The Credit Analyst

In this chapter, various credit analysis subfields and the different roles performed in each field are surveyed with the aim of providing a practical overview of the field and defining our inquiry. Analysis of credit and their analysts are categorized in the following ways: by function, by the type of analyzed entity.

The Universe of Credit Analysts

The main duty of a credit analyst is to assess the risks associated with credit where a wide range of functions is encompassed without modifications. However, depending on factors like responsibility scope, content and their compensation, the ranks of credit analysts differ significantly.

Job Description 1: Credit analyst

The following are the tasks performed under this job: loan pipeline management, loan, and client documentation review to establish whether to approve or decline the loan, data entry, perform property appraisals and some fundamental mortgage computations.

Consumer Credit

Retail consumer credit and basically mortgage financing are dealt with in this position. The holders of this rank are usually junior officers with little say. A lot of emphases is placed on documentation and establishing whether the loan applicant meets the required score.

Job Description 2: Credit analyst

The following are the tasks performed under this level: analyze and review scoring analytics, developing, testing, implementing and maintaining a variety of scorecard collections and origination, reviewing modifications are to existing systems and finally making of reports that support risk decisions.

Credit Modeling

Even though the position involves consumer credit, it does not analyze exposure at an individual level. The position focuses on both the development and the review of structures of consumer credit and scoring.

Job Description 3: Credit Analyst

The holders of this position are normally experienced analysts of credit responsible for modeling and credit presentation.

Corporate credit

Corporate credit analysts may also perform duties regarding the development of credit risk models since the scope extends only to corporate entities.

Job Description 4: Credit Analyst

The other task performed include to monitor exposures to counterparties (banks, brokers, insurance companies and hedge funds), prepare credit reviews, approve limits, and update policy and procedures.

Counterparty credit

The majority are employed by financial intermediaries whereas others may work for nonfinancial corporations and government bodies. Here, the analytical role embraces a broad range of situations and activities.

Classification by Functional Objective

Functional roles can also be used to differentiate practitioners in credit analysis. While most are employed to evaluate risk, a small group may be employed to explore investments in a debt security; this may have an impact on the analyst’s objective and daily work.

Risk Management Versus Investment Selection

The primary role of credit analysts is to facilitate risk management. Within the private sector, the function may include: researching prospective clients, preparing credit reports, setting risk limits and facilitating the risk management.

Within the public sector, credit analysts undertake independent reviews of specific institutions. They are employed by regulatory agencies who aim to maintain a sound financial system, encourage investments and foster economic growth.

Risk rating agency on the other hand, even though not directly involved in risk management, provides unbiased analysis on which to assign rating by evaluating issuers, counterparties, and debt issues. The agency is thus used to facilitate risk management and investment selection.

Credit analysts that perform investment selection are classified as fixed income analysts. Their function involves identifying potential investments and making recommendations on how to allocate resources.

Note that the function of risk management and investment selection are separate domains within a financial institution.

Primary Research versus Secondary Research

The amount of time and resources availed to an analyst to assess relevant risks will often depend on the nature of the position. The cost of analysis may be higher when performed by a human as opposed to when the analysis is automated. The cost rationale may also constrain counterparty credit analysts since banks and other financial institutions cannot be fully automated.

Even though counterparty credit analysts may conduct an independent review of banks’ financial statements, the conclusion will include the analyst’s own assessment; this may cause the resulting credit report to vary from one institution to another.

Rating agency analysts are required to produce a comprehensive credit evaluation that helps facilitate complete credit reviews fast and efficiently. They do so by undertaking an intensive primary research. To ensure high-quality credit evaluation and that adequate resources are allocated, each analysis covers a fairly small number of instructions.

A Special Case: The Structured Finance Credit Analyst

Structured finance credit analyst functions are generally outside the scopes described above. Structured finance refers to the advance of funds secured by defined assets or cash flow, the credit analysis in such a case, therefore, depends on the manner in which the said asset or cash flows are assembled.

Additional security is provided for structured finance even though, ideally, structured finance methods resemble ordinary secured lending backed by collateral. This can be by means of transferring the assets to a special purpose vehicle (SPV) or transfer of credit using credit derivatives.

Classification by Type of Entity Analyzed

Credit analysis may be categorized into four fields that correspond to the basic credit exposure: these are Consumer, Corporate, Financial institutions, and Sovereign/Municipal. In the field of both counterparty credit analysis and fixed-income analysis, differences can be made between the generic credit evaluation of an issuer of debt without reference to a security issued and the credit evaluation of securities themselves.

1. Corporate Credit Analysts

These analysts evaluate the credit risk of nonfinancial companies; this can be done for the purpose of lending to them, holding their stock or providing service.

2. Bank and Financial Institutions Analysts

These analysts look at banks and other financial institutions with the objective of assessing the creditworthiness of financial third parties. This is done before entering into multiple bilateral transactions with the bank as counterparty. In such a setting, the credit risk that arises is known as counterparty credit risk; it is the job of such an analyst to evaluate these risks.

3. Sovereign/Municipal Credit Analysts

These analyst asses the risk of default on funds borrowed through the issue of fixed-income securities in local and international markets, they also help profile credit risk with respect to other exposures. They make use of tools similar to those used by corporate analysts in examining macroeconomic indicators among other metrics.

The Relationship between Sovereign Risk and Bank Credit Risk

The two are closely linked and affect each other, thus, therefore, the level of sovereign risk associated with a given market is important in the credit analysis of banks in that market. While the sovereign risk may seem itself relevant to the analytical process, bank credit analysts are generally interested in the systemic risk associated with the banking industry.

Classification by Employer

Looking at the employing organization can also help show what kind of work credit analysts do. This may correspond to the following functional roles:

  1. Banks, non-bank financial institutions (NBFI), and institutional investors;
  2. Rating agencies: these analysts evaluate the creditworthiness of banks, corporations, and governments; and
  3. Government agencies: these analysts function in a regulatory capacity to assess the riskiness of bank and insurance companies.

Role of the Bank Credit Analyst: Scope and Responsibilities

The main role of counterparty credit analysts is evaluating banks and other financial intermediaries as part of risk management.

Credit Analyst versus Credit Officer

Both fixed-income and counterparty credit analyst research are undertaken with the aim of drawing conclusions and making recommendations that influence a business decision. In some banks, the role of credit analyst may be separated from that of the credit officer whereas, in other organizations, the role may closely overlap – one employee performs both functions.

Product Knowledge

Product knowledge is the understanding of the features of a broad range of financial products, and it is important in making decisions about specific limits on exposure and approval or disapproval of a proposed transaction. These features include:

  1. The impact of a proposed transaction on borrower’s financials;
  2. The amount and type of credit risk mitigation;
  3. The features of the obligation and its risk attributes; and
  4. iv. The contract agreed to by the borrower.

The Fixed–Income Analyst

Credit analyst may also act as investment analysts where they take decisions on whether to buy, sell or hold a given fixed-income security (bond). Their analysis can be divided into:

  1. i. Fundamental analysis: explores most of the issues undertaken by a credit analyst; and
  2. Technical analysis: which looks at market timing issues affected by risk appetite of institution and market perception.

Impact of the Rating Agencies

The impact of the rating agencies on fixed income analysis is as follows:

  1. It facilitates the establishment of benchmark yield curves, which strengthen markets an enhance liquidity through independent credit assessments of bond and sovereign risk; and
  2. ii. It is critical in fixed-income analysis with regard to the fundamentals they reveal, timing and probability of rating action being taken.

Credit Analysis versus Equity Analysis

Given that bank stocks are often of greater interest, most of the available analysis on banks is produced by equity analysts. Their aim is to determine whether an investor should invest in the shares of a particular firm. They confine their analysis to publicly listed financial institutions.

Another difference between the two is that equity analysis base their share price valuation on financial projections derived from historical data which in turn is the sole focus of credit analysts.

Credit Analysis: Tools and Methods

Credit analyst may use different tools and resources to gather information, distill the data, compare it and reach conclusions which are then expressed as credit reports or profile. Often times, the analytical approach used will differ according to the circumstances. This means is that tools, methods and resulting work products depend on the nature of the analyst’s role.

Qualitative and Quantitative Aspects

Credit analysis is both qualitative and quantitative; it involves a review of the company’s past performance, present condition, and future prospects.

Quantitative element of assessment includes a comparison of financial indicators and ratios. This allows the analysts to compare company performance and financial condition over time and across the industry. Qualitative element, on the other hand, concerns attributes of financial performance that cannot be directly reduced to numbers.

Macro and Micro Analysis

Analysts need to be aware of the risk environment of the market in which a bank operates, and the economic and business condition of the entire financial sector. Therefore, sovereign, systemic, legal and regulatory concerns must all be incorporated.

Primary Research

Audited annual financial statements are very important in credit analysis. Others important documents include regulatory filings, prospectuses, offering circular and internal or public documents.

Requisite Data for the Bank Credit Analysis

The nature of the assignment undertaken determines the items needed to perform credit analysis. The resources to be reviewed include the following:

  • Annual reports including auditor’s report, financial statement and supplementary information
  • Annual and interim financial statements
  • Security pricing data
  • Prospectuses and regulatory filings
  • Reports by rating agencies, regulators and investment banks
  • Notes from primary and field research

Bank credit analyst may then employ the CAMEL system once all the above information is available to them. The elements of the CAMEL system are: Capital, Asset quality, Management, Earnings, and Liquidity.

Practice Questions

1) Which of the following statements is most accurate?

  1. Given that bank bonds are often of greater interest, most of the available analysis on banks is produced by credit analysts.
  2. Given that bank bonds are often of greater interest, most of the available analysis on banks is produced by equity analysts.
  3. Given that bank stocks are often of greater interest, most of the available analysis on banks is produced by credit analysts.
  4. Given that bank stocks are often of greater interest, most of the available analysis on banks is produced by equity analysts.

The correct answer is D.

Given that bank stocks are often of greater interest, most of the available analysis on banks is produced by equity analysts. Their aim is to determine whether an investor should invest in the shares of a particular firm. They confine their analysis to publicly listed financial institutions.

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