3.1 The Credit Analysis Framework

Credit analysis is the cornerstone of corporate banking. The goal is to assess a borrower’s ability and willingness to repay debt. The framework encompasses qualitative and quantitative analysis .

Qualitative Analysis

Management and Company Quality: Evaluation of management track record, depth of management team, corporate governance, ownership structure, and strategic direction .

Industry Analysis: Assessment of competitive dynamics, barriers to entry, industry lifecycle, regulatory environment, and technological disruption risks .

Business Model Assessment: Understanding revenue drivers, cost structure, competitive advantages, and customer/supplier concentration.

Quantitative Analysis

Financial Statement Review: Comprehensive analysis of income statements, balance sheets, and cash flow statements over multiple periods .

3.2 Key Financial Ratios for Credit Analysis

Liquidity Ratios

  • Current Ratio: Current Assets / Current Liabilities

  • Quick Ratio: (Current Assets – Inventory) / Current Liabilities

  • Cash Ratio: Cash / Current Liabilities

Leverage Ratios

  • Debt-to-Equity: Total Debt / Total Equity

  • Debt-to-EBITDA: Total Debt / EBITDA

  • Interest Coverage: EBIT / Interest Expense 

Profitability Ratios

  • EBIT Margin: EBIT / Revenue

  • ROE: Net Income / Shareholders’ Equity

  • ROA: Net Income / Total Assets

Cash Flow Measures

Key cash flow measures used by credit analysts include:

  • Operating Cash Flow (OCF): Cash generated from core operations

  • Free Cash Flow (FCF): OCF minus capital expenditure

  • Cash Flow Available for Debt Service (CFADS) : Cash available after operating expenses and taxes 

3.3 Expected Loss and Loan Pricing

Expected loss (EL) is the foundation of credit analysis and pricing :

EL = PD × LGD × EAD

Where:

  • PD (Probability of Default): Likelihood borrower will default

  • LGD (Loss Given Default): Percentage of exposure lost in default

  • EAD (Exposure at Default): Outstanding exposure at time of default

Loan Pricing Formula

To achieve a target Return on Equity (RoE), loan pricing must account for:

  • Expected loss

  • Operating costs

  • Risk weighting and capital requirements

  • Target RoE 

3.4 Credit Rating Methodologies

External and internal credit ratings are essential tools:

External Ratings (S&P, Moody’s, Fitch)

  • Investment grade: BBB- (S&P) or Baa3 (Moody’s) and above

  • High yield (speculative): Below investment grade

  • Rating scales reflect default probability 

Internal Rating Systems
Banks develop proprietary models to assess credit risk, typically incorporating:

  • Financial metrics and ratios

  • Qualitative factors

  • Industry-specific risk factors

  • Rating migration analysis

Rating Agency Preferred Ratios: Standard & Poor’s, Moody’s, and Fitch publish ratio benchmarks for each rating category .

3.5 Credit Proposal Structure

A typical corporate credit proposal contains :

  1. Executive Summary: Deal rationale and key terms

  2. Client Overview: Business description, history, ownership

  3. Financial Analysis: Historical and projected financials, ratio analysis

  4. Risk Assessment: Key risks and mitigation strategies

  5. Facility Structure: Terms, pricing, covenants, collateral

  6. Recommendation: Approval request with supporting rationale

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