Credit Analysis and Lending
Credit Analysis and Lending tests whether a candidate can move from financial statements to a defensible credit decision: assessing repayment capacity and willingness, structuring facilities and covenants, valuing collateral with haircuts, pricing for risk, and recognising deterioration early enough to act.
Core framework
- The 5Cs: character, capacity, capital, collateral, conditions. Capacity (cash flow) repays the loan; collateral is a secondary source.
- Facilities: term loan (amortising or bullet), revolving credit and overdraft (working-capital cyclicality), trade finance (LC, guarantees), syndicated and club deals.
- Covenants: maintenance (tested each period, e.g. net debt/EBITDA ≤ 3.5x) versus incurrence (tested on an action, e.g. new debt). Financial covenants should have headroom and be tied to the repayment drivers.
- Provisions follow IFRS 9: Stage 1 = 12-month expected credit loss, Stage 2 = lifetime ECL after a significant increase in credit risk, Stage 3 = credit-impaired.
Worked example
A borrower has EBITDA 18m, cash tax 2m, maintenance capex 3m, interest 4m and scheduled principal 3m. Cash flow available for debt service = 18 − 2 − 3 = 13m. Debt service = 4 + 3 = 7m. DSCR = 13 / 7 = 1.86x, comfortable against a 1.30x covenant. Note that EBITDA alone (18/7 = 2.57x) flatters the position by ignoring tax and capex. If the facility is 65m against an appraised value of 95m with a 15% forced-sale haircut, net realisable value is 80.75m and LTV = 65 / 80.75 = 80.5%, above a 75% policy cap - so the loan would be cut back or extra collateral required.
Traps that cost marks
- Quoting EBITDA/interest as DSCR and ignoring scheduled principal.
- Using stale or asking-price valuations with no haircut.
- Assuming collateral substitutes for weak cash flow.
- Reporting covenant headroom without stress-testing it.
- Evergreening: new facilities to service old ones, delaying Stage 2/3 recognition.