Articles by kenli

LO 18.1: Describe the role o f ratings in credit risk management.
Credit ratings measure a borrowers creditworthiness. They are critical in ensuring that (1) borrowers can access capital markets, (2) the various risks of value creation are appropriately managed, and (3) the economic performance of business units can be compared.
C l a s s i f i c a t i o n s o f C r e d i t R i s k

LO 17.4: Assess the quality o f various sources o f information used by a credit analyst.
Annual Report
Although there is likely bias on the part of management to present the entity in the most favorable way, the annual report does contain some useful information about culture, strategy, company performance, and economic outlook in the Management Discussion and Analysis (MD&A). Other information pertaining to regulation, such as changes to accounting or banking rules, may also be present in the annual report.
A uditors Report
The auditor of a banks financial statements is usually a major international accounting firm, and the staff on the audit engagement would possess specialized knowledge of the accounting rules pertaining to banks in order to successfully audit the bank in question.
The auditor provides an independent opinion on the banks financial statements. If an unqualified opinion (or clean opinion) is provided, then it means that the auditor accepts the financial statements prepared by management as meeting the minimum standards of presentation (i.e., no material misstatements). The opinion assumes that management has provided the auditors with accurate information. Because of the cost-benefit tradeoff of analyzing every single item, auditors utilize a sampling approach and/or focus on high-risk areas during the testing phase. As a result, the financial statements may not be perfect or 100% accurate, but they present a reasonable indication of the financial performance for the stated period (income statement) and financial condition at a given point in time (balance sheet). In addition, it is not the auditors responsibility to detect fraud committed by the
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audited bank. It is up to the analyst to verify that an unqualified opinion has been issued and to watch for any exceptions from the standard wording of an unqualified opinion.
Analysts should be cautious when a qualified opinion is issued. With a qualified opinion, the auditors are saying that the financial statements might not fairly represent the companys financial performance and condition. The wording will be clear in the final paragraph of the report, with the existence of the word except. Common reasons for a qualified opinion include (1) substantial doubt as to the banks ability to continue as a going concern, (2) a specific accounting treatment used by management is inconsistent with accounting rules, and (3) significant amounts of related-party transactions. It is up to the analyst to investigate and determine the exact nature of the qualification, its severity, and its impact on the analysts overall assessment.
Rarely will the auditors issue an adverse opinion where they state that the financial statements do not fairly present the banks financial performance and condition.
Sometimes there will be a change in auditors, and it is up to the analyst to inquire and determine if the change was valid. For example, sometimes management will dismiss its auditors because of a disagreement over one or more accounting treatments or the auditors unwillingness to provide an unqualified opinion. The analyst should generally look upon those situations unfavorably. Alternatively, it is sometimes mandatory in some countries for a change in auditors every few years because they may have developed a comfortable relationship with the audited entity, preventing them from demonstrating independence and objectivity. In such a situation, the change in auditors is valid.
Financial Statements Annual and Interim
The financial statements generally consist of the (1) balance sheet, (2) income statement, and (3) statement of cash flows. The balance sheet documents the net worth of the bank at a given point in time (e.g., year-end), and the income statement provides a quantification of performance over the period (e.g., net income for the year). The statement of cash flows is very useful for analyzing nonfinancial entities but not useful for bank credit analysis. An additional item, the statement of changes in capital funds, is useful for bank credit analysis (and regulatory purposes) because it explains changes in capital levels.
Supplementary footnotes to the financial statements may be included that provide more detail on specific items (e.g., off-balance sheet items such as leases and accounting policies).
Interim financial statements may be issued quarterly or semiannually, and they provide more timely financial information that would be useful to an analyst in making a current assessment of the bank.
Banks Website
On the banks website, the analyst is often able to find valuable information such as the annual report, financial statements, press releases, and background information. The quality, layout, and ease of accessibility of the website itself are often good indications of the stability of the bank.
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News, the Internet, Securities Pricing D ata
The analyst should check for any significant subsequent events (e.g., mergers, acquisitions, or new regulations) occurring after the corporate year-end that might not be covered in the annual report.
Proprietary electronic data services such as Bloomberg or a simple web search may provide necessary data on current bond and equity prices (especially for public listings or debt offerings).
Prospectuses and Regulatory Filings
Prospectuses and regulatory filings tend to minimize the discussion of the benefits of the investment and emphasize more of the potential risks so they could provide some useful information. Notably, prospectuses for equity and international debt issues may provide an effective resource.
Rating Agency Reports and Other Third-Party Research
As stated previously, counterparty credit analysts will find the rating agency reports most useful for their analysis. Other third party research includes investment reports from regulatory agencies and equity analysts.
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K e y C o n c e p t s
LO 17.1
Common credit analyst roles include consumer credit, credit modeling, corporate credit, counterparty credit, rating agency, fixed income, and bank examiner/supervisor. The roles are generally risk management in nature, although the fixed-income credit analyst focuses on investment selection. Primary and/or secondary research methods may be applied, and analysts could be analyzing nonfinancial entities, financial institutions, or sovereigns. Credit analysts are generally employed by banks, nonbank financial institutions, institutional investors, rating agencies, or government agencies.
LO 17.2
A counterparty credit analyst may perform risk evaluations of a given entity on a transaction-by-transaction basis or through an annual review. At times, the duties may extend into decision making (e.g., authorizing credit limits, suggesting guarantees and collateral, authorizing excesses). Additionally, there may be duties related to examining and amending the banks existing credit policies and compliance tasks related to Basel II and III.
Fixed-income and equity analysts provide recommendations whether to buy, sell, or hold securities. Both types of analysts use fundamental and/or technical analysis techniques. Fixed-income analysts focus on determining relative value while equity analysts focus on determining return on equity.
LO 17.3
As a fundamental skill, banking credit analysts should be able to read and interpret financial statements in order to perform ratio analysis. They should also have a reasonable background in statistical concepts, in order to properly process and analyze data, and in macroeconomics, in order to understand the given banks performance within the context of the overall economic environment. Additionally, significant judgment and skill in choosing relevant information to analyze is required in order to capture the important qualitative elements of any analysis.
LO 17.4
The annual report, auditors report, financial statements (annual and interim), banks website, internet, rating agency reports, other third-party research, prospectuses, and regulatory filings are some of the many available sources of information that may be used by a credit analyst. The annual report, together with financial statements, is the usual starting point for the analyst. For example, a counterparty credit analyst will rely heavily on rating agency reports.
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C o n c e p t C h e c k e r s
1.
2.
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4.
3.
Richard Marshall, FRM, is a rating agency analyst who is currently performing financial statement analysis on a major bank. Which of the following financial statements would be least useful for bank credit analysis? A. Balance sheet. B. Income statement. C. Statement of cash flows. D. Statement of changes in capital funds.
Krista Skujins, FRM, is a bank credit analyst who is examining the financial statements of a bank. She notices that there is a paragraph noted in the auditors report that states that although the auditors agreed with virtually all of the banks accounting treatments of the financial statement items, the auditors did not agree with the banks decision to treat some of the leases as operating leases instead of capital leases. Based on that information, which of the following audit report opinions has the auditor most likely issued? A. Adverse opinion. B. Denial of opinion. C. Qualified opinion. D. Unqualified opinion.
Which of the following statements regarding a banking credit analysts skills is most likely correct? A. High earnings quality suggests that the bank is profitable. B. Peer analysis is facilitated by the standardized nature of financial performance
measures.
C. Although qualitative analytical skills are required, quantitative analytical skills
are more important.
D. In analyzing an unfamiliar banking sector, an analyst should start by performing
detailed reviews of the major banks.
Which of the following types of credit analysts would most likely be performing fundamental and/or technical analysis on a day-to-day basis? A. Equity analyst only. B. Fixed-income analyst only. C. Counterparty analyst and equity analyst. D. Equity analyst and fixed-income analyst.
Which of the following statements regarding the role of a corporate credit analyst is most likely correct? A. Earnings analysis is by far the most important analyst task. B. The larger the size of the firm, the lower the cost of analysis. C. Analysts are generally required to cover multiple industry areas given the huge
diversity among corporations.
D. The smaller the firm, the lower the cost of analysis.
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C o n c e p t C h e c k e r An s w e r s
1. C Although the statement of cash flows is most useful for analyzing nonfinancial entities (uses of cash and sources of cash differentiated between operating, investing, and financing), it is not useful for bank credit analysis.
2. C This situation is one where a specific accounting treatment used by the banks management is inconsistent with the accounting rules. It is an isolated instance and so a qualified opinion would most likely be issued.
3. B Peer analysis refers to the comparison (financial and creditworthiness) of a subject bank to
similar banks and financial institutions.
High earnings quality does not necessarily mean a bank is profitable. Earnings quality refers to the reliability and consistency of the reported earnings.
Quantitative and qualitative analytical skills are equally important and serve different (but related) purposes; qualitative skills are necessary to assist in determining the willingness of an entity to repay debt while quantitative skills are necessary to assist in determining the ability of an entity to repay debt.
In analyzing an unfamiliar banking sector, the analyst should start with preliminary research on the overall structure, characteristics, and nature of regulation. After that, a detailed review of the largest (followed by smaller) banks could be performed.
4. D Both fixed-income analysis and equity analysis can be divided into two broad approaches:
fundamental and technical analysis. Those approaches are valid because both types of analysts have the objective to earn profits for their respective employers and/or clients. In contrast, counterparty credit analysts are not likely to use either approach and are more focused on performing risk evaluations and possibly making some decisions on granting credit.
5. B With a large public company, there may be a lot of publicly available information 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.
Although the basic analytical principles are the same, there is huge diversity in the business 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 most likely focus on only one or two industry areas.
Corporate credit analysts specifically analyze firms that are NOT financial institutions.
Cash flow analysis, not earnings analysis, is key to assessing corporate credit risk.
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The following is a review of the Credit Risk Measurement and Management principles designed to address the learning objectives set forth by GARP. This topic is also covered in:
C l a s s i f i c a t i o n s a n d K e y C o n c e p t s o f C r e d i t R i s k
Topic 18
E x a m F o c u s
In this topic, we look at the various classifications of credit risk, how to measure individual and portfolio credit risks, and how to apply risk-adjusted pricing when making credit decisions. For the exam, be able to distinguish between default-mode valuations (default, recovery, and exposure risks) and value-based valuations (migration, spread, and liquidity risks). Also, understand the differences between expected and unexpected losses, since they have materially different implications on risk expectations and measurement. Value at risk (VaR), marginal VaR, and concentration risks are important measures of unexpected losses. Finally, understand risk-adjlisted pricing, and be ready to interpret and calculate risk-adjusted return on risk-adjusted capital.
T h e R o l e o f C r e d i t R a t i n g s

LO 17.3: Describe the quantitative, qualitative, and research skills a banking credit analyst is expected to have.
Quantitative skills are necessary to assist in determining the ability of the entity to repay debt. A banking credit analyst must be able to read and interpret financial statements in order to perform a wide range of ratio analysis. The ratios to be analyzed depend on which measures of financial performance are relevant (i.e., liquidity, solvency, profitability). For example, return on equity (ROE) is a commonly used measure because it considers efficiency and leverage in addition to profitability. Because of the standardized nature of financial performance measures, peer analysis (i.e., comparison with similar banks and financial institutions) is possible and can be used to compare financial results.
Analysts must also understand statistical concepts (e.g., sampling, confidence intervals, correlation) in order to properly interpret data to arrive at reasonable conclusions under uncertainty. An example of a statistical analytical tool would be trend analysis (comparison of current year performance to past performance). The ability to analyze asset quality is also important. For example, a banking credit analyst could quantitatively assess a banks loan portfolio by computing nonperforming loan ratios. Finally, analysts should have an understanding of monetary policy and an ability to compute and interpret macroeconomic data (e.g., GDP growth rates), both of which impact the general banking industry.
Qualitative skills are necessary to assist in determining the willingness of the entity to repay debt (e.g., reputation, repayment track record). It is critical for analysts to think beyond numbers and apply considerable judgment, reasoning, and experience in determining which factors are relevant for making decisions (e.g., management competence, banks credit culture, and the robustness of credit review process).
The ability to analyze the quality, reliability, and consistency of reported earnings is also necessary. In addition, an understanding of the regulatory environment of banks and the impact(s) of any regulatory changes is important (e.g., central bank given more authority to regulate banks).
An analyst should have basic research skills in order to analyze an unfamiliar banking sector. Some preliminary research on overall sector structure, sector characteristics, and nature of regulation should be performed first. Then a reasonably detailed review of the largest banks followed by smaller banks may be performed. Examining larger banks first provides a basis of comparison when subsequently looking at smaller banks. After gaining a
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Topic 17 Cross Reference to GARP Assigned Reading – Golin and Delhaise, Chapter 2
thorough understanding of the banking sector, a bigger-picture perspective might be taken. For example, an analyst might try to research the countrys entire banking sector, making note of the dominant entities and their impact on the sector.
A rating agency analyst would most frequently utilize primary research skills while a counterparty credit analyst would most frequently utilize secondary research skills.
Primary research skills include detailed analysis of (audited) financial statements for several years together with annual reports and recent interim financial statements. In addition, the rating analyst would usually need to make one or more due diligence visits to the bank to meet with senior management to discuss operational and business strategy. In addition to the visit, a questionnaire may also be provided to management to complete and return to the analyst.
Secondary research skills involve using the research published by others (e.g., rating agencies). The counterparty credit analyst would not make frequent visits to banks. Any site visits would tend to be brief and focused on very specific areas.
I n f o r m a t i o n S o u r c e s

LO 17.2: Describe common tasks performed by a banking credit analyst.
There are three main types of banking credit analysts: (1) counterparty credit analyst, (2) fixed-income analyst, and (3) equity analyst. Common tasks for each type of analyst are described in the following.
Counterparty credit analysts perform risk evaluations (reports) for a given entity. The triggering event to perform such evaluations may be an annual review of the entity or an intent to engage in an upcoming transaction with that entity. The tasks might be limited to simply covering certain counterparties or even only certain transactions or might be expanded to include decision making, recommendations on credit limits, and presenting to the credit committee.
Should the duties extend into the decision-making process, responsibilities would include the following: (1) authorizing the allocation of credit limits, (2) approving credit risk mitigants (i.e., guarantees, collateral), (3) approving excesses or exceptions over established credit limits, and (4) liaising with the legal department regarding transaction documentation.
Some analysts may be required to review and propose amendments to the banks existing credit policies. With the implementation of the extensive regulatory requirements of Basel II and Basel III, credit analysts are now responsible for a wider range of regulatory compliance tasks.
Finally, counterparty credit analysts must understand the risks inherent with specific financial products and transactions. Therefore, it is necessary to obtain knowledge of the banks products to supplement their credit decisions.
In an effort to make profits for the entity, fixed-income analysts provide recommendations regarding the decision to buy, sell, or hold debt securities. Therefore, they must ascertain the relative value to determine whether the security is undervalued, overvalued, or correctly valued. Both fundamental and technical analyses are generally performed in arriving at investment decisions. Fundamental analysis focuses on default risk while technical analysis focuses on market timing and pricing patterns. In making an investment decision, fixed- income analysts consider the ratings for specific debt securities issued by the rating agencies. The ratings provide reliable input in computing the relative value of securities.
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Equity analysts analyze publicly traded financial institutions to help in determining whether an investor should buy, sell, or hold the shares of a given financial institution. When performing valuations, there is an emphasis on using return on equity (ROE). ROE takes into account both profitability and leverage. Other types of analysts would look at a wider range of financial ratios dealing with a banks asset quality, capital strength, and liquidity. Equity analysts usually perform company valuations based on unaudited projections (while other analysts usually use audited historical data). Similar to fixed-income analysts, there are two general approaches to equity analysis. Analysts could choose to perform fundamental analysis, technical analysis, or a combination of the two.
B a n k i n g C r e d i t A n a l y s t S k i l l s

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.
B a n k i n g C r e d i t A n a l y s t T a s k s

LO 16.7: Com pare bank failure and bank insolvency.
Bank insolvency and bank failures are not identical. Banks become insolvent and are often merged into healthier institutions. It is more convenient and less expensive for the government to simply fold a troubled bank into a stronger bank than it is to close the bank. In fact, there is an assumption that bank failures are relatively common, but in reality, it rarely happens in non-crisis periods. Weak banks are merged with healthier banks, and the system avoids outright failures. This is especially true for large, international banks (i.e., banks that are too big to fail). In the United States, only 50 banks failed between 2001 and 2008, half of which failed in 2008. This equates to a rate of approximately 0.1% per year during the period. Following the financial crisis, approximately 2% of banks failed in both 2009 and 2010. An additional 1.2% of banks failed in 2011. Research indicates that bank failures are considerably less likely than nonfinancial firm failures.
In the last few years, beginning with the financial crisis in late 2007, many more large banks in Europe and the United States have suffered from financial stresses. Flowever, it was clear during the crisis that some banks were considered too big to fail. In response, the Financial Stability Board (FSB) created a list of 29 systemically important financial institutions that are required to hold additional loss absorption capacity tailored to the impact of their [possible] default. The concern is systemic risk that spreads to other institutions. There was substantial evidence of this occurrence during the financial crisis.
A bank can remain insolvent (without failing), so long as it has a source of liquidity. The Federal Reserve is one such source and acts as a lender of last resort. A bank failure that results in significant losses to depositors and other creditors is quite rare, although as noted, the incidence increases in times of crisis, such as in 2007. For a credit analyst evaluating a financial institution, the expectation of an outright failure is unlikely. However, because banks are heavily leveraged, the risks cannot be ignored. The analyst must place the bank somewhere on the continuum between pure creditworthiness and bankrupt. At one end of the continuum are banks with AAA-rated debt, and at the other end are banks with default ratings. Thus, thinking about bank risk on a continuum is useful in defining the banks credit risk.
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K e y C o n c e p t s
LO 16.1
Credit risk is the probability that a borrower will not pay back a loan in accordance with the terms of the credit agreement. Credit risk results when an individual or firm defaults on a financial obligation. It arises short of default when there is an increased probability of default on a financial obligation. A more severe loss than expected due to a greater than expected exposure at the time of a default or a more severe loss than expected due to a lower than expected recovery at the time of a default are also components of credit risk. Finally, credit risk can arise from a default on a payment for goods or services that are already rendered (i.e., settlement risk).
LO 16.2
There are four primary components of credit risk evaluation: (1) the borrowers (obligors) willingness and capacity to repay the loan, (2) the effect of external conditions on the borrowers ability to repay the loan, (3) the inherent characteristics of the credit instrument and the extent to which the characteristics affect the borrowers willingness and ability to perform the obligation, and (4) the quality and adequacy of risk mitigants such as collateral and loan guarantees.
LO 16.3
If collateral is used as a credit risk mitigant, a bank or other lender may not have to force a delinquent borrower into bankruptcy but may instead sell the collateral to satisfy the financial obligation. If a loan guarantor is used as a credit risk mitigant, the guarantor accepts liability for debt if the primary borrower defaults. Typically, the guarantor has a greater ability to pay than the primary borrower.
LO 16.4
Qualitative techniques are used primarily to assess the borrowers willingness to repay the loan. Quantitative techniques are used primarily to assess the borrowers ability to repay the loan. Gathering information from a variety of sources about the character and reputation of the potential borrower, face-to-face interviews with potential borrowers, and using past loan payment information to draw conclusions about a borrowers willingness to pay in the future are all qualitative techniques. .Analyzing the borrowers recent and past financial statements is the primary quantitative method used in credit analysis.
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LO 16.5
There are key differences between the analysis of the creditworthiness of consumers, versus that of nonfinancial and financial firms. Individual factors such as a persons net worth, salary, assets, reputation, and credit score are used to evaluate individuals. It is more complex to evaluate firms. Liquidity, cash flow combined with earnings capacity and profitability, capital position (solvency), state of the economy, and strength of the industry are used to evaluate nonfinancial firms. Similar data is used for financial firms in addition to bank-specific measures such as capital adequacy, asset quality, and the banks ability to withstand financial stress. Detailed manual analyses, including financial statement analysis and interviews with management, are used to analyze the creditworthiness of both nonfinancial and financial firms.
LO 16.6
Current measures used to evaluate credit risk are:
The probability of default (PD), which is the likelihood that a borrower will default. The loss given default (LGD), which represents the likely percentage loss if the borrower

does default. Exposure at default (EAD), which can be stated as a dollar amount (e.g., the loan balance outstanding) or as a percentage of the nominal amount of the loan or the maximum amount available on a credit line. Expected loss (EL), which is, for a given time horizon, calculated as the product of the PD, LGD, and EAD (i.e., PD x LGD x EAD).
Time horizon or tenor of the loan. The longer the time horizon, the greater the risk to
the lender.
LO 16.7
Bank insolvency and bank failure are not one in the same. A bank may be insolvent but avoid failure so long as liquidity is available. Also, many insolvent banks are merged with financially sound banks, avoiding outright failure. For the credit analyst, the fact that failure of financial institutions is rare makes analysis easier. However, banks are highly leveraged, placing the bank somewhere on the continuum between fully creditworthy and insolvent.
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C o n c e p t C h e c k e r s
1.
2.
3.
Blackstone Credit, Inc., made a loan to a small start-up firm. The firm grew rapidly, and it appeared that Blackstone had made a good credit decision. However, the firm grew too fast and could not sustain the growth. It eventually failed. Blackstone had initially estimated its exposure at default to be $1,200,000. Because of the firms rapid growth and resulting increases in the line of credit, Blackstone ultimately lost $1,550,000. In terms of credit risk, this is an example of: A. default on payment for goods or services already rendered. B. a more severe loss than expected due to a ratings downgrade by a rating agency. C. a more severe loss than expected due to a greater than expected exposure at the
time of a default.
D. a more severe loss than expected due to a lower than expected recovery at the
time of a default.
Brent Gulick, a credit analyst with Home Town Bank, is considering the loan application of a small, local car dealership. The dealership has been solely owned by Bob Justice for more than 20 years and sells three brands of American automobiles. Because of the rural location, most of the cars sold in the past by the dealership have been large pick-up trucks and sports utility vehicles. However, sales have declined, and gasoline prices have continued to increase. As a result, Justice is considering selling a line of hybrid cars. Justice has borrowed from Home Town Bank before but currently does not have a balance outstanding with the bank. Which of the following statements is not one of the four components of credit analysis Gulick should be evaluating when performing the credit analysis for this potential loan? A. The business environment, competition, and economic climate in the region. B. Justices character and past payment history with the bank. C. The car dealerships balance sheets and income statements for the last few years
as well as Justices personal financial situation.
D. The financial health of Justices friends and family who could be called upon to
guarantee the loan.
Sarah Garrison is a newly hired loan officer at Lexington Bank and Trust. Her boss told her she needs to make five commercial loans this month to meet her sales goal. Garrison talks to friends and hears about a local businessperson with a great reputation. Everyone in town says John Johnson is someone you want to meet. Garrison sets up a meeting with Johnson and is immediately impressed with his business sense. They discuss a loan for a new venture Johnson is considering, and Garrison agrees that it is a great idea. She takes the loan application back to the bank and convinces the chair of the loan committee that Lexington Bank and Trust is lucky to be able to do business with someone with Johnsons reputation. This is an example of: A. historical analysis technique. B. qualitative analysis technique. C. quantitative analysis technique. D. extrapolation analysis technique.
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4.
5.
Stacy Smith is trying to forecast the potential loss on a loan her firm made to a mid- size corporate borrower. She determines that there will be a 75% loss if the borrower does not perform the financial obligation. This is the: A. probability of default. B. C. expected loss. D. exposure at default.
loss given default.
Bank of the Plain States has been struggling with poor asset quality for some time. The bank lends primarily to large farming operations that have struggled in recent years due to a glut of soybeans and corn on the market. Bank regulators have recently required that the bank write off some of these loans, which has entirely wiped out the capital of the bank. However, the bank still has some liquidity sources it can use, including a correspondent bank and the Federal Reserve. Bank of the Plain States is: A. an insolvent but not failed bank. B. both a failed bank and an insolvent bank. C. neither a failed bank nor an insolvent bank. D. a failed bank but not an insolvent bank.
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C o n c e p t C h e c k e r An s w e r s
1. C Blackstone lost more than expected due to greater exposure at the time of default than
initially estimated. The borrowing firm was a small start-up, so it was not likely rated. There were no goods or services rendered in this case. In addition, there is no mention of recovery. This is also an example of credit risk arising from default on a financial obligation.
2. D There are four primary components of credit risk evaluation: (1) the borrowers (obligors)
willingness and capacity to repay the loan, (2) the effect of external conditions on the borrowers ability to repay the loan, (3) the inherent characteristics of the credit instrument and the extent to which the characteristics affect the borrowers willingness and ability to repay the loan, and (4) the quality and adequacy of risk mitigants such as collateral and loan guarantees. In this case, the local business environment, Justices character, his payment history, and the businesss financial positions are all relevant. While risk mitigants such as collateral and loan guarantees are part of credit analysis, it is unlikely that a local car dealer who has been in business for 20 years would be seeking a loan guarantee from a friend or family member. In addition, even if Justice were looking at a potential loan guarantor, Gulick would not simply evaluate his friends and family but would evaluate the specific person or business that intended to guarantee the loan.
3. B Name lending is a qualitative technique that is sometimes used to take the place of financial
analysis. It is a technique used to evaluate the borrowers willingness to repay a financial obligation.
4. B Current measures used to evaluate credit risk include the firms probability of default, which
is the likelihood that a borrower will default; the loss given default, which represents the likely percentage loss if the borrower does default; the exposure at default; and the expected loss, which is, for a given time horizon, calculated as the product of the PD, LGD, and EAD. The stated 75% loss if the borrower defaults is the loss given default or LGD.
5. A Bank of the Plain States is insolvent because capital is wiped out. However, the bank has not failed because it is still operating with liquidity from the correspondent bank and the Federal Reserve. Therefore, the bank is insolvent but not failed.
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The following is a review of the Credit Risk Measurement and Management principles designed to address the learning objectives set forth by GARP. This topic is also covered in:
T h e C r e d i t A n a l y s t
Topic 17
E x a m F o c u s
This topic focuses on the role and tasks performed by a banking credit analyst. For the exam, understand the objectives of the analyst (e.g., risk management, investment selection) as well as the difference between primary and secondary research. In addition, know the quantitative and qualitative skills that an analyst must possess in order to be successful. Finally, be able to recognize and describe the key information sources used by credit analysts such as the annual report, auditors report, and company financial statements.
C r e d i t A n a l y s t R o l e s

LO 16.6: Describe quantitative measurements and factors o f credit risk, including probability o f default, loss given default, exposure at default, expected loss, and time horizon.
Credit risk, the likelihood that a borrower will repay a loan according to the loan agreement, and default risk, the probability that a borrower will default, are essentially the
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same because a default on a financial obligation almost always results in a loss to the lender. In the last decade, there have been significant changes in the financial sector. These changes, combined with regulatory changes in the industry, have resulted in a somewhat revised view of credit and default risks. Current measures used to evaluate creditworthiness are described as follows:
Probability of default (PD): The likelihood that a borrower will default is not necessarily the creditors greatest concern. A borrower may briefly default and then quickly correct the situation by making a payment, paying interest charges or penalties for missed payments. Creditors must rely on other measures of risk in addition to PD.
Loss given default (LGD): LGD represents the likely percentage loss if the borrower defaults. The severity of a default is equally as important to the creditor as the likelihood that the default would occur in the first place. If the default is brief and the creditor suffers no loss as a result, it is less of a concern than if the default is permanent and the creditor suffers significant losses. Both PD and LGD are expressed as percentages.
Exposure at default (EAD): The loss exposure may be stated as a dollar amount (e.g., the loan balance outstanding). EAD can also be stated as a percentage of the nominal amount of the loan or the maximum amount available on a credit line.
Expected loss (EL): Expected loss for a given time horizon is calculated as the product of the PD, LGD, and EAD (i.e., PD x LGD x EAD).
Time horizon: The longer the time horizon (i.e., the longer the tenor of the loan), the greater the risk to the lender and the higher the probability of default. Also, EAD and LGD change with time. The exposure (EAD) increases as the borrower draws on a credit line and falls as the loan is paid down. The LGD can also change as the terms of the loan or credit line change.
Expected loss generally depends on four variables: PD, LGD, EAD, and time horizon. A bank should also consider the correlations between various risk exposures when analyzing credit risk in a portfolio context.
Example: Calculating expected loss
Star City Bank and Trust has examined its loan portfolio over the past year. It has determined that the probability of default was 4%, adjusted for the size of the exposure. The loss given default over the period was 80%. Bank risk managers estimate that the exposure at default was 75% of the potential exposure. Calculate the expected loss given a one-year time horizon.
Answer:
expected loss = 4% x 80% x 75% = 2.4%
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Professors Note: It is straightforward to calculate PD, LGD, and EAD after the fact. As the previous example illustrates, a lender can analyze historical occurrences o f default, loss given default, and loss exposure. However, it is difficult to estimate these measures in advance. A financial institution or other nonhank lender can use historical experience to help predict future losses, but the forecast will not be perfect. Using historical mortgage loss data would have been little help in forecasting actual losses that occurred during the 20072009 financial crisis.
Fa i l u r e v s . I n s o l v e n c y

LO 16.5: Com pare the credit analysis o f consumers, corporations, financial institutions, and sovereigns.
Four basic types of borrowers for which credit analysis must be performed are as follows:
1. Consumers the analyst evaluates the creditworthiness of individuals.
2. Corporations the analyst evaluates the creditworthiness of nonfinancial firms.
Businesses are typically more difficult to analyze than individuals, although the process is similar.
3. Financial institutions the analyst evaluates the creditworthiness of financial
institutions, including banks and nonbank firms such as insurance companies and investment companies.
4. Government or government-related entities (i.e., sovereigns) the analyst evaluates
the creditworthiness of nations, government bodies, and municipalities. Non-state entities in specific locations or jurisdictions are also subject to analysis in the sovereign category.
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There are similarities and differences in the approaches taken to analyze the creditworthiness of the various groups. Figure 1 details some specific aspects of each type of analysis.
Figure 1: Comparison of Borrowers
Corporations Consumers Capacity Wealth (i.e., net Liquidity, cash worth), salary, or flow combined incoming cash per with earnings capacity and period, expenses profitability, per period, assets capital position such as houses and cars, amount (solvency), state of debt (e.g., of the economy, credit card debt), strength of the net cash available industry. to service debt (i.e., cash flow minus household and mortgage expenses).
W
illingness Reputation
of individual, payment history.
Quality of management, historical debt service.
Financial Institutions Similar to nonfinancial firms but bank specific. Liquidity (the banks access to cash to meet obligations), capital position, historical performance including earnings capacity over time (and ability to withstand financial stress), asset quality (affects the banks likelihood of being paid back and by extension the banks lenders likelihood of being paid back), state of the economy, strength of the industry. Quality of management; qualitative analysis is even more important for financial firms than for nonfinancial firms.
Sovereigns Financial factors including the countrys external debt load and debt relative to the overall economy; tax receipts are important.
Credit analysis for sovereigns is often more subjective than for financial and nonfinancial firms because the legal system and the enforcement of creditor rights is critical to the analysis. Sovereign legal risk ratings, as discussed previously, are often considered in the analysis.
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Figure 1: Comparison of Borrowers (Cont.)
Consumers
Corporations
Methods of evaluation
Loan size/type
Credit scoring models that consider income, duration of employment, and amount of debt for unsecured debt like credit cards. Credit scoring and some manual input and review for large exposures such as mortgage loans or automobile loans.
Large exposures are typically secured (e.g., mortgage loans). Smaller exposures are unsecured (e.g., credit card loans).
Financial Institutions Similar to nonfinancial firms.
Detailed manual analysis including financial statement analysis, interviews with management. More complex than consumer analysis because companies are so diverse in terms of assets, cash flow, financial structure, etc. Typically larger exposures (sometimes considerably larger) than firms (i.e., loans to consumers. Debt may be secured or unsecured.
large). Similar to
Sovereigns
Similar to financial and nonfinancial firms but with increased subjective analysis of the political environment. Similar to nonfinancial nonfinancial and
Similar to
financial firms (i.e., large).
The two primary differences between nonfinancial firm credit analysis and financial firm credit analysis are (1) the importance of the quality of assets in financial firms and (2) cash flow as an indicator of capacity to repay for nonfinancial firms but not a key indicator of creditworthiness for financial firms. It is clear from the 20072009 financial crisis that asset quality is a key indicator of a banks financial health. The ability to withstand financial stress is critical for a bank. That is why earnings capacity over time is a more relevant indicator of creditworthiness than cash flow. A bank must be able to withstand periods of financial stress/crisis in order to repay debts.
Professors Note: Sovereign credit analysis is not explicitly discussed in this topic. However, in contrast to consumers and financial and nonfinancial firms, consider the political issues/concerns that would arise when lending to a foreign government. Even a financially healthy sovereign may he a risky loan candidate due to the legal systems strength (or lack thereof); a lack of legal protections for creditors and other factors might negatively affect the lender and the lenders rights. I f you have to compare credit analysis across the four groups (i. e., consumers, nonfinancial firms, financial firms, and sovereigns), think about the differences between the groups and the various factors that explain and/or increase!decrease the lenders risk in each case.
Q u a n t i t a t i v e M e a s u r e s

LO 16.4: Compare and contrast quantitative and qualitative techniques o f credit risk evaluation.
The willingness to repay a loan is a subjective attribute. Lenders must make unverifiable judgments about the borrower. In some cases, intuition, or gut feelings, are necessary to conclude whether a borrower is willing to repay a loan. As such, qualitative credit analysis techniques are largely used to evaluate the borrowers willingness to repay. Qualitative techniques include:

Gather information from a variety of sources about the character and reputation of the potential borrower. Old-fashioned lending relied on first-hand knowledge of the people and businesses in a town. In this case, lenders knew (or thought they knew) potential borrowers. It is more difficult in the modern world, where lending decisions are centralized, to know customers personally. Face-to-face meetings with the potential borrower to assess the borrowers character are routine in evaluating willingness to pay. Name lending involves lending to an individual based on the perceived status of the individual in the business community. Some lenders substitute name lending for financial analysis. Extrapolating past performance into the future. Lenders often assume that a pattern of borrowing and repaying in the past (e.g., a credit record compiled from past history with the borrower and data garnered from credit bureaus) will continue in the future.

Historical lending norms relied on the moral obligation of borrowers who could pay to repay their debts. Thus, gauging the borrowers willingness to pay was a critical component of credit analysis. However, in modern society, the moral obligation to pay if one is capable of paying has been replaced by the legal obligation to pay. In other words, in terms of credit analysis, determining the capacity to pay is more important than determining the willingness to pay because the legal system will force those who can pay to honor their commitment. Courts can seize the assets of those who will not fulfill their financial obligations. In corrupt or ineffective states, a borrower will not suffer, even if able to pay but not doing so.
The willingness to pay is more important in countries with less-developed financial markets and legal systems. Creditors must evaluate the legal system and the strength of creditors rights in emerging markets, along with the prospective borrowers ability and willingness to repay the obligation. This is a qualitative endeavor. Sovereign risk ratings may be used to evaluate the quality of a countrys legal system and, by extension, the legal risk associated with the country or region. The lower the score, the greater the legal risk. For example, in 2010, Finland had a Rule of Law Index of 1.97, the United States had a rating of 1.58, Brazil had a rating of 0.0, and Somalia had a rating of 2.43. However, even in countries with robust legal systems such as Finland and the United States, the creditor must also consider the costs associated with taking legal action against a delinquent borrower. If costs are high, the creditor may be unwilling to take action regardless of the strength of the enforcement of creditor rights. As such, the willingness to pay should never be completely ignored in credit analysis.
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The ability of a borrower to repay a loan is an objective attribute. Quantitative credit analysis techniques are largely used to evaluate the borrowers ability to repay The primary quantitative technique used in financial analysis is examining the past, current, and forecasted financial statements of the prospective borrower. This forms the core of the quantitative credit analysis used to determine a borrowers capacity to meet its financial obligations. There are limitations associated with quantitative data, which include:
Historical nature of the data. Financial data is typically historical and thus may not be up-to-date or representative of the future. Also, forecasted financial data is notoriously unreliable and susceptible to miscalculations and/or misrepresentations.
Difficult to make accurate projections using historical data. Financial statements
attempt to represent the economic reality of a firm in a highly abbreviated report. As such, some information is lost in translation that is critical to the loan decision. The rules guiding financial reporting are created by a diverse group with varying interests and are often decided by compromise. Also, firms are given discretion regarding what and how they report financial information, subject to established accounting rules. Firms may use the latitude in financial reporting to deceive interested parties. Even if the reports are accurate, financial data is subject to interpretation. There can be a range of conclusions drawn from the same data due to the variety of needs, perspectives, and experiences of the various analysts. This means there is a subjective, qualitative component to an objective, quantitative exercise.
Given the shortcomings of financial reporting, lenders should not ignore qualitative analysis. The quality of management, the motivation of the firms management, and the incentives of management are relevant for both nonfinancial and financial firms. Even quantitative analysis is subject to interpretation. In fact, many would argue that financial analysis is much more of an art than a science. Judgment is as important as the quantitative analysis supporting it. The most effective analysis combines quantitative assessments with qualitative judgments.
C r e d i t A n a l y s i s C o m p a r i s o n

LO 16.3: Describe, compare and contrast various credit risk mitigants and their role in credit analysis.
The four primary components of credit risk evaluation are as follows.
1. The borrowers (or obligors) capacity and willingness to repay the loan. Questions the
lender must consider include: What is the financial capacity to pay?
Is it likely the borrower can fulfill its financial obligations through the maturity of the loan?
Are there outside forces that affect the borrowers capacity and/or willingness to pay?
For example, does the ownership structure of the firm, relationships within and outside the firm, and other obligations of the firm affect the borrowers ability to pay?
How does the business itself affect the borrowers capacity to pay? Are there credit risk characteristics tied to this particular industry or sector? Does the firm have a niche within the industry or sector?
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2. The external environment and its effect on the borrowers capacity and willingness to repay the borrowed funds. Factors such as the business climate, country risk, and operating conditions are relevant to the lender. Are there cyclical changes that will affect the level of credit risk? Will political risks affect the likelihood of repayment?
3. The characteristics of the credit instrument. The credit instrument might be a bond issue, a bank loan, a loan from a finance company, trade credit, or other type of debt agreement/security. Concerns include: Risk characteristics that are inherent in the credit instrument, including legal risks
and obligations that are specific to the instrument.
The maturity (also called tenor) of the instrument.
Is the debt secured or unsecured? Is there collateral backing the loan? Are there loan guarantors? Is the debt subordinated or senior to other obligations? What is the priority assigned to the creditor? Flow do loan/bond covenants increase or decrease the credit risk for each party? Can the borrower repay the loan early without penalty? Can the lender call the loan? Can the security be converted to another form (e.g., a convertible bond)?

What is the denominated currency of the obligation? Are there any contingent risks?
4. The quality and adequacy of risk mitigants such as collateral, credit enhancements, and loan guarantees. Secured lending (i.e., using risk mitigants in the lending process) is generally the preferred method of lending. If there is collateral, a bank or other lender may not have to force a delinquent borrower into bankruptcy but may instead sell the collateral to satisfy the financial obligation. Secured lenders are also generally in a better position than unsecured lenders in the event of bankruptcy. The use of collateral not only mitigates losses in the event of default, but also lowers the probability of default because the obligor typically does not want to lose the collateral. Flistorically, banks have substituted collateral for analysis of the borrowers ability to pay. In some sense, the use of collateral eliminates the need for credit analysis, or at the very least makes the credit decision simpler. A lender can normally put a market value on collateral and determine if it is sufficient to cover potential losses. Three issues regarding risk mitigants include:

Is the collateral pledged to, or likely to be pledged to, another loan? lias there been an estimation of the value of the collateral? If there is a loan guarantor, has there been sufficient credit analysis of the third Is the collateral pledged to, or likely to be pledged to, another loan? lias there been an estimation of the value of the collateral? If there is a loan guarantor, has there been sufficient credit analysis of the third partys willingness and ability to pay in the event the borrower does not pay? A guarantor accepts liability for debt if the primary borrower defaults. The bank is able to substitute analysis of the guarantors creditworthiness for that of the primary borrower. Typically, the guarantor has a greater ability to pay than the primary borrower (e.g., a parent guaranteeing a childs car loan or a parent company guaranteeing a loan to a subsidiary).
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Q u a l it a t iv e a n d Q u a n t it a t iv e Te c h n iq u e s