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What Is Credit Analysis?: Credit Risk Default Risk Bonds Stocks Loans Credit Analyst Certification

Credit analysis is the process of determining a company or individual's ability to repay debt obligations by analyzing both qualitative and quantitative factors. It is used by lenders to assess default risk when deciding whether to issue loans or bonds. Credit analysis involves examining a company's character, capacity to pay, capital structure, market conditions, and collateral, or an individual's payment history, debts, credit history, and recent applications for new credit. The results of the analysis help lenders understand the likelihood of repayment and determine whether to extend credit.

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59 views6 pages

What Is Credit Analysis?: Credit Risk Default Risk Bonds Stocks Loans Credit Analyst Certification

Credit analysis is the process of determining a company or individual's ability to repay debt obligations by analyzing both qualitative and quantitative factors. It is used by lenders to assess default risk when deciding whether to issue loans or bonds. Credit analysis involves examining a company's character, capacity to pay, capital structure, market conditions, and collateral, or an individual's payment history, debts, credit history, and recent applications for new credit. The results of the analysis help lenders understand the likelihood of repayment and determine whether to extend credit.

Uploaded by

selvarajsathiya
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Credit Loan Assessments

What is Credit Analysis?


Credit analysis is the process of determining the ability of a company or person to repay their
debt obligations. In other words, it is a process that determines a potential borrower’s credit
risk or default risk. It incorporates both qualitative and quantitative factors. Credit analysis is
used for companies that issue bonds and stocks, as well as for individuals who take out loans. To
learn more, check out CFI’s Credit Analyst Certification program.

 
 

Quick Summary

 Credit analysis is a process that determines the ability of a company or


individual to fulfill their financial obligations.
 The process contains both qualitative and quantitative factors such as
amounts owed, character, and capacity to make payments.
 Credit analysis is used to determine whether a company or individual
qualifies for a loan or mortgage. It is also used to determine the quality of
a bond.

Uses for Credit Analysis

Credit analysis is important for banks, investors, and investment funds. As a corporation tries to
expand, they look for ways to raise capital. This is achieved by issuing bonds, stocks, or taking
out loans. When investing or lending money, deciding whether the investment will pay off often
depends on the credit of the company. For example, in the case of bankruptcy, lenders need to
assess whether they will be paid back.

Similarly, bondholders who lend a company money are also assessing the chances they will get
their loan back. Lastly, stockholders who have the lowest claim priority access the capital
structure of a company to determine their chance of being paid. Of course, credit analysis is also
used on individuals looking to take out a loan or mortgage.

Credit analysis is used by:

 Creditors to determine a corporation’s ability to pay back loans


 Creditors to determine an individual’s ability to pay back a loan or mortgage
 Investors to determine a corporation’s financial stability
 A Commercial Banking & Credit Analyst (CBCA)

Credit Analysis for Loans

When a corporation is in need of capital, they can ask banks for a loan. Banks, or creditors, can
be secured or unsecured. As briefly mentioned before, there is an order of priority for claims
during bankruptcy. Secured lenders have the first claim on assets used as collateral. They are
followed by unsecured creditors. Of course, creditors would like to avoid a bankruptcy scenario,
which is why they utilize a credit analysis process to determine a corporation’s ability to pay
back the loan. Loans can also be given to individuals and individuals also go through a credit
check.

For corporate loans, the 5 C’s of Credit are often used to determine credit quality:
 Character
 Capacity
 Capital
 Conditions
 Collateral

For individual loans, credit scores are used, which include:

 Payment history
 Amounts owed
 Length of credit history
 Credit mix
 New credit

Bonds

Bondholders look at a corporation’s bond rating to determine the default risk. Popular rating
systems that perform credit analysis include Moody’s and S&P. Bonds that are ranked high are
investment grade and have low default risk. Those that are non-investment grade are called high
yield or junk bonds. They are dependent on favorable business, financial, and economic
conditions to meet financial commitments.

A company that already has high levels of debt will have a lower bond rating, as they are
considered to have a higher level of risk. Bondholders are usually behind creditors for claim
priorities. So, in the case of bankruptcy, they have less claim on a company’s assets. That’s
another reason why high levels of existing debt are a risk.

Equity

Equity investors buy stock in a company and benefit from a rise in stock price and
from dividends. The credit of a company affects investors in two ways: (1) the value of the stock;
(2) their claim on assets.

Firstly, the value of the stock depends on the growth and stability of a company. Balancing
growth and stability is important and debt plays a role. Debt can drive investment and growth but
too much debt will decrease the stability of a company. If a company has too much debt, then the
stock value will decrease due to lower perceived stability. Higher debt can signify that there is a
higher risk the company will not be able to satisfy its financial commitments and that its stock
price will drop.
On the other hand, if a company has no debt at all, then investors will wonder if the company has
the ability to expand and grow. If not, then stock prices will not appreciate. Credit analysis helps
determine both the growth potential and stability of a company.

The second concern for equity holders about credit quality is the claim on assets. Equity holders
have the least claim on assets of a company in the case of bankruptcy. If the company goes
bankrupt, shareholders will get their claim only if secured and unsecured creditors did not
already take all the remaining assets. This is why the level of existing debt is important for equity
holders as well.

Additional Resources

Thank you for reading CFI’s article on credit analysis. To keep learning and advancing your
career, we recommend the following CFI resources:

 Credit Event
 Leveraged Loans
 Credit Analysis Ratios
 Financial Analyst vs. Credit Analyst

Financial Analyst Training

Get world-class financial training with CFI’s online certified financial analyst training program!

Gain the confidence you need to move up the ladder in a high powered corporate finance career
path.

 
Learn financial modeling and valuation in Excel the easy way, with step-by-step training.

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