Credit Analysis Report

What is a Credit Analysis Report?

The Credit Analysis Report lets you evaluate how much credit you can advance to your business associates. It contains details about a company's financial position, payment behavior, and risk involved.

Credit analysis involves concluding an entity's creditworthiness based on readily accessible information (both quantitative and qualitative) and providing suggestions about perceived needs and risks.

• Credit Analysis is also concerned with identifying, evaluating, and mitigating risks associated with an entity's failure to meet financial commitments.
• Credit risk is the risk of loss resulting from a borrower's failure to make full and on-time interest and/or principal payments.
• The risk of default and loss severity in the event of default are the two main elements of credit risk. The sum of the two is an expected loss. Due to the low default risk associated with higher-quality bonds, investors need to pay more attention to the magnitude of losses. 

Downgrade risk (also known as credit migration risk) and market liquidity risk are two credit-related risks. Any of these could increase yield spreads (also known as yield premiums) and drive down bond prices.

An issuer's creditworthiness declining is referred to as downgrade risk. When bonds are downgraded, yield spreads on the market are wider, resulting in lower prices for the bonds.

Secured debts are generally ranked above unsecured debt in the order of claims, and senior debt is rated above subordinate debt within the unsecured debt.

Due to cross-default clauses found in most indentures, an issuer's bonds typically have an equal chance of defaulting. Therefore, in the event of default, a claim with a higher priority is likely to recover more money with a smaller degree of loss.

Debt at the holding company is structurally subordinated to subsidiary debt for issuers with more complex corporate structures, such as a parent holding company with operating subsidiaries.

The possibility of more diverse assets and earnings streams from other sources may result in the parent having higher effective credit quality than a specific subsidiary.

Contents of a Credit Analysis Report

Credit rating agencies dominate the credit market. Credit ratings—perceptions of a bond issuer's creditworthiness—are attached to nearly every bond issued in the broad debt markets.

With the help of credit ratings, investors can compare the credit risk of debt issues and issuers within a particular industry, across industries, and geographical markets.

Corporations undergo corporate credit analysis to evaluate their capacity to repay principal and interest on time.

As a result, it is crucial to compile a credit analysis report and consider all relevant factors, ensuring that neither businesses nor consumers suffer losses.

It is important to consider various things while preparing the report. The following are the key components:

• Personal Information
• Credit Accounts
• Credit Inquiry
• Bankruptcy along with foreclosures.

Personal Information

A credit report contains a section on an individual's basic personal information, such as their name, precise location, occupation, birth date, and Social Security number.

A list of past addresses, places of work, and any misspellings of names may be included in the report. Individual credit scores are not calculated using personal details.

If it is a company, a brief history of the firm, its capital configuration, its founding members, phases, expansion plans, a summary of the customer base, subcontractors, network operators, management board, product lines, and all other relevant information is meticulously gathered to shape a reasonable and just perception about the business.

Financial institutions or establishments may request a credit analysis report to verify a potential borrower's authenticity and prevent identity theft.

Credit Accounts

The credit accounts comprise data on past and existing payment history disclosed by prior lending institutions and creditors.

The segment should include information about the various lending accounts directly connected to an individual.

Credit cards, mortgage loans, vehicle loans, and student debt are examples of various accounts. In addition, the report provides details about the user's official account opening, available credit, cash position, and financial history for every type of credit.

Financial statements (perfect scenario /worst scenario), tax filings, the business's market values and asset assessments, the latest income statement, credit links, and all other records that could provide an understanding of the company's financial position are thoroughly scrutinized.

Credit Inquiry

Specific vital records, such as distributor and customer contractual arrangements, insurance plans, lease terms, and images of product lines or webpages, must be attached as exhibits to the credit proposal as evidence of the actual details as ascertained by the metrics mentioned earlier.

Inquiries include relevant data concerning entrepreneurs or financial firms that have previously handled a borrower's credit rating, whether for promotional inspection or in connection with a revolving credit card proposal.

Soft and hard investigations are shown on the borrower's edition of the credit analysis report.

Soft inquiries are only observable to the borrower and prospective lending institutions, including the borrower's proposal, current lenders' queries, and businesses that provide previously approved credit card proposals.

On the other hand, potential lenders perform hard inquiries while evaluating a borrower's credit record as part of their general proposal for a credit or credit card. In the lender's edition of the credit history, only the hard inquiries are considered.

Bankruptcy and Foreclosures

The bankruptcy and foreclosures segment contains relevant data on bankruptcy and defaulted funds that have been spun over to debtors for a compendium.

Foreclosures, bank failures, and past-due accounts with a health center. Healthcare and telecom companies are all considered.

The data can harm a borrower's goodwill, and lenders may hesitate to approve loan requests from people with bad credit records.

Bankruptcy and Credit Analysis Report

So far, we've established that a Credit Analysis presents the public reputation of a company/industry in market trends.

As a result, bankruptcy ruins a company's reputation because it shows its inability to operate satisfactorily and prosper.

Impacts of Bankruptcy:

1. Bankruptcy will have a significant impact on credit scores. The precise consequences will differ. However, per FICO, filing for bankruptcy can cause a high credit score of 700 or higher to drop by at least 200 points. 
2. If your score is less than 680, you may lose between 130 and 150 points.
3. Generally speaking, if one already has a poor credit score, they need not worry about bankruptcy since they will have fewer points to lose, but those with high credit scores can see the implications.

Can you remove bankruptcy from the credit analysis report early? There is a provision if one's Credit Analysis Report shows default. It will last for 7-10 years before disappearing on its own.

However, if it is mistakenly included in the report, proper documentation can be used to persuade the relevant authority to remove it.

Credit Analysis Report Purpose

Credit risk analysis assesses the potential risk associated with borrowers' ability to repay their debts.

The main objective of credit analysis is to determine potential borrowers' creditworthiness and ability to meet their debt obligations. If the borrower presents an acceptable level of default risk, the analyst can recommend approval of the credit application on the agreed terms.

The report delineates how borrowers manage their credit accounts, the total amount of outstanding debt, and the frequency of bill payments. If the firm approves (or rejects) a loan application, the risk rating will determine how much credit is provided.

A business's financial performance tells investors about its overall health. It gives an overview of the company's financial situation, management's performance, and the outlook for its stock.

It also offers a glimpse into the company's management, revenues, and long-term growth plans. Therefore, evaluating one's company's performance should be a regular practice.

It not only provides the chance to think through one's options, but it also enables one to spot problem areas before they turn into major issues.

This financial picture will help educate the managerial strategic plan to achieve one's organization's objectives, which may include data on cash flow, capital, and revenue growth.

Risk analysis through The Credit Analysis Report

Lenders use credit risk modeling to evaluate the credit risk affiliated with loaning money to a counterparty. Methods for credit risk analysis can be influenced by financial statements, default possibility, and perhaps even machine learning.

Some of the risks include:

1. Probability of Default

Credit analysts may use various financial analysis techniques to quantify credit loss, such as ratio and trend analysis. The techniques assess the risk of credit losses caused by changes in borrowers' creditworthiness.

When calculating credit loss, consider both the loss due to counterparty defaults and the deterioration of the credit risk rating.

• The default probability is the likelihood that a borrower cannot make scheduled principal and interest payments for a particular time frame. One year.
• Their Credit score can determine borrowers' default odds.
• Lenders use this score to determine whether or not to approve a loan. A company's credit rating determines the probability of default for businesses.

2. Loss Given Default

The lender's loss if a borrower defaults on their debt obligations is called the default loss. There is no accepted way to quantify the default loss per loan, but most lenders calculate it as a percentage of their total exposure to the loss of the entire loan portfolio.

For example, if XYZ Bank lends $2,500 to borrower F and $25,000 to borrower H and borrower H fails to repay, the bank will lose more money.

3. Exposure at Default

Default exposure measures the loss a lender exposes at a particular point in time due to loan defaults.

Financial institutions use their internal risk management models to estimate the likelihood of default. First, the bank calculates the exposure at default for each loan in its portfolio. Then, as the repayment is made, the exposure to bankruptcy for that loan gradually decreases.

benefits of hiring a Credit Analyst for a Credit Analyst Report?

The main obligation of a credit analyst is to evaluate a person's or firm's credit ratings.

Credit analysts collect financial data from consumers, such as income and credit history, to determine their capacity to meet financial commitments.

Credit analysts are typically employed by financial institutions such as credit rating agencies, corporate and institutional banks, credit card companies, and other financial firms.

How is information collected & processed for the report?

1. The first step in the credit analysis process is to gather information about the applicant's credit history. 
2. The lender looks at the customer's repayment history, organizational reputation, financial solvency, and transaction records with other financial institutions. 
3. The lender also considers the purpose of the loan and its feasibility. It wants to ensure that the project being funded is feasible and will generate enough money in return.
4. The credit analyst assigned to the borrower is responsible for determining the adequacy of the loan amount for the project to be completed and for determining whether there is a good plan to undertake the project successfully.
5. Every loan application is considered and evaluated by banks based on merits in bank credit analysis. 
6. They investigate each borrower's creditworthiness to assess the level of risk they expose themselves to by lending to an entity or individual.

How do you Evaluate a Company's Creditworthiness via a Credit Analysis Report?

1. The bank collects information about the loan's collateral, which acts as security if the borrower defaults on its debt obligations.
2. Often, lenders prefer to take out the loan from the project's proceeds being funded and only use the guarantee as a backup in the event of a default by the borrower.
3. The information collected in the first stage is analyzed to determine whether the notification is accurate and true.
4. The credit analyst evaluates personal and corporate documents to ensure they are accurate and genuine. They also examine financial statements to determine whether the borrower can repay the loan.

Credit Analysis Ratios in Credit Analyst Report

Credit analysis ratios are helpful tools used during the credit analysis process. Ratios can help analysts and investors determine whether individuals or corporations can fulfill financial obligations.

Credit analysis involves both qualitative and quantitative aspects. It can identify whether a credit is good or bad and help determine how much credit a person is eligible for. Ratios can be roughly separated into four groups:

1. Profitability Ratio

Profitability ratios show the ability of a company to earn a satisfactory profit over time.

2. Leverage Ratio

These ratios deal with the ability of the company to repay its creditors, expenses, etc.

For instance, Assume you're lending someone $200. Given that they both earn the same amount, would you rather lend to someone who already owes someone else $2000 or someone who owes $200?

You are more likely to choose the person who owes only $200 because they have less existing debt and more disposable income to repay you.

3. Coverage Ratio

Coverage ratios measure the coverage that income, cash, or assets provide for debt or interest expenses.

For instance, the bank is considering whether to lend money to Company F, which has a coverage ratio of 10, or Company H, which has a coverage ratio of 5.

The ratio suggests that Company F's operating income can cover its total outstanding debt ten times. It is more than Company H, which has a debt-to-equity ratio of 5.

4. Liquidity Ratio

To calculate the liquidity ratio, companies must be able to convert assets into cash. In credit analysis, the percentages indicate whether a borrower can pay back the current debt.

Higher liquid ratios suggest a company is more fluid and can pay off outstanding debts more easily. For instance, the quick ratio is calculated by dividing a company's current assets (less inventory and prepaid expenses) by its current liabilities.

Investors are considering investing in two very similar companies, except one has a quick ratio of 10, and the other has a ratio of 5.

Company F is a better choice because a ratio of ten indicates that the company does have enough liquid assets to cover future borrowings ten times over.

Importance of a Credit Analysis Report

It is the only data catalyst used to calculate creditworthiness, a statistical measure used by lending institutions to assess a creditor's creditworthiness.

Suppose an applicant's credit report shows coherent on-time payments for all prior credit accounts. In that case, they will be delegated a good credit rating that could assist them in procuring desirable financing options.

However, if the borrower has a history of late payments and defaults, they will have a low credit score and find it challenging to access credit.

If a bank approves a loan request for a borrower with a poor credit rating, the interest rate will increase to reimburse the lender for the elevated probability of insolvency.

The rate of interest that will be charged to the customer is the primary factor in the case of banking institutions. The value of the security offered as collateral, the periodicity of the loan required, and the customer's financial situation are used to determine the interest rate.

Low-interest rates are applied to customers with high creditworthiness and longer payment intervals.

The penal interest rate is set in the case of entities other than banking institutions if the customer postpones making the payment.

Importance to a Bank

Commercial banks that lend money to businesses to finance their inventories must also evaluate the possibility of being repaid in full and on time.

Banks must then exemplify their ability to repay other financial institutions that lend to them by purchasing their investment products and securities. In all of these instances, Credit Analysis Report analysis can significantly impact the decision to offer or not offer loans.

However, as important as financial statements are in determining credit risk, the analyst must remember that other processes also play a role.

Credit Analysis Report reveals much about a borrower's ability to repay a loan but nothing about the similarly vital willingness to pay back.

A meticulous credit analysis may review the individual's reimbursement history, which is not included in a regular financial statement.

Furthermore, to evaluate the business's creditworthiness in this illustration, the bank should always take into account, in particular, the income statement and balance sheet, the business conditions, and the strength of the local economic system wherein the borrower conducts business.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Predatory Lending
• Priority Sector Lending Certificates (PSLCs)
• Quality of Collateral
• Risk Rating Models
• Sales Risk