Credit analysts collaborate with various departments in a company, such as accounting and legal, to inform their decision-making regarding these complex challenges. Explore the role’s responsibilities, the types of credit analyst jobs, everyday skills, required education, and the average salary. To become a credit analyst you will usually be required to have a minimum of a bachelor’s degree in finance, accounting, or a related field. A potential employer may look to see if you have completed courses in statistics, economics, financial statement analysis, and risk assessment.
Typically on a quarterly basis and using trailing twelve months (“TTM”) financials. Affirmative (or positive) covenants are specified tasks that a borrower must complete throughout the tenor of the debt obligation. In short, affirmative covenants ensure the borrower performs certain actions that sustain the economic value of the business and continue its “good standing” with regulatory bodies. In return for this security (and collateral protection), bank debt has the lowest expected return, while unsecured lenders (similar to equity shareholders) demand higher returns as compensation for the additional risk taken on. If a borrower were to breach a debt covenant in place, this would constitute a default stemming from the violation of the credit agreement (i.e., serving as a restructuring catalyst). But in most cases, there will be a so-called “grace period”, whereby there may be monetary penalties as stipulated in the lending agreement but time for the borrower to fix the breach.
A company’s debt is considered junk or below investment grade, once it goes below a certain rating. These investments typically carry higher yields to accommodate for the additional credit risk. A company’s competitive position in its market can have a significant bearing on its ability to sustain its financial position, so detailed credit analysis may consider competitive factors and positions.
For example, a company cannot raise debt or complete a debt-funded acquisition if doing so would bring its total leverage ratio above 5.0x. Failure to pay taxes or to file its financial statements, for example, would certainly harm the economic value of the business from potential legal problems arising. The higher the default risk, the higher the required yield is, as investors require more compensation for the additional risk being undertaken. There is considerable opportunity for finance enthusiasts that wish to make a career in commercial banking; 2022 commercial banking industry revenue in the United States was estimated at USD$963bn[1].
Indicators of a strong competitive position include a business strategy that appears consistent with industry trends and is adaptable to changes in the market. A strongly competitive company also demonstrates track records of product development, service quality, and customer satisfaction and retention. Strong companies may also benefit from high barriers to competition with strong patent and copyright protection, protective regulations, and franchise, permit, or licensing agreements. Negative covenants restrict borrowers from performing actions that might damage their creditworthiness and impair lenders’ ability to recover their initial capital.
We also provide an example of a typical career path to help you envision if this is the direction you want to pursue. Our coverage focuses primarily on analysis of corporate debt; however, credit analysis of sovereign and nonsovereign, particularly municipal, government bonds will also be addressed. Structured finance, a segment of the debt markets that includes securities backed by such pools of assets as residential and commercial mortgages as well as other consumer loans, will not be covered here. While leverage ratios assess whether the borrower has an excess level of leverage on its balance sheet, the coverage ratios confirm whether its cash flows can cover its interest expense payments. Credit analysts play a pivotal role in companies by assessing financial risk through the analysis of financial information. Using the results from this analysis, credit analysts provide recommendations on whether a loan or other request for credit becomes granted or rejected and what the particular terms of the deal are.
Credit Analysis 101: Financial Risk Ratios
Credit analysis also includes an examination of collateral and other sources of repayment as well as credit history and management ability. As mentioned, analysts attempt to predict the probability that a borrower will default on its debts, and also the severity of losses in the event of default. Credit analysis seeks to provide a fundamental view of a company’s financial ability to repay its obligations. While factors such as operating margins, fixed expenses, overhead burdens, and cash flows might be the same in equity and credit analyses, the emphasis is different for each. And while a strong credit rating does not seek to forecast strong equity performance per se, an understanding of credit ratings can help assess the equity performance potential of a company. An example of a financial ratio used in credit analysis is the debt service coverage ratio (DSCR).
How Covenants Impact Debt Pricing (and Credit Risk)
Credit analysis is also used to estimate whether the credit rating of a bond issuer is about should i use an accountant or turbotax to change. By identifying companies that are about to experience a change in debt rating, an investor or manager can speculate on that change and possibly make a profit. According to Lightcast™, the average annual salary for credit analysts in the United States is $92,186 [1].
The univariate approach enables an analyst starting an inquiry to determine whether a particular ratio for a potential borrower differs markedly from the norm for its industry. In reality, however, the unsatisfactory level of one ratio is frequently how to calculate direct labor cost mitigated by the strength of some other measure. A firm, for example, may have a poor profitability ratio but an above-average liquidity ratio. One limitation of the univariate approach is the difficulty of making trade-offs between such weak and strong ratios. However, some univariate measures – such as the specific industry group, public versus private company, and region – are categorical rather than ratio-level values.
Negative Loan Covenants
Credit analysts who assess bonds often work at credit rating agencies such as Moody’s or Standard & Poor’s (S&P). Insurance companies are also rated on their credit risk and financial stability by rating agencies such as AM Best. Banks can use financial data to determine whether they want to approve certain loans by analyzing how much risk is involved in lending. If a loan is approved, the credit analyst monitors the borrower’s performance and may recommend terminating the agreement if it becomes risky.
Whether structuring a secured senior loan or other forms of debt lower in the capital structure, covenants are negotiations between the borrower and the creditor to facilitate an agreement that is satisfactory to both parties. Note, when a borrower is at risk of default, the metrics used are on a short-term basis, as seen in the working capital metrics and cash conversion cycle. But for non-distressed borrowers, extended time horizons would be used for calculating working capital metrics.
We first introduce the key components of credit risk—default probability and loss severity— along with such credit-related risks as spread risk, credit migration risk, and liquidity risk. We then discuss the relationship between credit risk and the capital structure of the firm before turning attention to the role of credit rating agencies. We also explore the process of analyzing the credit risk of corporations and examine the impact of credit spreads on risk and return. Finally, we look at special considerations applicable to the analysis of (i) high-yield (low-quality) corporate bonds and (ii) government bonds.
What Is a Credit Analyst?
Private, non-bank lenders come in many shapes and sizes, including residential and commercial real estate lending, equipment finance, and asset-based lending, among others. There are also many opportunities for people with lending experience to look at private loan and mortgage broker firms. Lenders, also known as creditors, employ a variety of qualitative and quantitative techniques (including risk models) when conducting credit analysis in order to quantify and effectively price risk. As a credit analyst, you’ll utilize various technical and workplace skills to complete your job effectively.
The financial assessment of a borrower looks at its revenue and cost structures, both in isolation (using a cross section of meaningful ratios and metrics) and in relation to peer-group and industry benchmarks. The more senior lenders there are, the more difficult it could be for lower priority claims to be paid in full, as senior lenders such as banks are risk-averse; meaning capital preservation is their priority. Maintenance covenants require the borrower to maintain remain in compliance with certain levels of credit metrics and are tested periodically.
- This growth is greater than the average for all occupations in the US and represents over 27,000 job openings per year [4].
- Credit analysis is conducted in order to understand the level of credit risk presented by a borrower, given the parameters of a specific credit request.
- Such companies should show near-optimal capacity utilization at peak times and will also tend to produce above-average results even under the financial stress of a business downturn.
Qualitative techniques include trying to understand risks in the external environment, like where interest rates are heading and the state of the broader economy, among others. Alternatively, the resource may be a physical product (like inventory); this is called trade credit. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
