Credit analysis topics

8/7/2019 Credit analysis topics

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The borrower could be a corporation, a large project, or

a sovereignty (such as a government). The loan may involve

fixed amounts, a credit line, or a combination of the two.

Interest rates can be fixed for the term of the loan or

floating based on a benchmark rate such as the London

Interbank Offered Rate (LIBOR).


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Typically there is a lead bank or underwriter of the loan,

known as the "arranger", "agent", or "lead lender". This

lender may be putting up a proportionally bigger share of

the loan, or perform duties like dispersing cash f lows

amongst the other syndicate members and administrative

tasks.


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M

EANING:The process by which a financial institution / Bankcalculate interest rates and fees that cover their Cost of

Funds and overheads and provide them with an acceptable

return.

PURPOSE:

To cover costs

Prevent impact on earnings, credit risk & capital adequacy

Protect against losses due to bad debts

Provide for borrowers need and growth


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FACTORS TO BE CONSIDERED:

Cost of funds

Cost of operations

Credit riskCustomer options (Cash credit / working capital term loan)

Interest payment and amortization (payment by borrower

to be adjusted to principal or interest)

Loanable funds (availability of funds at the bank)

Capital and earning requirements


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1. The base loan rate is prefixed as per general loan

pricing methodology

2. Depending on the loan category backed up by the type

and soundness of security, a numeric value is added to

the base loan price.

3. Quantum of risk is measured by conventional models.


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Example:

CATEGORIES RISK PRICE SECURITY CATEFORIES

1Base + 0

Cash or Certificate of depositsecured, or Govt. guaranteedloan

2Base + 0.25%

Loans secured by stock, cashvalue of life insurance,corporate bonds

3Base + 0.45%

(Average risk) loans secured byreal estate. Receivables etc.

4Base + 0.75%

(Above average risk) loans tocompanies with slightlydeteriorating profitability etc.)


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LOAN PORTFOLIO MANAGEMENT

(LPM)It is a technique by which risks that are inherent in the

credit process are managed and controlled

It involves evaluation ofthe steps taken by the bankto

identify and control risk, throughoutthe credit process.

Such steps should identify indicators to provide sufficient

lead time for corrective action, when there is a systematic

increase in risk.


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ELEMENTS OF LPM

1. Assessment of credit culture

2. Portfolio objectives & risktolerance limits

3.M

anagement

information sys

tems

4. Portfolio segments and risk diversification

5. Analysis of loans originated by other lenders

6. Aggregate policy and underwriting

7. Stress testing of portfolio

8. Independent & effective control functions

9. Analysis of portfolio and risk/reward trade off


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STRESS TESTING OF LOANPORTFOLIOS

Stress testing isused to evaluate the potential vulnerability to

some unlikely but plausible events or movements in financial

variables. There are broadly two categories of stress tests viz.

sensitivity tests and scenario tests.

Sensitivity tests are used to assess the impact of change in one

variable (Eg., a significant movement in the foreign exchange

rates, a large movement in the equity index etc.) on the banks

financial position.


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STRESS TESTING OF LOANPORTFOLIOS

Scenario tests include simultaneous moves in a number of variables

(eg.,, equity prices, oil prices, foreign exchange rates, interest rates,

liquidity etc.) based on a single event experienced in the past (eg., natural

disasters, stock market crash, depletion of a countrys foreign exchange

reserves) or a plausible market eventthat has not yet happened (i.e.,

hypothe

tical scenario (eg., collapse of communica

tion sys

tems across

the entire region/ country, sudden or prolonged severe economic

downturn) and the assessment oftheir impact on the banks financial

position.


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INTERNAL RATING SYSTEMORIGIN:

Proposed by Basel II recommendations to impose a

risk based capital adequacy frame work for banks.

Such frame work will depend on 3 pillars:

P

illarI

M

inimum capit

al requirement

sPillarII - Supervisory Review process

PillarIII Market discipline


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One of the methodologies for determining capital

requirements for credit risk is Internal Rating:

1. To determine approval requirements and

identification of problem loans

2. To account for proper gradations in risk and

the overall composition of portfolios in

originat

ing new loans, assessing port

foliorisks and concentrations and reporting on risk

profiles


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CREDIT RISK ANALYSIS

MEANING:

The potential loss that a Bank may be

subjected to, because of inability of a

counter party (borrower) to meet its

(his/her) obligations.

Such a loss occurs in the event of default ofa borrower or in the event of a deterioration

ofthe borrowers credi

tquali

ty


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COMPONENTS OF CREDIT RISK

1. Default risk

2. Exposure risk (eg. L C which may not be honoured)

3. Recovery risk

4. Collaterals value

5. Guarantors value

6. Enforceability of securities


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CREDIT DERIVATIVES

A contractbetween two parties that allows forthe use of

a derivative instrument to transfer credit riskfrom one

party to another. The party transferring riskaway has to

pay a fee to the party that will take the risk.


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CREDIT DERIVATIVES ContdCredit derivative products yet to be introduced in

India. Evolution of developed market for credit

derivative is required to mange credit risk

effectively and to get full benefit of risk mitigation.


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ASSET SECURITISATION

A device of structured financing where an entity

seeks to pool together its interest in identifiable

cash flows overtime, transferthe same to

investors either with or withoutthe support of

further collaterals, and thereby achieve the

purpose of selling a stream of cash flows that

was otherwise to accrue to it.


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ASSET CLASSIFICATIONSTANDARD ASSET:

The account is NOT non-performing and does not carry

more than normal risk attached to the business.

NON PERFORMING ASSET:

An account of a borrower if interest charged to that

particular borrower is not realised despite the account

being fully secured


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NON PERFORMING ASSET

1. SUB STANDARD ASSET :

Remained as NPA for 12 months or less than 12

months2. DOUBTFUL ASSET:

A sub standard asset remained as such for 12

months3. LOSS ASSET:

An asset considered as uncollectible and of little

value identified by auditors or RBI


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INCOME RECOGNITION

1.Income from

NPA no

tto be recognized unlessrealised.

2. Fees & Commission receivable on account

ofre scheduling of loans to be recognised on

accrual basis.

3. Income from Govt guaranteed advances NOT

to be recognised, unless realised


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PROVISIONING NORMS

SUB-STANDARD ASSETS:20% OF OUTSTANDING BALANCE

DOUBTFULASSETS:

100% OF THEEXTENTTO WHICHTHEADVANCEIS NOT COVERED BY THE

REALISABLEVALUE OF THESECURITY

CHARGED TO THE BANK

LOSS ASSETS:

100% OF THEENTIRELOAN


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PROBLEM LOAN

y In the banking industry, a problem loan is one

oftwo things; it can be a commercial loan that

is at least 90 days past due, or a consumer loan

that it at least 180 days past due.


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SUSTAINABLE DEBT

Generally used in external borrowing by countries.

In the context of banks, it would mean to support anover due account by rescheduling the loan

repayment / grant of additional loan for turn

around etc., by which the loan account can becarried forward without foreclosure. Such support

should be based on its viability.


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LOAN RESTRUCTURING

Also referredt

o as loan rescheduling, loanrenegotiation.

To re adjustthe terms of loan agreement , subjectto the following situations:

1. Before the commencement of commercialproduction

2. After the commencement of commercial

product

ion but

beforet

he asset

is declared assub standard

3. After the commencement of commercialproduction and after the asset is declared as sub

standard


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LOAN WRITE OFF

yBanks write offbad debt that is declared non-

collectable (such as a loan on a defunct business or

a credit card due that is in default), removing it

from their balance sheets

ySituations like natural calamities, change in Govt.

Policies, Legal disputes and decrees


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DEBT EQUITY SWAP

y In a debt/equity swap, the debt is exchanged for

a predetermined amount of equity (or stock).

The value ofthe swap is determined usually at

current market rates. However, the

management may offer higher exchange values

to convince the share and debt holders

t

o part

icipat

e int

he swap

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Credit analysis topics