Credit Analysis and Lending Decisions: From Financials to Sanction
Credit analysis converts information about a borrower into a lending decision. Candidates must understand the information sources (application forms, financial statements, bank statements, credit reference reports, trade references, site visits), the analytical tools (ratio analysis, cash-flow analysis, trend and common-size analysis, projections, sensitivity analysis), and the decision outputs (approve, decline, approve with conditions, or refer).
Know the ratio families: liquidity (current, quick), leverage (debt-to-equity, gearing, interest cover), profitability (gross, operating, net margins, return on capital), and activity (receivable days, inventory days, payable days, cash conversion cycle). Understand that lending decisions hinge on capacity to repay from cash flow, not just collateral. Understand loan structuring: amount, tenor, repayment schedule, pricing, covenants, security, and conditions precedent.
Traps: relying on a single ratio; ignoring quality of earnings or one-off items; treating security as a substitute for repayment capacity; confusing profitability with liquidity; and misreading the cash conversion cycle. Another trap is accepting projections without testing assumptions.
Worked example: a borrower has EBITDA of 1,200, interest of 300 and scheduled principal of 200. Debt service cover = 1,200 / (300 + 200) = 2.4 times. A common rule of thumb is a minimum of 1.25 to 1.5 times; at 2.4 the borrower has comfortable headroom, but the analyst should still stress-test EBITDA down 20% (to 960), giving cover of 1.92 times, which remains acceptable.