Loan Request Evaluation
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Loan Request Evaluation
This report introduces a procedure that can be used to analyze the quantifiable
aspects of commercial credit requests. The procedure incorporates a systematic
interpretation of basic financial data and focuses on issues that typically
arise when determining creditworthiness. Cash flow information is equally
important when evaluating a firm’s prospects. Reported earnings and EPS can be
manipulated by management debts, are repaid out of cash flow not earnings. The
basic objective of credit analysis is to assess the risk involved in credit
extension to bank’s customers. Risk refers to the volatility in earnings.
Lenders are concerned with net income or the cash flow that hinders a borrower
ability to service a loan. Credit analysis assigns some probability to default.
Some risks can be measured with historical and projected financial data. The key
issues include the following: 1. For what are the loan proceeds going to be
used? 2. How much does the customer need to borrow? 3. What is the primary
source of repayment, and when will the loan be repaid? 4. What collateral is
available? Fundamental credit issues: Virtually every business has a credit
relationship with a financial institution. But regardless of the type of loan,
all credit request mandate a systematic analysis of the borrower’s ability to
repay. When evaluating a loan a bank can make two types of errors: 1. Extending
credit to a consumer who ultimately would repay the debt. 2. Denying a loan
request to a customer who ultimately would repay the debt. In both cases the
bank loses a customer and its profit decreases. For this reason, the purpose of
credit analysis is to identify the meaningful and probable circumstances under
which the bank might lose. So a credit analyst should analyze the following
items: *Character: The foremost issue in assessing credit risk is determining a
borrower’s commitment and ability to repay debts in accordance with the terms
of a loan agreement. An individual’s honesty, integrity, and work ethic
typically evidence commitment. Whenever there is deception or a lack of
credibility, a bank should not do business with the borrower. It is often
difficult to identify dishonest borrowers. The best indicators are the
borrower’s financial history and personal references. When a borrower has
missed past debt service payments or has been involved in default or bankruptcy
a lender should carefully document why to see if the causes were reasonable.
Similarly,...
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