11-1
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
11-2
Five C’s of Credit Analysis
Capacity Capital Collateral Conditions Character
11-3
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
11-4
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
11-5
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
11-6
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
11-7
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
11-8
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
11-9
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
11-10
Ratio Analysis (cont.)
Debt and Solvency ratios
debt to assets = ST Liab +LT Liab/total assetsnote 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/Debtthis ratio should easily exceed debt interest rate
11-11
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