The Handbook of Credit Risk Management, 2nd Edition

CHAPTER 6Fundamental Credit Analysis

A basic requirement for any career in credit risk management is being able to perform a fundamental credit analysis. Within the credit risk management function, counterparty risk assessment employs the most professionals. The responsibilities of the credit analysts are to review the financial strength of entities that, in turn, is used to establish credit limits and approve transactions.

Senior executives who sit on credit committees also must have a thorough working knowledge of credit analysis because they are the ultimate decision makers in those credit committees. They must be able to quickly understand the credit reports produced by risk managers, to ask relevant questions, and then to make informed decisions using their judgment and experience.

The credit analysis of an entity revolves around the knowledge of:

• Its political, economic, regulatory, and competitive environment.
• Its management, products, and operations.
• Its financial status, such as liquidity, leverage, profitability, and cash flow, much of which is knowable through analysis of its financial statements.

In this chapter, we focus on fundamental concepts of credit analysis.

The deliverable of the work of a credit analyst is a credit report that summarizes the financial situation of an entity and that outlines its strengths and weaknesses. To be able to produce a credit report, analysts must have several essential skills:

• A strong understanding of the relevant accounting ...