Most businesses look for commercial loans to run their everyday operations smoothly. These loans are used to grow, expand, and build working capital. With the increasing demand for commercial loans, many banks outsource their mundane and repetitive tasks to commercial lending solutions providers. These experts have the knowledge, experience, and equipment to conduct varied tasks involved in commercial lending, including origination, underwriting, credit monitoring, lending operations, KYC and compliance services. However, one more essential service they offer is credit analysis.
In 2022, many businesses are struggling to revive after the Covid-19 induced lockdowns worldwide. Therefore, lending to such companies is a risky endeavor for corporate banks in the present scenario. That is why credit analysis is of utmost importance for commercial lending in 2022. Let’s see how.
What is Commercial Credit Analysis?
Commercial credit analysis aims at evaluating a company’s capability to meet its obligations. Its primary objective is to determine the level of risk in lending to a particular entity. For instance, the investors would want to analyze a company’s audited financial statements to determine risk in its bonds. Lenders also review potential borrowers’ financial statements to check their repayment capacity before lending. After evaluation, the commercial lender can obtain an applicant’s risk rating and take its lending decision.
How does Credit Analysis work?
When analyzing a company’s credit, banks, analysts and investors use cash flow analysis, trend analysis, and ratio analysis to determine its default risk. Apart from a review of the applicant’s credit history, credit analysis also verifies the collateral provided and management team. While reviewing loan applications, the analysis mainly emphasizes a company’s cash flows and measures its repayment capacity. The analysts predict a potential borrower’s probability to default on their commercial loans and the level of loss the lender may suffer as a consequence.
Credit analysis takes a lot of work, time, and effort that commercial lenders may not afford. Since they need to focus on their core business, they outsource credit analysis tasks to specialists offering commercial lending solutions to corporate, investment, commercial, and regional banks.
Major Components of Commercial Credit Analysis
These are a few components that guide a credit analyst assess a borrower’s creditworthiness:
- Background: Analyzing an applicant’s background is crucial for commercial lenders. It involves looking at the borrower’s repayment history, industry knowledge, and experience. Analysts check the borrower’s background by looking at their reputation, credentials, credit length and history, and people’s interactions. They check their credit report to look at their past credit behavior and repayment habits. That is why many commercial lenders have a minimum credit score requirement for loan applicants.
- Repayment Capacity: The analysis involves looking at the company’s cash flows to evaluate its loan repayment capacity. The business should generate enough cash flow to repay the principal and interest amount on time. Analysts measure borrowers’ repayment capacity by checking their repayment history, current cash flows, and credit rating.
- Capital: Capital is the amount a company has invested in business or can invest when required. Lenders prefer borrowers who invest their own funds into the business, which proves their commitment. Borrowers with a significant capital contribution have a lower risk of default.
- Security: In the case of secured loans, borrowers need to provide a loan guarantee by pledging an asset. It also acts as a backup for the lender if the borrower defaults. For instance, borrowers may pledge a residential or commercial property, working capital, factory equipment, business inventory, or accounts receivables as collateral for a commercial loan. The lenders take the help of commercial lending solutions to review the collateral and assess its value before lending.
- Purpose: The company’s purpose of taking the loan is crucial in assessing its condition. It makes a difference whether the company needs funds to grow and expand or sustain business operations. The lenders also consider the environmental conditions of the business, including its economic state, competition, and industry trends. All these factors influence the borrower’s loan repayment capacity. Lenders frequently outsource credit analysis tasks to third-party experts to analyze borrowers and use data-based solutions to make lending decisions.
Analysis for commercial lending solutions in 2022 helps understand a borrower’s financial performance to determine its consistency, sustainability, and quality. Lenders can also identify risks associated with the borrower’s business, industry, and management. All in all, analysis builds efficient loan structures to mitigate the risks involved. So, those involved in the commercial lending processes must hire credit analysts to collect and analyze data and draw conclusions.
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