Victoria Stoughton
MCE’s Financial Analyst
Long practical experience enabled analysts from Meridian Capital Enterprises Ltd. to develop several methods of the evaluation of the creditworthiness, which can be classified to the following categories:
- descriptive – (traditional or logical and deductive) involving the evaluation of the creditworthiness of a client based on the information on his economic and financial position;
- statistical and mathematical (empirical and deductive) – the creditworthiness of a client is evaluated on the basis of characteristics and behaviour of previous borrowers (clients).
Descriptive approach
When applying the descriptive approach, analysts from Meridian Capital Enterprises Ltd. evaluate different ratios obtained through the economical analysis (of the balance sheet, cash flow statement, debt, collateral, etc.) and own judgement. These ratios are to describe different aspects of the client's business. Analysts from Meridian Capital Enterprises Ltd. often apply comparisons with ratios obtained in a given sector in order to provide more objective results. It is also recommended to supplement the analysis with forecasts regarding the future financial position of the company. Decisions made on the basis of such evaluation are to a great degree subjective and depend on the judgement of the person granting the loan.
Financial analysts from Meridian Capital Enterprises Ltd. take into account six criteria, which are analysed when evaluating the creditworthiness:
Basing on the descriptive evaluation method, Meridian Capital Enterprises Ltd. introduced the scoring method involving assigning a given number of points to the value obtained. At the same time, the value range of individual ratios can be different, depending on its weight and individual preferences of Meridian Capital Enterprises Ltd. Then the analysts sum up the scorings. The number obtained remains within a certain range (e.g. 0-66) and reflects the estimated level of risk of a given borrower. Depending on the total number of points, the client is classified to a proper risk category predefined (partially subjectively) by Meridian Capital Enterprises Ltd. A sample classification to the risk groups is presented in the table below:
The obtained number provides a basis for making a decision on granting or non-granting the loan (however sometimes non-technical matters decide on granting the loan). The scoring method is an attempt to introduce more objective approach into the procedure of the evaluation of the creditworthiness of a given client. It has proven to be very useful when a high number of routine decisions is made.
Statistical and mathematical approach
The empirical and deductive approach is based on a completely different philosophy (that is more interesting to a statistician). Methods employing this philosophy evaluate the creditworthiness of a given client on the basis of behaviour of previous borrowers (clients). This approach assumes that a given borrower would behave in the same way as previous borrowers similar to him. The task of an analyst from Meridian Capital Enterprises Ltd. applying such methods is to select proper variables describing the behaviour of the borrower and use them to develop a model allowing to determine whether the client is reliable or not. Such model should be able to generalise information included in the historical data and to function with a similar effectiveness on new, unknown data. Financial analysts from Meridian Capital Enterprises Ltd. understand that models pivoting on the mathematical and statistical approach prove the best in short periods. Over time, relationships between individual parameters change, which can result in a drop in forecasting effectiveness of the model. Therefore analysts reestimate the model (namely recalculate its parameters) using new observations with a predefined frequency.
Similar models are developed by analysts from Meridian Capital Enterprises Ltd. to evaluate behaviour of clients that already received a loan. They are aimed at determining whether some irregularities in the loan repayment by the client are due to his financial problems or acts of God. Such analyses are very important to analysts from Meridian Capital Enterprises Ltd. as they allow for faster reaction time in case of recognising a client in difficult situation, which increases chances to recover the loan.
MCE’s Financial Analyst
Long practical experience enabled analysts from Meridian Capital Enterprises Ltd. to develop several methods of the evaluation of the creditworthiness, which can be classified to the following categories:
- descriptive – (traditional or logical and deductive) involving the evaluation of the creditworthiness of a client based on the information on his economic and financial position;
- statistical and mathematical (empirical and deductive) – the creditworthiness of a client is evaluated on the basis of characteristics and behaviour of previous borrowers (clients).
Descriptive approach
When applying the descriptive approach, analysts from Meridian Capital Enterprises Ltd. evaluate different ratios obtained through the economical analysis (of the balance sheet, cash flow statement, debt, collateral, etc.) and own judgement. These ratios are to describe different aspects of the client's business. Analysts from Meridian Capital Enterprises Ltd. often apply comparisons with ratios obtained in a given sector in order to provide more objective results. It is also recommended to supplement the analysis with forecasts regarding the future financial position of the company. Decisions made on the basis of such evaluation are to a great degree subjective and depend on the judgement of the person granting the loan.
Financial analysts from Meridian Capital Enterprises Ltd. take into account six criteria, which are analysed when evaluating the creditworthiness:
- Character – competent management and willingness to repay the loan.
- Capacity – ability of the borrower to repay the loan.
- Capital – relationship of equity or assets to the loan granted.
- Collateral – the market value, as well as marketability of the collateral offered.
- Conditions – manufacturing capacity of the client, his market position, competition.
- Confidence – ability to maintain (continue) activities.
Basing on the descriptive evaluation method, Meridian Capital Enterprises Ltd. introduced the scoring method involving assigning a given number of points to the value obtained. At the same time, the value range of individual ratios can be different, depending on its weight and individual preferences of Meridian Capital Enterprises Ltd. Then the analysts sum up the scorings. The number obtained remains within a certain range (e.g. 0-66) and reflects the estimated level of risk of a given borrower. Depending on the total number of points, the client is classified to a proper risk category predefined (partially subjectively) by Meridian Capital Enterprises Ltd. A sample classification to the risk groups is presented in the table below:
| Scoring | Creditworthiness|
| 66-51 | not raising doubts |
| 50-36 | raising doubts |
| 35-20 | at risk |
| 19-0 | lost |
The obtained number provides a basis for making a decision on granting or non-granting the loan (however sometimes non-technical matters decide on granting the loan). The scoring method is an attempt to introduce more objective approach into the procedure of the evaluation of the creditworthiness of a given client. It has proven to be very useful when a high number of routine decisions is made.
Statistical and mathematical approach
The empirical and deductive approach is based on a completely different philosophy (that is more interesting to a statistician). Methods employing this philosophy evaluate the creditworthiness of a given client on the basis of behaviour of previous borrowers (clients). This approach assumes that a given borrower would behave in the same way as previous borrowers similar to him. The task of an analyst from Meridian Capital Enterprises Ltd. applying such methods is to select proper variables describing the behaviour of the borrower and use them to develop a model allowing to determine whether the client is reliable or not. Such model should be able to generalise information included in the historical data and to function with a similar effectiveness on new, unknown data. Financial analysts from Meridian Capital Enterprises Ltd. understand that models pivoting on the mathematical and statistical approach prove the best in short periods. Over time, relationships between individual parameters change, which can result in a drop in forecasting effectiveness of the model. Therefore analysts reestimate the model (namely recalculate its parameters) using new observations with a predefined frequency.
Similar models are developed by analysts from Meridian Capital Enterprises Ltd. to evaluate behaviour of clients that already received a loan. They are aimed at determining whether some irregularities in the loan repayment by the client are due to his financial problems or acts of God. Such analyses are very important to analysts from Meridian Capital Enterprises Ltd. as they allow for faster reaction time in case of recognising a client in difficult situation, which increases chances to recover the loan.
