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11C Fundamental Credit Analysis. Topics covered: Five C’s of credit analysis Home loan underwriting Credit scoring C&I loan underwriting Cash flow analysis Other considerations Ratio analysis. Five C’s of Credit Analysis. Capacity Capital Collateral Conditions Character.

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11c fundamental credit analysis
11C Fundamental Credit Analysis
  • Topics covered:
    • Five C’s of credit analysis
    • Home loan underwriting
    • Credit scoring
    • C&I loan underwriting
      • Cash flow analysis
      • Other considerations
      • Ratio analysis
five c s of credit analysis
Five C’s of Credit Analysis
  • Capacity
  • Capital
  • Collateral
  • Conditions
  • Character
home loan underwriting
Home Loan Underwriting
  • Relies heavily on collateral
    • But ability/tendency to pay also important
      • Recourse loan
  • Two key measures
    • LTV (loan to value)
    • Debt service ratios
      • GDS (gross debt service)
        • Housing cost/gross income
          • Typically (interest + principal + taxes + insurance)/gross income 28% for FNMA
      • TDS (total debt service)
        • (all debts & commitments/gross income) 36% for FNMA
credit scoring
Credit Scoring
  • Actually began in C&I, but primarily used in consumer lending
  • Quick & low cost
  • Typical Factors:
    • Income
    • Mortgage/rent cost
    • Credit card debts
    • Payment history
    • Age
    • Own/rent & length of time
    • Job stability
    • Relationship with institution
credit scoring cont
Credit Scoring (cont.)
  • FICO Score is the most common consumer credit score
    • Ranges from 300 to 850
    • 760+ Excellent credit, may get better terms
    • 723 median US score
    • 680 typically qualify for prime flat on HELOC
    • 620 typically qualify for FNMA mortgage
c i loan underwriting
C&I Loan Underwriting
  • Larger loan balances
  • Customized Terms
  • Priced to credit risk rather than just accept/reject decision
  • Significant post-issuance monitoring
  • Bread and butter for local commercial banks
c i loan underwriting cont
C & I Loan Underwriting (cont.)
  • Focus on ability to repay
    • Hence, extensive cash flow analysis
  • Financial statements are verified
    • Tax returns a common source
  • Check with related parties
    • Customers
    • Prospects
    • Suppliers
  • Capability and character of management key
  • Key facets of business investigated
    • Production
    • Marketing
    • Capital Requirements
cash flow analysis
Cash Flow Analysis
  • There should be enough cash flow from business operations to service debt
    • Should not have to sell assets
    • Should not have to borrow
  • Most measures are “coverage” ratios of the general form:

Cash from operations/debt payments

  • See Handout
    • Tables 11-A-1 and 11-A-2
ratio analysis
Ratio Analysis
  • Common-sizing statements is standard
  • Liquidity Ratios:

current ratio = current assets/current liabilities

Quick ratio = current assets-Inv./current liabilities

  • Asset management ratios:

Number days receivables (DSO) = A/R x 365/sales or credit sales

Number of days inventory = Inv x 365/COGS

Sales to WC = Sales/WC

Sales to assets = Sales/Fixed Assets

Sales to total assets = sales/total assets

ratio analysis cont
Ratio Analysis (cont.)
  • Debt and Solvency ratios

debt to assets = ST Liab +LT Liab/total assets

note that 1:1 debt to equity = .5 debt to assets

Times interest earned (interest coverage ratio) =

earnings available to meet interest charges/interest charges

Cash flow to debt ratio = EBIT + Depreciation/Debt

this ratio should easily exceed debt interest rate

ratio analysis cont1
Ratio Analysis (cont.)
  • Profitability ratios:

Gross margin = gross profit/sales

Operating profit margin = Operating Profit/Sales

ROA = EAT/ Total Assets

ROE = EAT/Total Equity

Dividend payout = Dividends/EAT

  • Always need to be careful about comparability in ratio analysis
    • Same items can be accounted for in different ways
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