditworthiness.

CHARACTER
 Responsibility, truthfulness, serious purpose, and serious intention to
repay all monies owed make up what is called character.
 The loan officer must be convinced that the customer has a well-defined
purpose for requesting credit and a serious intention to repay. The loan
officer must determine if the purpose is consistent with the bank’s loan
policy.
 Even with a good purpose. However, the loan officer must determine
that the borrower has a responsible attitude toward using borrowed
funds, is truthful in answering questions, and will make every effort to
repay what is owed.

CAPACITY
 The loan officer must be sure that the customer has the authority to request a
loan and the legal standing to sign a binding loan agreement; this customer
characteristic is known as the capacity to borrow money.
 For example, in most areas, a minor cannot legally be held responsible for a
credit agreement; thus, the lender would have difficulty collecting on such a
loan.
 Similarly, the loan officer must be sure that the representative from a
corporation asking for credit has proper authority from the company’s board of
directors to negotiate a loan and sign a credit agreement binding the company.

CASH
 This feature of any loan application centers on the question.
 Does the borrower have the ability to generate enough cash to repay the
loan in the form of flow? In an accounting sense, cash flow is defined as:
 Cash flow = Net profits + Noncash expenses.
 This is often called traditional cash flow and can be further broken down
into Cash flow = Sales revenues – Cost of goods sold – Selling, general,
and administrative expenses- Taxes paid in cash + Noncash expenses.
 The lender must determine if this volume of the annual cash flow will be
sufficient to comfortably cover repayment of the loan and deal with any
unexpected expenses.
 Loan officers should look at five areas carefully when lending money to
business firms or other institutions. These are:
 The level of and recent trends in sales revenue.
 The level of and recent changes in the cost of goods sold.
 The level of and recent trends in selling, general, and administrative
expenses.
 Any tax payments made in cash.
 The level of and recent trends in noncash expenses.

CAPITAL
 Capital represents the potential borrower’s general financial position,
emphasizing tangible net worth and profitability, which indicates the
ability to continuously generate funds over time.
 The net worth figure in the business enterprise is the key factor that
governs the amount of credit made available to the borrower.

COLLATERAL
 In assessing the collateral aspect of a loan request, the loan officer must
ask, Does the borrower possess adequate net worth or own enough
quality assets to provide adequate support for the loan.
 The loan officer is particularly sensitive to such features as the
borrower’s assets’ age, condition, and degree of specialization.
 Technology plays an important role here as well. If the borrower’s assets
are technologically obsolete, they will have limited value as collateral
because of the difficulty finding a buyer for those assets should the
borrower’s income falter.

CONDITIONS
 The loan officer and credit analyst must be aware of recent trends in the
borrower’s work or industry and how changing economic conditions
might affect the loan.
 A loan looks very good on paper, only to have its value eroded by
declining sales or income in a recession or by high-interest rates
occasioned by inflation.

CONTROL
 The last factor in assessing a borrower’s creditworthiness status is
control.
 This factor centers on such questions as to whether changes in law and
regulation could adversely affect the borrower and whether the loan
request meets the lender’s and the regulatory authorities’ standards for
loan quality.

PROCESS OF CREDIT ANALYSIS
Credit analysis covers the area of analyzing the character of the
borrowers, capacity to use the loan amount, condition of capital,
objectives of taking a loan, planning for uses, probable repayment
schedule & so on.
Credit proposals are needed to be analyzed by following Process.:
1. Collecting loan information of the applicant,
2. Collecting business information for which loan is sought,
3. Collecting the risk related information,
4. Assembling all credit information together,
5. Analyzing sensitive risky credit information,
6. Analyzing refined & very essential risk information,
7. Making a decision on the basis of loan analysis,
8. Design the appropriate loan structure according to a positive

 (1) Collecting loan information of the applicant: It requires a
collection of information from the past and present financial
statements of the business provided by the applicant. Analysis of the
personal characteristics, that is, whether he is involved in any
forbidden activities such as gambling, drinking habit or any other
unethical affair’s is also focused on this step.
 (2) Collecting business information for which loan is sought:
 The bank should know the purpose of the loan, the amount of the
loan and whether it is possible to implement the project by that
amount. It is essential to collect the information about the sources
from which repay the loan. The information of past loan of the
borrower should also be collected by the loan officer.

(3) Collecting the primary risk related information:
 Assessing the overall political and economic risks.
 Identification and give explanations to the positive and negative factors
in conducting the business.
 Evaluation of the positive sides of cash inflow and its possible stability in
the light of the historical demand of the business.
 Consideration of the future consequences and need for investment in
light of the applied loan proposal and repayment assurance of the loan.
 Evaluation of the impact on the balance sheet of the borrowers after
using the loan.
 Assessing the possibility and the extent to which change is occurred in
the risk level previously measured.

(4) Assembling all credit information together:
 Collection of detailed descriptions about the proposed loan
 Collection of detailed information about the loan applicant
 A detailed description of the general financial objectives and plans of
the business.
(5) Analyzing sensitive risky credit information:
 Inspection of the proposed business location,
 Collection of detailed information regarding profit earnings from the
existing bank-clients and other parties related to the business,
 Inspection of the internal working environment of the business,
 Analysis of the Information regarding trading (selling/purchasing)
and the availability of getting credit opportunity from the suppliers
(Trade Credit) and the relationship with the suppliers.

(6) Analyzing refined and very essential risk information: Analysis
of the honesty, integrity sincerity in individual and overall sense
towards the proposed business on the part of the owners,
employees, staffs and laborers of the company.
 Analysis of the possible political and economic risk.
 Evaluation of the operational possibility in consideration of the
proposed loan.
 Identification of the sources and uses of future cash inflow and
outflow of the proposed loan project.
 Assessment of the secondary safety of the collateral and surety.
(7) Making a decision on the basis of loan analysis:
 Determination of the explicit or implicit risk level of the proposed
loan.
 If the level of risk is beyond acceptable, then loan proposal should
be closed with a negative comment.

8) Design the appropriate loan structure according to the positive
decision:
 Determination of the types of loan, duration of loan and amount of
interest in light of risks associated with the loan.
 Loan analysis process should be here if the terms and conditions for
applied loan are not acceptable.
 Get approvals from the appropriate loan sanctioning authority.
 Sit for discussion with the borrowers about the acceptable conditions of
the loan Preparation & Maintenance of necessary documents of the
permitted loan.

CREDIT PROCESS
 The process of assessing whether or not to lend to a
particular entity is known as the credit process.
 It involves evaluating the mindset of the potential
borrower, underwriting of the risk, the pricing of the
instrument and the fit with the lender's portfolio.
 It encompasses setting objectives and guidelines
based on the lender's credit culture, gathering
necessary information of the applicant, analyzing the
information include cash flows and financial
statements and presenting and documenting
information in such a manner so that a credit decision
may be made.

YOUR COMMERCIAL BANKING OFFICER WILL REVIEW YOUR BUSINESS LOAN
PACKAGE BASED ON CRITERIA KNOWN AS THE "FIVE C'S OF CREDIT"
 Character : It involves a review of your personal honesty, integrity,
trustworthiness and management skills A banking officer also makes a
judgment of character based on your business plan, credit history and the
quality of your presentation.
 Capitalization : The capital structure of your company is important to Bank
of Ann Arbor because it helps determine the level of risk associated your
loan request. An analysis of capitalization includes a review of equity, total
debt, the value of assets and permanent working capital.
 Cash Flow. This is the cash your business has to pay the debt. A cash flow
analysis helps us determine if you have the ability to repay the loan.
 Collateral: This provides a secondary source of repayment, thereby
minimizing the risk for Bank of Ann Arbor. The amount and type of collateral
require depends on the type and purpose of the loan.

 Conditions : This refers to outside conditions that may affect the ability
of your business to repay the loan. Factors such as general economic
conditions or a large concentration of sales to a single customer are
evaluated during our review of your loan application.

CREDIT FACILITY
 A credit facility is a type of loan made in a business or corporate finance
context. It allows the borrowing business to take out money over an
extended period of time rather than reapplying for a loan each time it
needs money. In effect, a credit facility lets a company take out an
umbrella loan for generating capital over an extended period of time.

 Credit Facility is an agreement with bank that enables a person or
organization to be taken credit or borrow money when it is needed.
 All types of credit facilities may broadly be classified into two groups on
the basis of Funding
1. Fund Base Credit
2. Non Fund Base Credit

FUND BASE CREDIT
It is the any credit facility which involves direct outflow of
Bank’s fund to the borrower. Various types of it are as
follows :-
(i) Loan:
(ii) Cash Credit
(iii) Over Draft:
(iv) Packing Credit
(v) Some other fund based credit facilities

(i) Loan: – It refers to credit facility that is repayable in a definite period. (e.g.
Term Loan , Demand Loan)
(ii) Cash Credit: – It refers to credit facility in which borrower can borrow any
time with in the agreed limit for certain period for their working capital need.
It secured by way of Hypothecation of Stock(goods) and Debtors and all other
current Assets of the business generated during the course of business. Cash
credit can also be secured by way of mortgage of immovable properties (as
collateral security)
(iii) Over Draft: – An overdraft allows a current account holder to withdraw in
excess of their credit balance up to a sanctioned limit. It secured by way of
Mortgage of immovable properties and pledge of F.D., Bonds, Shares securities
, Gold & silver and any physical asset and Hypothecation of Stock and Debtors
and all other current Assets of the business generated during the course of
business.

(iv) Packing Credit: – It is a credit facility which sanctioned to an exporter in the
Pre-Shipment stage. Such credit facilitates the exporter to purchase raw
materials at competitive rates and manufacture or produce goods according to
the requirement of the buyer and organize to have it packed for onward
export. It secured by way of Hypothecation of Stock of goods and Debtors and
all other current Assets of the business generated during the course of
business.
(v) Some other fund based credit facilities are Bill Discounted , Bill Purchased
, Advance against hypothecation of Vehicles ( Transport Loan) , House Building
Loan , Consumer Loan , Agriculture Loan -Farming -Non Farming , Consortium
Loan , Lease Financing , Hire Purchase , Import Financing – Loan Against
Imported Merchandise (LIM) – Payment Against Document (PAD) .

(2) NON FUND BASE CREDIT
 Non Fund Base credit is a credit facility where there is no involvement of direct
outflow of Bank’s fund on account of borrower rather the outflow of Bank’s
fund on account of Third party on behalf of borrower. Types of it are as follow:
 (i) Letter Of Credit:
 (ii) Bank Guarantee:
 (iv) Suppliers Credit
 (iii) Buyer Credit:

 (i) Letter Of Credit: – When a buyer or importer wants to purchase goods from
an unknown seller or exporter. He can take assistance of bank in such buying
or importing transactions.
Bank issues a LETTER OF CREDIT in addressed to the supplier or exporter after
it, supplier or exporter will supply the goods to such unknown buyer or
importer. A signed Invoice with Letter Of Credit is presented to the bank of
buyer/importer and the payment is made to the seller/exporter DIRECTLY by
the bank.
 (ii) Bank Guarantee: – It is a guarantee issued by a banker that, in case of an
occurrence or non-occurrence of a particular event, the bank guarantees to
fulfilled the loss of money as stipulated in the contact. It may of various types
like Financial Guarantees, Performance Guarantees and Deferred Payment
Guarantee.

 (iii) Buyer Credit: – It is the credit availed by an Importer from overseas
lenders (i.e. Banks & Financial Institutions) for payment against his imports.
The overseas bank usually lends the Importer based on letter of credit, bank
guarantee issued by the importer bank.
 (iv) Suppliers Credit: – Under such credit facility an exporter extends credit to
a foreign importer to finance his purchase. Usually the importer pays a portion
of the contact value in cash and issues a Promissory note as evidence of his
obligation to pay the balance over a period of time. The exporter thus accepts
a deferred payment from the importer and may be able to obtain cash
payment by discounting or selling such promissory note created with his bank.

(iii) Buyer Credit: – It is the credit availed by an Importer from overseas lenders
(i.e. Banks & Financial Institutions) for payment against his imports. The
overseas bank usually lends the Importer based on letter of credit, bank
guarantee issued by the importer bank.
(iv) Suppliers Credit: – Under such credit facility an exporter extends credit to a
foreign importer to finance his purchase. Usually the importer pays a portion
of the contact value in cash and issues a Promissory note as evidence of his
obligation to pay the balance over a period of time. The exporter thus accepts
a deferred payment from the importer and may be able to obtain cash
payment by discounting or selling such promissory note created with his bank.

CREDIT PROCESS
 Process of assessing whether or not to lend to a particular
entity is known as the credit process.
 It involves evaluating the mindset of the potential borrower,
underwriting of the risk, the pricing of the instrument and the fit
with the encompasses lender's setting portfolio.
 objectives It and guidelines based on the lender's credit culture,
gathering necessary information of the applicant, analyzing
information including cash flows and financial statements and
presenting and documenting information in such manner so that
a credit decision may be made

 Your commercial banking officer will review your business loan
package based on criteria known as the "Five C's of Credit.“
 Character: It involves a review of your personal honesty, integrity,
trustworthiness and management skills. A banking officer also
makes judgment of character based on your business plan, credit
history and the quality of your presentation.
 Capitalization: The capital structure of your company is
important to Bank of Ann Arbor because it helps determine the
level of risk associated with your loan request. An capitalization
includes analysis a review of of equity, total debt, the value of
assets and permanent working capital.

 Cash Flow: This is the cash your business has to pay the debt. A cash
flow analysis helps us determine if you have the ability to repay the loan.
 Collateral: This provides a secondary source of repayment, thereby
minimizing the risk for Bank of Ann Arbor. The amount and type of
collateral required depends on the type and purpose of the loan.
 Conditions: This refers to outside conditions that may affect the ability
of your business Factors such conditions or as to repay the loan.
general economic a large concentration of sales to a single customer
are evaluated during our application. review of your loan

 To put things into perspective, let’s consider the example of one Sanjay Sallaya,
who is credited to being one of the biggest defaulters in recent history, along
with being one of the biggest businessmen in the world. He owns multiple
companies, some sports franchises, and few bungalows in all major cities.
 Who is the client? Ex. Sanjay Sallaya, a reputed industrialist, owning majority
share in XYZ ltd., and some others.
 Quantum of credit they need and when? Ex. Starting a new airline division,
which would cater to the high-end segment of society. Credit demand is $25
mil, needed over the next 6 months.
 The specific purpose the credit will be employed for? Ex. Acquiring new
aircraft and capital for day to day operations like fuel costs, staff emoluments,
airport parking charges, etc.

 Ways and means to service the debt obligations (which include application
and processing fees, interest, principal, and other statutory charges) Ex.
Revenue generated from flight operations, freight delivery, and freight delivery.
 What protection (collateral) can the client provide in the event of default? Ex.
Multiple bungalows in prime locations are offered as collateral, along with the
personal guarantee of Sanjay Sallaya, one of the most reputed businessmen in
the world.
 What are the key areas of the business, and how are they operated and
monitored? Ex. Detailed reports would be provided on all key metrics related
to the business.
 Answers to these questions help the credit analyst to understand the broad
risks associated with the proposed loan. These questions provide the basic
information about the client and help the analyst to get deeper into the
business and understand any intrinsic risks associated with it.

CREDIT ANALYST – OBTAINING QUANTITATIVE DATA FROM THE
CLIENTS
 Other than the above questions, the analyst also needs to obtain quantitative
data specific to the client:
 Borrower’s history – A brief background of the company, its capital structure,
its founders, stages of development, plans for growth, list of customers,
suppliers, service providers, management structure, products, and all such
information are exhaustively collected to form a fair and just opinion about the
company.
 Market Data – The specific industry trends, size of the market, market share,
assessment of competition, competitive advantages , marketing, public
relations, and relevant future trends are studied to create a holistic
expectation of future movements and needs.

 Financial Information – Financial statements (Best case/ expected case/ worst
case), Tax returns, company valuations and appraisal of assets, current balance
sheet, credit references, and all similar documents which can provide an
insight into the financial health of the company are scrutinized in great detail.
 Schedules and exhibits – Certain key documents, such as agreements with
vendors and customers, insurance policies, lease agreements, picture of the
products or sites, should be appended as exhibits to the loan proposal as
proofs of the specifics as judged by the above-mentioned indicators.

DOCUMENTATION
 Credit administration and documentation are two of the critical
components in managing credit and supporting the credit
process. Following proper credit administrative and
documentation process allow credit analysts to monitor accounts
and identify ways to reduce default risk.
 Credit Document means Agreement, the Notes, if any of this any,
the Collateral Documents, any documents or certificates executed
by Company in favour of Issuing Bank relating Letters of Credit,
documents, instruments and ог all to other agreements executed
and delivered by a Credit Party for the benefit of any Agent,
Issuing Bank or any Lender in connection herewith.

LOAN PRICING
 The process of determining the interest rate for granting a
loan, typically as an interest spread (margin) over the base
rate, conducted by the book runners in loan syndication
 Loan pricing is the process of determining the interest rate
for granting a loan, typically as an interest spread (margin)
over the base rate, conducted by the book runners. The
pricing of syndicated loans requires arrangers to evaluate
the credit risk inherent in the loans and to gauge lender
appetite for that risk.

 For market-based loan pricing, banks incorporate credit default spreads as a
measure of borrowers’ credit risks. It is standard procedure in loan pricing to
benchmark a loan against recent comparable transactions (“comps”) and
select the base rate on which the financing costs are pegged. A comparable
deal is one with a borrower in the same industry, country and of the same size
with the same credit rating, for which a certain market rate of return is
required.

 A bank’s credit rating has a direct impact on its cost of funding and, thus, the
pricing of its loans. Banks with a high credit rating generally have access to
lower cost funds in debt markets and low counterparty margins in swap and
foreign exchange markets. The lower cost of funds can be passed on to
borrowers in the form of lower loan pricing.

LOAN PRICING OBJECTIVES
 Explain debt as a funding source, its pros, and its cons
 Identify loan types and their relative degree of profitability
 Define risk-adjusted return, and risk-adjusted return on capital
 Calculate and interpret an example risk rating
 Recommend pricing structures based on risk rating and loan type

 It is a binding short-term financial instrument that mandates one
party to pay a specific sum of money to another at a
predetermined date or on-demand. Also known as a bill of
exchange, it essentially denotes, in writing, that one person
(debtor) owes money to another (creditor).
 Businesses predominantly use bill finance during international
trade, since the degree of uncertainty concerning the payment is
considerable in that regard. However, there’s no set law as such,
and companies can use a bill of exchange for intra-border trade
as well.
 Usually, bill finance does not involve any interest payment. But, a
creditor might charge a penalty fee or interest if it does not
receive the due amount by a predetermined date. In that case,
the issuer must mention these details in such a document.

BILL FINANCE WORK
The practice of bill of exchange issuance involves three parties primarily –
 Drawee – This is the person or entity on which a bill of exchange is issued, also
referred to as the debtor. A drawee needs to accept the bill, which legally binds
it to pay a specific sum.
 Drawer – This person issues a bill of exchange, usually before undertaking credit
sales. A drawee is obliged to pay the due amount to a drawer. This entity must
sign a bill of exchange during issuance.
 Payee – The payment ultimately goes to a payee. In most cases, a drawer, and
payee are the same entity. However, in some cases, a drawer can transfer bill
finance to a third-party, in which case that person becomes the payee.

Types Explanation
Demand bill Also known as sight draft, this type of bill finance comes
with an on-demand payment stipulation.
Usance bill Bills of exchange that feature the clause of payment by a
specific date and time. These are also known as time draft.
Documentary
bill
A type of bill of exchange that requires the presentation of
supporting documents attesting to the legitimacy of a
transaction(s).
Clean bill It involves no supporting documents, and therefore, the
interest that one needs to pay, if any, is much higher.
Inland bill This is issued for transactions within national borders.
Foreign bill As opposed to the inland bill, a foreign bill of exchange is
issued to debtors beyond national borders.
Trade draft Bill finance issued by an individual is called a trade draft.
The following table discusses the various types of bill finance that are
mostly used.

Bank draft When a bank issues a bill of exchange, it’s called a bank
draft. In this case, a bank enforces bill payment as per
terms.
Accommodation
bill
It refers to the unconditional bill finances.