11c fundamental credit analysis
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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

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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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