1. MCF 304: Bank Management
Lecture 4.2
Credit Analysis

2. Credit Analysis
Credit analysis is the most important activity in the lending process of any commercial bank. This activity involves a network of task which are based on theoretical model to ascertain the credit standing of loan applicants
At the end of credit analysis process, a credit decision proposal will be presented to the bank’s management for final decision making

3. Credit Analysis
The credibility of a credit decision is very much dependent on the credibility of the credit analysis.
Credit analysis is greatly influenced by ratio analysis because of the availability of financial information

4. Credit Analysis Determine the credit standing of potential borrower
However the issue of asymmetric information often arise because borrowers certainly have more information than banks on their future
Credit analysis is practiced to determined the repayment capacity of prospective borrowers & their attitude towards loan repayment

5. Credit Analysis
Banks desire borrowers not only with repayment capacity but also posses the sense of responsibility towards loan repayment
The 5C model is used in credit analysis to determine credit risk related to non-repayment of loans

6. 5 C’s
Character
Evaluation on the applicant willingness to make payment
Historical credit records & character reference from third party
Image, good standing, reputation, business prospects, etc.

7. 5 C’a
Capacity
Evaluate the applicants both from the legal & finance point of view
Is the borrower have legal capacity to enter into a contract?
Main objective is to determine the borrowers capacity to repay the loan

8. 5 C’s Collateral Any asset pledge by borrower to secure a loan
Need to know the age, condition & specialization level of the pledged assets
Banks however is more interested in loan repayment rather than the collateral

9. 5 C’s
Conditions
Evaluate the economic conditions that may effect the borrowers capacity to repay the loan
Forecast the exposure of borrower’s business to economic and interest rate changes
Capital
Applicant’s net worth because its symbolize success & commitment
Higher net worth indicates higher loan repayment capacity
Net worth encompasses accumulated earnings

10. Scope of credit Analysis
Depends on the size & maturity period of the loan, the track records of the company, the collateral involved and the past relationship between the applicant & the bank
Does not mean that credit analysis can be forgone even if the collateral value exceeds the loan amount

11. Source of Credit Information Source of Credit Information
Loan applicant interviews – to collect information on the character of applicants
Bank records – factual & highly reliable credit information
Business premises – to verify the existence of business & understand the structure and operations of the company

12. Credit Analysis
Financial statements – to performed trend analysis on credible (audited) financial statements
Credit bureau – CCRIS / CTOS / RAM
Inter bank references – cross checks from other banks

13. Evaluation of Financial Statements
Assets Evaluation
Review the accounts receivables / debtors for possible bad / doubtful debts disaster
Ageing analysis, trade debtors, factoring
Determine the age, liquidity & stability of inventories and the efficiency & effectiveness of the company asset management

14. Evaluation of Financial Statements
Liability & Net Worth Evaluation
Determine the status of creditor’s on clients balance sheet to protect the interest of the bank in the event of loan default
Creditors can be categorized as secured, preferential & general creditors
The amount & maturity of short / long term debts must be taken into consideration in determining the financial risk of applicants

15. Evaluation of Financial Statements
Income Statement Evaluation
Information on the profitability & stability level of the company
Will reveal the effectiveness of the company credit, operations & debt utilization policy
The sensitivity of each expenditure level to change in sale

16. Evaluation of Financial Statements
Statement of Changes in Financial Position
Reflect the change in liquidity of the company
Determine the source & uses of funds to determine the balance between financing & investment policy

17. Ratio Analysis
Trend analysis is used to find out if the financial performance & position have improved / deteriorated / remain unchange over a period of time
Four groups of ratio analysis
Liquidity ratio
Asset management ratio
Financial leverage ratio
Profitability ratio

18. Liquidity ratio Current Ratios.
Measure the ability of the company to fulfills its long term loans using its current assets.
current assets
current liabilities

19. Liquidity ratio Quick Ratios
Measures the ability of the company to pay its short terms loans quickly.
Current assets – (inventory + prepayments)
current liabilities

20. Assets management ratios
Average collection period
Measure the average days taken by the company to collect accounts receivables
Account Receivables x 365 days
Annual Credit Sales

21. Assets management ratios
Inventory turnover
Measures the efficiency of inventory management
Sales
Average Inventory

22. Assets management ratios
Fixed assets turnover
Measures the efficiency of the company in using its fixed assets to generate sales.
sales
fixed assets

23. Assets management ratios
Total assets turnover
Measures the efficiency of the company in using its assets to generate sales
sales
total assets

24. Financial Leverage ratios
Debt ratio
Measures the percentage of total assets that are financed by debts
total debts
total assets

25. Financial Leverage ratios
Fixed Charged Coverage Ratio
- Measure a company capacity to pay fixed charges such as interest on loans
Net Income
Fixed Charges

26. Profitability ratio Return on assets
Measures the effectiveness of the company in using its assets in generating profit
after tax earnings
total assets

27. Profitability ratio Return on equity
Measures the efficiency of the company in generating profits for its ordinary shareholders
after tax earnings
shareholder's equity

28. Profitability ratio Net profit margin
Measure the ability of a company to generate net profit from each dollar of sale after deducting all expenditure
after tax earnings
sales

29. Izdihar Baharin @ Md Daud
Thank You!
Izdihar Md Daud
Post Graduate Centre
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