LO 17.1: Describe, compare and contrast various credit analyst roles.
There are several methods to describe, compare, and contrast the various credit analyst roles, including:
Job descriptions (e.g., consumer credit analyst, credit modeling analyst, corporate credit analyst, counterparty credit analyst, credit analysts at rating agencies, sell-side/buy-side fixed-income analysts, bank examiners and supervisors). Functional objective (e.g., risk management vs. investment selection, primary vs. secondary research).
Type of entity analyzed (e.g., consumer, corporate, financial institution, sovereign/
municipal).
Classification by employer (e.g., banks and other financial institutions, institutional
investors, rating agencies, government agencies).
Job Description
Brief descriptions of typical analyst roles provide a general understanding and an appreciation for the wide range of available roles.
Consumer Credit Analyst
An administrative role with little opportunity for detailed analysis, data entry duties for
loans that are then scored electronically (i.e., the relative score will determine status as approved or declined). Primarily works with individual consumer mortgages, with a key objective that all documentation is in place for approved loans. Large dollar loans referred by analyst to more senior personnel.
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Credit Modeling Analyst
A more quantitative role focused on the electronic scoring system described previously;
some interaction with risk management personnel.
Developing, testing, implementing, and updating various consumer credit scoring
systems.
Corporate Credit Analyst
Scope of analysis is limited to corporations (i.e., no financial institutions or sovereign credits). Some duties developing credit risk models may be required.
Counterparty Credit Analyst
Analyzes typical counterparties (i.e., banks, nonbanks brokers, insurance companies, hedge funds); usually employed by a financial institution to analyze other institutions with which it contemplates a two-way transaction. Performs credit reviews, approves limits, and develops/updates credit policies and procedures.
Review process is often detailed requiring the following: (1) capital structure
analysis (i.e., debt, equity), (2) financial statement analysis, (3) qualitative analysis of counterparty, and (4) qualitative analysis of the operating sector of counterparty. Finally, an internal rating is assigned and the analyst may also be required to comment on any of the following: (1) recommended limits to set on certain credit risk exposures, (2) approval or denial of a given credit application, and (3) recommended changes to the amounts, tenor, collateral, or other provisions of the transaction.
Credit Analysts at Rating Agencies
Provide unbiased external ratings on bonds and other debt instruments issued by financial institutions, corporations, and governments.
Sell-Side and Buy-Side Fixed-Income Analysts
Employed by financial institutions or hedge funds. In addition to credit risk, there is a focus on the relative value of debt instruments and their attractiveness as investments.
Bank Examiners and Supervisors
Assessing the financial stability of financial institutions within a supervisory (risk
management) role.
Functional Objective
Most credit analysts are employed to evaluate credit risk as part of an entitys overall risk management function. At the same time, others are employed for security selection and investment opportunity purposes. In terms of the amount and nature of work performed by analysts, there is a distinction between performing primary research versus secondary research.
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Risk Management
Credit risk management is the most common functional objective, and it occurs in both the private and public sector. Credit risk analysts in the public sector will perform research on potential counterparties. The output of the research typically consists of internal use credit reports on the counterparties as well as recommendations as to which deals to accept and the appropriate risk limits. Bank examiners operate in the public sector in a regulatory capacity by reviewing the credit risk of certain financial institutions. Within that role, two key risk management objectives for the financial system are to ensure it is robust and to promote depth and liquidity.
Investment Selection
Investment selection is a much less common functional objective. Generally, credit analysts examine fixed-income securities with a focus on the risk of default. Specifically, an analyst must assess the likelihood of a given investment deteriorating in credit quality, thereby increasing credit risk and resulting in a decline in value. Additionally, a fixed-income analyst must also focus on the relative value of the investment. Relative value refers to the attractiveness of a given debt security compared to similar securities (e.g., other debt issues with the same asset class or same rating).
Rating Agency
The work of rating agency analysts is used for both risk management and investment selection purposes. The analysts examine issuers, counterparties, and debt in generally the same manner as credit risk analysts in the public sector.
Primary Research
Primary research refers to analyst-driven credit research or fundamental credit analysis. This is usually detailed (and often time-consuming) research with human effort that is both quantitative and qualitative in nature. The analysis looks at microeconomic factors (specific to the entity) and macroeconomic factors (e.g., political, industry). Rating agency analysts provide value by performing detailed credit analysis and arriving at independent conclusions, all of which is subsequently relied upon by other analysts. One of the disadvantages of primary research is its high cost; as a result, some financial institutions have an automated credit scoring system for simpler and less expensive transactions.
Secondary Research
It is often difficult for the credit analyst to perform detailed first-hand analysis (e.g., in- person visits), especially if the counterparty is very large or is located in a foreign country. An alternative is to perform secondary research, which involves researching the ratings provided by other rating agency analysts. Such information is combined with other relevant information sources, current information about the counterparty, and the analysts own research, to conclude the counterpartys credit risk assessment. Given the reliance on other research, secondary research reports tend to be much shorter than primary research reports.
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The goal of using secondary research is for a financial institution to perform counterparty credit analysis in a quick and efficient manner while maintaining reliability.
Type o f Entity Analyzed
Corporate Credit Analyst
This role focuses on analyzing firms that are not financial institutions, notable examples being manufacturing firms or service providers. The purpose of the analysis is to assess the level of the firms credit risk. That assessment is then used in deciding whether or not an entity would conduct business with, lend money to, or purchase securities of the other firm. In general, such analysis is very specialized based on the industry as well as focused on specific transactions.
Although the basic analytical principles are the same, there is huge diversity in the sectors, products, size, and geographic locations of the firms being analyzed. As a result, the corporate credit analyst must possess specific industry knowledge in order to be effective. An analyst will generally focus on only one or two industries, especially among fixed-income and rating agency analysts (given their need to perform detailed primary research).
Common sectors analyzed include the following: (1) real estate, (2) chemicals, (3) energy, (4) utilities, (3) telecommunications, (6) natural resources, (7) paper and forest products, and (8) automotive.
Another point of consideration is the size of the firm being analyzed. With a large public company, there may be a lot of public information available that would only necessitate secondary research, thereby reducing costs. With a smaller private company, less information is likely available, and as a result, more due diligence and primary research would be required, thereby increasing costs.
Finally, cash flow analysis is key to assessing corporate credit risk, so corporate analysts must also be equipped with strong accounting and financial statement analysis skills.
Bank and Financial Institution Credit Analyst
Counterparty credit analysts are employed by banks and other financial institutions and focus on analyzing the creditworthiness of other banks and other financial institutions. Compared to corporate credit analysis, the objective is not to make a lending decision but to determine whether the entity being analyzed is sufficiently creditworthy to function as a counterparty in future two-way transactions, with the entity requesting the analysis. Counterparty analysts could also establish exposure limits or decide whether to transact with the potential counterparty.
Both the nature of the financial instrument(s) and the length of time (tenor) of proposed contracts have a direct impact on the potential losses, and, as a result, have a direct impact on the type of analysis to be performed. Common financial instruments involved in counterparty transactions include (1) unsecured debt through the interbank market, (2) repurchase (repo) or reverse repurchase (reverse repo) transactions, (3) receivables factoring, (4) foreign exchange, and (3) derivatives.
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Sovereign!Municipal Credit Analyst
Sovereign credit analysts determine the risk of default by foreign governments on borrowed funds. Primarily, sovereign credit analysts need to consider macroeconomic indicators in determining a governments ability to repay its debts. Additionally, political risk is an important consideration; the analyst attempts to gauge political stability and its impact on the ability to repay. Sovereign credit analysts examine the risks involved with specific international transactions or transactions with specific countries, provinces, states, or cities.
The stability of a given countrys banking system strongly correlates with the ability of a countrys government to repay foreign debt. The correlation also means that a governments financial stability impacts its banking system. Therefore, when analyzing the credit risk of foreign banks, analysts must place a lot of emphasis on sovereign risk. The obvious component of sovereign risk would include an analysis of the foreign countrys debt-issuing ability in addition to the securities already issued. Another component would include an analysis of the impact of the countrys general operating environment on its banking environment.
Classification by Employer
Banks, Nonbank Financial Institutions, and Institutional Investors
Credit analysts are most frequently employed by banks. Amongst all three groups, credit analysts usually function either within a risk management or an investment selection role.
Rating Agencies
Credit analysts employed by rating agencies analyze banks, corporations, and governments to determine their creditworthiness. Analysis includes the following steps:
Step 1: A general analysis of the credit risk of the entity. Step 2: An analysis of issued securities and their impact on credit risk. Step 3: An overall rating recommendation for the entity (communicated through rating
symbols that are widely recognized and understood).
The information provided by the rating agencies is used by investors and risk personnel in making decisions regarding lending amounts, lending rates, and investment amounts.
Government Agencies
A typical role is a regulatory one, whereby the credit analyst analyzes a bank or insurance company to determine its level of risk, financial stability, and whether it meets the regulatory requirements to continue operating. A lesser-known role is when the government acts as an investor or lender, whereby the credit analyst has similar functions (i.e., investment selection or a risk management focus) to its counterparts in other organizations.
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Rating Advisor
This is a unique role most frequently found in investment banks. The rating advisor has likely been a rating agency analyst and is now working to help a debt issuer obtain the highest rating possible. The rating advisor would perform an independent credit analysis of the issuer to arrive at a likely rating. The advisor would then provide advice to the issuer on how to mitigate any issues and respond to rating agency questions.
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