The Five Habits of Highly Effective “Credit Analyst”

1. I believe in Quality – Quantity does not really matter!

Most of the credit analysts focus on broader credit metrics including leverage, gearing and coverage ratios to assess the financial health of an entity. However, what they miss out is these numbers are mostly a combination of Balance sheet and income statement items, and hence qualitative assessment of these items are critical.

Case example:

As an example, while analyzing a commercial broadcaster (with a focus on local language and exclusive distribution rights), initial screening of credit metrics suggested a healthy picture of the finances. One year later, the company reports a significant impairment of its licenses and distribution rights, changing the entire picture thoroughly. Most of the analysts will tend to ignore doing a thorough analysis on these intangibles and taking a call on its valuations – which is the key here.

An effective credit analyst will investigate into the nature of these distribution contracts and will identify critical contracts at the verge of cancellations in the context of challenging market conditions.

2. I love my neighbors – they are my first point of contact

Quite often, you need to go out of the box to start thinking outside the industry and peers, related to the credit you are analyzing. This is where creativity and relation mapping comes into play. If you are analyzing a steel conglomerate, you need to have a close look at iron ore mining companies. If you are analyzing a tyres manufacturer, you need to simultaneously evaluate prospects of car manufacturers. While this may sound simple, analysts typically avoid doing the relation mapping and thorough analysis of firm’s relations to gauge its future performance.

Case example:

An analyst covering a tyre manufacturing firm breaks its operating performance to be dependent on two factors – Original equipment manufacturer market and Replacement market. However, he does not look at the growth prospects of the models, where the company has the highest exposure.

3. I like to peep out of the window – it sometimes gets suffocating inside

Most of the credit analysts typically ignore, what the close competitors are doing. Even if they resort to a mechanized peer analysis, they fail to appreciate marked differences in their business models leading to remarkable differences in their financial performance. Credit analysts typically look at the peers from a very high level, and quite often don’t even look at the peer’s standard filings and presentations.

4. I like to meet new people, but I don’t forget the old ones

Frequent changes in management should raise an alarm that the business has internal concerns, which is not totally clear to the external world. Management analysis is a critical component of the credit analysis framework and does not only include looking at their experience and qualifications. Here is where, understanding of human behavior is the key. An effective credit analyst will try to understand key management’s personalities, their track record of earlier promises and guidance, level of their association with the firm etc.

5. I don’t like surprises – can you tell me in advance if you are going to ditch me!

An effective credit analyst will try to gauge early warning signals and will keep a close monitoring on these factors. Early warning signals are critical and need not be ignored. However, accurate assessment of these factors and understanding when things will really go wrong is a judgmental call.