There are two divisions of financial analysis. The main difference between them lies in the securities being valued. Equity research deals with analyzing publicly listed stocks on the stock exchange. On the other hand, credit research refers to evaluating the debt portion of a firm. The main objective of both the types of research is to value a company and find out the best price an investor could pay.
Credit research is the study of a company’s financial position. It also involves analyzing the company’s financial statements, but the focus is on its capital structure and how capable is it in managing its finances. The objective behind conducting credit research is to find out if the company will sustain long with its current equity and debt structure and will it be able to make payments to the debt it has taken.
In credit research you just cannot go wrong, while in equity there can be 60 – 70% accuracy.
Credit analyst work for their clients (i.e., investors) and all their research work is targeted to satisfy their needs and requirements. Debt (or credit) investors are people who lend money to the companies in the form of debt in order to receive some interest rate. In other words, debt investors are lenders for the company, their maximum upside is limited.
Credit research focuses on the downside risk . Analysts are only bothered about the company’s financial position. They look if the company is having sustainable cash flow and is able to repay their interest along with the bond principal after maturity.
Source: Market Quotient
A credit research analyst is responsible for researching an individual’s (or company’s) credit history and financial information to help determine how creditworthy they are. The analyst must look deeply into the personal and financial background of every credit applicant to help the lender determine if the applicant is worth the risk of offering credit or a loan.
Process of credit analysis
- Firstly, credit analysts review the past records of the borrower, the market reputation or any negative news issue to evaluate the repayment capability.
- Next, in order to implement effective credit analysis, the analyst should necessarily be proficient at studying the financial statements of a firm and analyzing the ratios intimated by the statements.
- Further, the analyst also requires to check whether the borrower will have enough free cash flows to honour his responsibilities.
- And finally, the analyst applies statistical tools to indicate a risk rating to the borrower and also checks the amount of potential loss to the lender in the event of an error.
Role of a credit analyst
- A credit analyst analyzes investments to determine their potential risk for the investor.
- They are typically employed by commercial and investment banks, credit card issuing institutions, credit rating agencies, and investment companies.
- They examine financial statements and use ratios when analyzing the financial history of a potential borrower.
- For debt issuers and their instruments such as bonds, credit analysts assign scores based on letter grades such as AAA, AA+, BBB, or junk, which is below investment grade.
Jobs for credit research analysts
1. Business Credit Analyst– Business Credit Analysts evaluate the risk when claiming business loans. They manage the credentials of the clients business. They thoroughly go through assets, profit, and losses. They even access the security of the client’s business client’s economic growth and client’s potential growth. They approve, provide, render and guide the clients who are involved in business.
2. Consumer Credit Analyst– A Consumer Credit Analyst analyzes the risk in seeking personal loans. They provide details of the loans, check the documents, study client’s history and liabilities. They even gather information such as past credit details, default, an asset in the form of money, investment or real estate, salary, and credit.
3. Corporate Credit Analyst– A Corporate Credit Analyst undertakes the credit risk of a non-financial Enterprises like industry, companies in manufacturing firms, trading firms and service providing agencies. A Corporate Credit Analyst manages the portfolio of corporate counterparties not only based on the financial background of the form but also based on its payscale, geography, manufactured products and the other industries for firms involved in it. They even provide the support analysis of loan and product transactions depending on individuals experience.
4. Financial Institution Credit Analyst – A Financial Institute Credit Analyst assesses the certification of a financial interdisciplinary. There is a lot of transaction between two banks, so they evaluate the cash flow and the collateral-based loans credit. They are responsible for accepting the loan servicing department in the maintenance of loan files, payoff and support portfolio of the financial firm.
5. Sovereign Credit Analyst – Countries all over the world borrow and lend funds from their symbiosis countries, IMF, World Bank and other financial firms. A Sovereign Credit Analyst measures the certification of the government of a country from where the fund will be borrowed. Analysis of the country is based on tax, the geopolitical situation, expenditure, and fiscal deficit. An ideal brain credit analyst has a good understanding of country risk and economics through working with experienced analysts.
6. Credit Investment Analyst – A Credit Investment Analyst analyses security based on certain factors, and depending on the factors comes the risk. They analyze both like credit risk, interest rate risk of the security so that the institution of form investors can make informed decisions before investing.
7. Banks and the other Financial Institutions – All the banks which provide credit to the individual and corporate firms are the biggest job givers of the credit analyst for the even measure the worth of the loan of an applicant.
8. Institutional Investors – Institutional investors recruit the employee analyst to measure the Predator is that it involves bonds and other securities.
9. Rating Firms – Rating Agencies give credit rating to banks, other Financial Institutions, corporate and government. These are some Global credit rating Agencies that recruit search analysts.
10. Government Agencies – Government Agencies like banks, credit providers, market participants and policy Agencies search for analysts to analyze the creditworthiness of the country.
source : Shiksha.com)
Skills that a credit analyst must possess include –
- Diligence: The job requires great attention to detail. As a credit analyst, any missing piece of information may lead to an incorrect analysis of a customer and a costly problem for the company.
- Quantitative Analysis Skills: A credit analyst has to be able to review or create a set of numbers and understand what they mean.
- Written and Oral Communication Skills: A credit analyst must be able to effectively report results and decisions orally or in writing.
- Industry Knowledge: For some jobs, a credit analyst may need specialized knowledge of a particular industry. If you line up an interview with a retail giant or an automaker, do some research in advance so that you can talk intelligently about the industry and its challenges.
- Multitasking and Prioritization Skills: A credit analyst needs to be able to work on multiple projects at the same time and prioritize them properly. This will be expected on the job.
- Experience with Financial Software: A credit analyst has to be comfortable using Microsoft Excel or similar software used to analyze numerical data.
(source : investopedia.com)
Research done by credit rating agencies
I. Business Risk Analysis – This includes an analysis of industry risk, market position of the company, operating efficiency of the company and legal position of the company.
II. Financial Analysis – This includes an analysis of four important factors namely – accounting quality, earnings potential/profitability , cash flows analysis and financial flexibility.
III. Management Evaluation – Any company’s performance is significantly affected by the management goals, plans and strategies, capacity to overcome unfavorable conditions, staff’s own experience and skills, planning and control system etc. Rating of a debt instrument requires evaluation of the management strengths and weaknesses.
IV. Geographical Analysis – Geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company. An issuer company having its business spread over large geographical area enjoys the benefits of diversification and hence gets better credit rating.
V. Regulatory and Competitive Environment – Credit rating agencies evaluate structure and regulatory framework of the financial system in which it works.
VI. Fundamental Analysis – Fundamental analysis includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company.
Some of the major credit rating agencies in India are – CRISIL, ICRA, CARE, Duff & Phelps
(Source: Management of Financial Services,Rai University, Journal)
Research done by lender (NBFC)
1. Information collection – the lender is interested in the past repayment record of the customer, organizational reputation, financial insolvency, as well as their transaction records with the bank and other financial institutions.
2. Information analysis – The information collected in the first stage is analyzed to determine if the information is accurate and truthful.The credit analyst also evaluates the financial statements, such as the income statement, balance sheet, cash flow statement, and other related documents to assess the financial ability of the borrower.
3. Approval (or rejection) of the loan application – The final stage in the credit analysis process is the decision-making stage. After obtaining and analyzing the appropriate financial data from the borrower, the lender makes a decision on whether the assessed level of risk is acceptable or not.
All ‘ratings’ are not the same – credit ratings and fund ratings are like chalk and cheese. Credit ratings are mandated and provide an audit of facts based on which they base their opinions on the financial viability of the entity. Fund ratings are not mandated and provide no audit of facts; some are simply a statement of history, others merely an opinion on the likely future performance of the funds relative to the market and peers. Read the full article – https://www.moneymanagementindia.net/role-of-financial-ratings/
Credit research as a career in India
The job of credit analysis provides exposure to a large variety of organisations and industries including SMEs, MNCs, and partnership firms along with other banks. This aspect makes the credit analyst as one of the most vibrant career opportunity in the field of finance in the country.
“There are vast opportunities in the field of a credit analysis in India as everyone seeking a loan, be it a small start-up or a substantial and famous MNC, have to undergo assessment before the bank approves their loan. A significant benefit of being a credit research analyst is that there is no shortage of an option for employers. The analyst is not limited to work for a bank or a credit rating agency only but can also work for other companies offering products related to accounting and finance. So, a credit research analyst is liable to be employed by a retail store, an energy company, automobile manufacturer, utility, etc. Another advantage of taking credit analyst as a career option is that it empowers a person to pursue more exciting career options in future such as portfolio manager, loan manager, investment banker and a trust manager. Although it is a lucrative career option, it demands a lot of hard work and dedication.
Pros and cons of being a credit research analyst
Work with important information and dataAccess to senior management of the companyHandling of confidential information, provide recommendations to improve the business Work with numbersBuild interesting presentations
Long hoursHigh level of responsibility (stress)High urgency for most workExtreme attention to detail requiredLittle opportunity to be creative.
The annual salary for credit analysts in India ranges between Rs 5 lakhs to 8 lakhs and is dependent upon the level of experience, type of industry, and geographic location. (source; India Today)