Metrics Your Credit Analysts Should Review Regularly

The Probability of Default (PD) plays a crucial role in credit risk analysis. It serves as a foundational metric that enables lenders to assess the creditworthiness of borrowers accurately.

However, this isn’t the only metric worth reviewing on a regular basis.

Credit analysts and portfolio managers should also be reviewing other key metrics, many of which influence the Probability of Default. This blog will examine four important metrics that drive effective credit decisions and can reveal opportunities to fine-tune an institution’s risk management strategies.

Credit Utilization Rate

A customer’s credit utilization rate is a key performance indicator that measures the percentage of a borrower’s available credit that is currently being used. The ratio is what one would expect from the name: The total credit outstanding divided by the credit limit. The lower the ratio the better.

This ratio, and the change in the ratio over time (is it rising or falling?) provides insights into the ability of the individual or business to handle credit responsibly and helps a lender assess the risk of extending additional credit.

Debt Service Coverage Ratio

The debt service coverage ratio (DSCR) evaluates the ability of a borrower to meet its payment obligations. It measures the cash flow available to cover debt payments, including principal and interest. It is calculated by dividing the income (net operating income for a business) by the total debt service.

Tracking the DSCR also enables lenders to assess a borrower’s financial health and help determine how risky it would be to extend additional credit. A DSCR of 1.25 is or higher is usually considered to be good, but a “good” score is different from industry to industry. For example, a lower ratio in the real estate industry may be acceptable if the property is expected to appreciate in value, according to an Americor  blog.

Credit Score Distribution

Credit score distribution is the range and distribution of credit scores within a given population. It gives a lender insight into the overall creditworthiness of businesses or individuals, helping financial institutions accurately measure risk within a specific market or vertical.

Tracking credit score distribution enables a financial institution to identify trends and patterns in creditworthiness, assess the effectiveness of risk analysis tools, compare credit risk profiles of different industries, identify high-risk individuals or businesses and ultimately, make informed lending decisions.

Collateral Analysis

Collateral management serves as a vital risk mitigation strategy for organizations in the financial realm. By accepting high-quality assets as collateral, institutions can minimize credit risk.

However, analyzing collateral can be tricky. Cash is straightforward. Receivables need to be analyzed in relation to ones that are current, ones that have been unpaid for 30 days and ones that are 90 days or more past due. Other collateral, like real estate, is even more complex to evaluate.

The financial institution needs to consider the complexity and diversity of the collateral requirements and regulations across different markets, products, and jurisdictions. Your team will need to keep track of the changing rules and regulatory standards and ensure that you comply with them.

Another challenge is the availability and cost of collateral. Your bank needs to have enough collateral to cover current and future exposures and manage its allocation and optimization. Analysts also need to consider the opportunity cost and funding cost of using collateral, and weigh them with the benefits. The more challenging the collateral analysis, the more important it is to work with a partner with expertise in analyzing and managing a wide variety of collateral across different markets.

What Gets Measured Gets Managed

When financial institutions have the right tools and reports to identify risks across products, business lines and clients, credit analysts can help maintain appropriate margins through the life of the credit.

This is more important than ever. Laurie Foster, credit program director for the Risk Management Association said it best in a recent Q&A, “We are in an unusual and uncertain economy right now as we continue to work through the aftereffects of the pandemic: high inflation and interest rates, empty office space, a mostly tight labor market. And while COVID-era buffers like student loan deferrals and stimulus savings are ending or eroding, the overall economy is surprisingly strong. Risk management is never easy, but the current environment is particularly challenging. It’s a lot to take in.”

The right reporting tools and metrics can make this process easier and more consistent for everyone involved – from the banker analyzing the deal to the borrower looking for the best financing option.

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