The Formal Credit Analysis Procedure
The formal credit analysis procedure includes a subjective evaluation of the borrower’s request and a detailed review of all financial statements. The loan officer may perform the initial quantitative analysis for the bank manager. The process consists of:
1. Collecting information for credit file such as credit history and performance.
2. Evaluating management, the company and the industry in which it operates, i.e., evaluation of internal and external factors.
3. Spreading financial statements i.e. financial statement analysis.
4. Projecting the borrower’s cash flow and thus its ability to service the debt.
5. Evaluating collateral or the secondary source of repayment.
6. Writing a summary analysis and making recommendation.
The credit file contains background information on the borrower, past and present financial statements, pertinent credit reports, and supporting schedules such as an ageing receivables a breakdown of current inventory and equipment, and a summary of insurance coverage. If the customer is a previous borrower, the file should also contain copies of past loan agreement , cash flow projections, collateral agreements and security documents and narrative comments provided by previous loan officers, and copies of all correspondence with the customer. One of the most important aspects of lending is determining the customer’s desire to repay the loan. Although this is critically important, it is difficult to measure. Information in the credit file will give the credit officer information on the customer’s repayment history.
The credit analyst also uses the credit file data to spread the financial statements, project cash flow, and evaluate collateral. An evaluation of management, the company and industry is also needed to ensure safety and soundness of loan. The last step is to submit a written report summarizing the loan request, loan purpose and the borrower’s comparative financial performance with industry standards, and to make a recommendation. The loan officer evaluates the report and discusses any errors, omissions and extensions with the analyst.
