M6: Interpreting Credit Evaluations

• Credit evaluation and approval is the process a business or an individual must go through to become eligible for a loan or to pay for goods and services over an extended period.

  
  

  It also refers to the process businesses or lenders undertake when evaluating a request for credit. Granting credit approval depends on the willingness of the creditor to lend money in the current economy and that same lender's assessment of the ability and willingness of the borrower to return the money or pay for the goods obtained-plus interest-in a timely fashion.
• Credit analysis is a type of financial analysis that an investor or bond portfolio manager performs on companies, governments, municipalities, or any other debt-issuing entities to measure the issuer's ability to meet its debt obligations.

  Credit analysis seeks to identify the appropriate level of default risk associated with investing in that particular entity's debt instruments (Barone, 2020).
• Following are some of the factors lenders consider when evaluating an individual or business that is seeking

  credit:

  • Credit worthiness. A history of trustworthiness, a moral character, and expectations of continued performance demonstrate a debtor's ability to pay. Creditors give more favorable terms to those with high credit ratings via lower point structures and interest costs.
• Following are some of the factors lenders consider when evaluating an individual or business that is seeking

  credit:

  • Size of debt burden. Creditors seek borrowers whose earning power exceeds the demands of the

  payment schedule. The size of the debt is necessarily limited by the available resources. Creditors prefer

  to maintain a safe ratio of debt to capital.
• Following are some of the factors lenders consider when evaluating an individual or business that is seeking

  credit:• Loan size. Creditors prefer large loans because the administrative costs decrease proportionately to the size of the loan. However, legal and practical limitations recognize the need to spread the risk either by making a larger number of loans, or by having other lenders participate. Participating lenders must have adequate resources to entertain large loan applications. In addition, the borrower must have the capacity to ingest a large sum of money.
• Following are some of the factors lenders consider when evaluating an individual or business that is seeking

  credit:

  • Frequency of borrowing. Customers who are frequent borrowers establish a reputation which directly impacts on their ability to secure debt at advantageous terms.

  • Length of commitment. Lenders accept additional risk as the time horizon increases. To cover some of the risk, lenders charge higher interest rates for longer term loans.
• Following are some of the factors lenders consider when evaluating an individual or business that is seeking

  credit:

  • Social and community considerations. Lenders may accept an unusual level of risk because of the social good resulting from the use of the loan. Examples might include banks participating in low-income housing projects or business incubator programs.
• What is a Credit Report?

  • It is a summary of a persons history of paying debts and other bills. It is usually prepared by the three (3) credit reporting agencies: Experian, Equifax and TransUnion.

  • It is used by those who has a need to understand the borrower’s borrowing history. The information is obtained from banks, stores, credit card companies, various lenders, and public records.
• Creditors and lenders utilize a number of financial tools to evaluate the credit worthiness of a potential borrower. When both lender and borrower are businesses, much of the evaluation relies on analyzing the borrower's balance sheet, cash flow statements, inventory turnover rates, debt

  structure, management performance, and market conditions.
• WHAT'S ON YOUR CREDIT REPORT?

  PERSONAL IDENTIFYING INFORMATION (PII)

  *Name

  *Address

  *Date of Birth

  *Employer

  *Social Security Number

  CREDIT HISTORY

  *Open Credit Accounts

  *Negative Accounts Information (Late payments, judgements, liens, collections) lines

  *Active trade lines

  PUBLIC RECORDS

  *Bankcruptcies

  *Foreclosures

  *Judgements

  *Liens 
• A credit score is a number scale based on the analysis of an individual’s credit reports that represents the consumers likelihood to pay debts. A higher score means that you are more likely to pay your debts.
• Steps to Improve Your Credit Score

  • Pay bills on time• Keep older accounts open (older accounts establish length of history)

  • Keep debt-to-available credit ratio less than 50%. (better to avoid using over 30% of available credit

  capacity)• Get a mix of types of credit (revolving and installment combination)

  • Check credit reports and fix mistakes to your bank.
• A credit report is a detailed summary of your borrowing and repayment activities. It contains your personal and/or business information, as well as pertinent details of your loans, credit cards, mortgage, and other financial transactions.
• In a nutshell, here’s how credit reporting works in the Philippines:

  1. Banks and other financial institutions submit their clients’ credit information (both positive and negative) to the Credit Information Corporation (CIC), the public credit registry and repository of credit information in the Philippines.
  2. The CIC compiles the collected credit information into in-depth credit reports.
• In a nutshell, here’s how credit reporting works in the Philippines:

  3. The CIC shares credit reports of borrowers to lenders that are officially accessing entities (submitting financial institutions authorized by CIC to access basic credit data), and to their accredited credit bureaus.

  4. Lenders use the information in credit reports to assess whether to lend money to a borrower or not.
• A credit score is a three-digit numerical value (ranging from 300 to 850) that indicates your ability to repay your debts. The higher your score, the more creditworthy you are.
• Your credit score tells lenders how likely you’ll pay back the money you will borrow based on your past financial transactions. Likewise, your credit score tells you how likely you’ll be approved for a loan or credit card.
• Four factors affect your credit score:

  • Payment history – Whether you’ve paid your loans and bills on time

  • Credit utilization rate – How much you’re using your total available credit

  • Length of history – How long it’s been since your accounts were opened

  • Credit mix – Whether you have different types of credit such as car loans, personal loans, credit cards, etc.
• What are the 5 C’s of Credit Analysis?

  • Character is the willingness to pay or integrity that looks for past repayment patterns and existing bank commitments.

  • Capacity means financial capability or the borrower to repay the credit.

  • Capital is the financial position of a borrower when borrowing for a business venture.

  • Condition means external factors influence repayment such as macro-assessment (i.e. market share and growth, business cycle, risks, etc.)

  • Collateral is something pledged as security for repayment of a debt such as property or any asset in value.
• GENERALIZATION:

  Credit evaluation is very essential. It helps lenders make the right decisions when it comes to extending loans to borrowers. On the other hand, it is a fundamental thing to consider and build up as both a lender and borrower in an economy. It helps citizens to become responsible and aware of the things they have to know about credit and how it affects their credit scores.
• GENERALIZATION:

  On the part of lending institutions, evaluating the credit worthiness of a potential credit customer in an efficient, repeatable, and accurate manner helps to minimize credit risk/exposure, protect margins, and maximize profits. The first step, and where much of the work is accomplished, is through a good credit application. Hence, less complications will apply in future payments on both lender and borrower.