PAPER NO. 8 CORPORATE CREDIT ANALYSIS

 

UNIT DESCRIPTION

The paper is intended to equip the candidate with the knowledge, skills and attitude that will enable him or her to make effective corporate lending decisions.

 

LEARNING OUTCOMES

A candidate who passes this paper should be able to:

• Undertake credit analysis for dynamic corporates
• Appraise risk tendencies of an entity’s management team and their influence on financial and operating decisions affecting creditworthiness
• Assess credit risk of debt instruments
• Examine the impact of debt instruments and debt structures on firm’s recovery prospects in case of insolvency.
• Evaluate the shaping of a corporation’s business by action of a sovereign government.

 

 

CONTENT

1. Overview of Credit Analysis

1.1 Lending philosophy

1.2 Identifying credit opportunity

1.3 Stages of analysis to a credit proposition

1.4 The credit decision

1.5 Credit monitoring

 

2. Overview of Corporate Borrowers

2.1 Types of corporates and their key features

2.2 Considerations in lending to corporates

2.3 Credit Risks associated with various corporates

2.4 Considerations in lending to groups of companies/conglomerates

 

3. Corporate Strategy and Credit risk

3.1 Analysis of Credit Risks inherent in a corporate’s:

3.1.1 Business strategy

3.1.2 Business model

3.1.3 Financial strategy

3.1.4 Marketing strategy

 

4. Structuring Credit Products

4.1 Objectives and process of facilities structuring

4.2 Loan agreements and covenants

4.3 Covenant clauses in lending

4.4 Facility pricing and structuring

4.5 Loans amortisation

 

5. The Management Factor

5.1 Managerial behavior and corporate’s credit profile

5.2 Competences of key management positions

5.3 Assessment of corporate governance

5.4 Influence of management actions on corporate performance

 

6. Corporate Financial Risk Analysis

6.1 Importance of financial policies in Credit analysis

6.2 Firm’s risk tolerance

6.3 Credit measures relative to financial reports

6.4 Forecasting and sensitivity analysis of corporate cash flow drivers.

 

7 Credit Risk on debt instruments

7.1 Types of debts instruments

7.2 Debts instruments pricing

7.3 Insolvency regimes and debt structures

7.4 Estimating recovery prospects on debt instruments

 

8 Industry Credit Risks

8.1 Credit profiles of various industries and sectors

8.2 Industry lifecycle stages

8.3 Patterns of business cycles and seasonality

8.4 Limitation of a corporate’s credit quality by specific industry risk

 

9 Analysis of Sovereign and Country risks

9.1 Impact of countries’ rules and regulations business activity and credit risk

9.2 Influence of political, legal and financial systems on corporates’ credit risk profiles

9.3 Shaping of credit risk by a country’s infrastructure and natural endowments

9.4 Country macroeconomic policies and corporate credit risk

 

10 Credit monitoring and control

10.1 Managing loan portfolio

10.2 Identification of warning signs of bad and doubtful debts

10.3 Early symptoms of financial distress

10.4 Dealing with problem accounts

10.5 Causes of credit deterioration and its control

10.6 Corporate remedial action – Recovery and restructuring

10.7 Loan workouts

 

 

SAMPLE WORK

Complete copy of CCP CORPORATE CREDIT ANALYSIS Study text is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP only) 

Phone: 0728 776 317

Email: info@masomomsingi.com

CHAPTER ONE

OVERVIEW OF CREDIT ANALYSIS

 

Credit analysis is a process undertaken by lenders to understand the creditworthiness of a prospective borrower, meaning how capable (and how likely) they are of repaying principal and interest obligations.

The borrower, also known as the debtor, could be an individual or a business entity; the former is referred to as retail (or personal) lending, and the latter is what’s known as commercial lending.

Lenders, also known as creditors, employ a variety of qualitative and quantitative techniques (including risk models) when conducting credit analysis in order to quantify and effectively price risk.

What is Credit?

Credit is “created” when one party receives resources from another party, but payment is not expected until some contracted date (or dates) in the future.

The resource may be cash, as is the case with a bank loan. Alternatively, the resource may be a physical product (like inventory); this is called trade credit.

In both cases, credit risk exists. This is defined as the risk that a creditor will advance resources to a debtor, but that payment (or repayment) will not be made. Credit analysis is conducted in order to understand the level of credit risk presented by a borrower, given the parameters of a specific credit request.

Credit Analysis Framework – The 5 Cs

A popular credit analysis framework is the 5 Cs of Credit; the 5 Cs underpin the component parts of most risk rating and loan pricing models. The 5 Cs are:

• Character – This is about understanding who the borrower is, including what their credit history may tell us about their likelihood of making future loan payments.
• Capacity – This speaks to the borrower’s actual ability to make payments using internally-generated cash flow(by the company for a business borrower or by way of personal earnings for a retail borrower).
• Capital – This is an evaluation of the borrower’s overall financial healthbut also an assessment of alternative sources of liquidity should it be necessary.
• Collateral – This factors in the quality and the overall desirability of any physical assets that are available as security.
• Conditions – This is, in part, understanding the purpose of the loan proceedsbut also “conditions” in the external environment that may impact the borrower’s financial health and cash position.

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CHAPTER TWO

OVERVIEW OF CORPORATE BORROWERS

 

Types of corporates and their key features

Corporate borrowers are companies or corporations that seek to borrow money from lenders, such as banks or other financial institutions. These borrowers may require funds for various purposes, such as financing a new project, expanding their business, or refinancing existing debt.

Corporate borrowers typically have to meet certain criteria to be eligible for loans, including demonstrating their ability to repay the loan, providing collateral or a guarantee, and having a good credit history. The terms and conditions of corporate loans can vary depending on factors such as the borrower’s creditworthiness, the lender’s risk assessment, and prevailing market conditions.

Corporate borrowers may also issue bonds or other debt securities to raise capital from investors. These securities typically have a fixed interest rate and maturity date, and the borrower is obligated to pay interest and repay the principal amount to the bondholders.

The borrowing and financing activities of corporate borrowers play a vital role in the economy, as they facilitate investment and growth in various sectors and industries. However, excessive borrowing or over-leveraging can lead to financial distress or default, which can have significant consequences for both the borrower and the lender.

 

Usage of a Corporate Loan

Some of the reasons to avail a corporate loan are

• To start a new venture: When you have an enterprising idea and would like to put it to action, you require the capital to start it. One can approach a bank to apply for a Venture loan to start a new business enterprise.
• Daily business needs: A firm or a business entity may need funds to meet the daily expensed of their business. These funds might be required for smaller expenses like rent, utilities, salaries, petty cash, etc. Then you can apply for a loan.
• Purchase of assets: When the business requires to purchase and install assets like building, machinery and other equipment, they can apply for a corporate loan.
• Procurement of raw materials: The business needs constant flow of capital to invest in new opportunities. They will require to buy raw materials to start a fresh batch of production. Corporate loans help you to avail quick cash while you are waiting for future payments or pending invoices.

SAMPLE WORK

Complete copy of CCP CORPORATE CREDIT ANALYSIS Study text is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP only) 

Phone: 0728 776 317

Email: info@masomomsingi.com

CHAPTER THREE

CORPORATE STRATEGY AND CREDIT RISK

 

Analysis of Credit Risks inherent in a corporate’s:

Credit risk is the possibility of loss due to a borrower’s failure to repay a loan or meet its contractual obligations. In the case of a corporate, credit risk analysis involves evaluating the company’s ability to meet its debt obligations and repay its creditors.

On the side of the lender, credit risk will disrupt its cash flows and also increase collection costs, since the lender may be forced to hire a debt collection agency to enforce the collection. The loss may be partial or complete, where the lender incurs a loss of part of the loan or the entire loan extended to the borrower.

The interest rate charged on a loan serves as the lender’s reward for accepting to bear credit risk. In an efficient market system, banks charge a high interest rate for high-risk loans as a way of compensating for the high risk of default. For example, a corporate borrower with a steady income and a good credit history can get credit at a lower interest rate than what high-risk borrowers would be charged.

Conversely, when transacting with a corporate borrower with a poor credit history, the lender can decide to charge a high interest rate for the loan or reject the loan application altogether. Lenders can use different methods to assess the level of credit risk of a potential borrower in order to mitigate losses and avoid delayed payments.

Here are some factors that are commonly considered in analyzing credit risks inherent in a corporate:

1. Financial health and performance: One of the most important factors in assessing credit risk is the financial health of the corporate. This includes factors such as the company’s profitability, liquidity, debt levels, cash flow, and ability to generate revenue. A strong financial position indicates that the company is more likely to be able to meet its debt obligations, while a weak financial position raises concerns about the company’s ability to repay its creditors.
2. Industry trends and competition: Industry trends and competition can have a significant impact on a corporate’s credit risk. For example, a company in a highly competitive industry may have a harder time generating revenue and maintaining profitability, which can increase the risk of default.
3. Management quality and experience: The quality and experience of a corporate’s management team can also play a role in its credit risk. A company with strong and experienced management is more likely to make good financial

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CHAPTER FOUR

STRUCTURING CREDIT PRODUCTS

 

Structured credit involves pooling similar debt obligations and selling off the resulting cash flows. Structured credit products are created through a securitization process, in which financial assets such as loans and mortgages are packaged into interest-bearing securities backed by those assets, and issued to investors. This, in effect, re-allocates the risks and return potential involved in the underlying debt.

Issuers of structured credit products can range from lenders and specialty financial companies to corporate borrowers. The benefits of securitization for these parties include potential off-balance sheet treatment of assets, reduction of an asset-liability mismatch and lower financing costs. For instance, a BB-rated company can carve out AA-rated assets as collateral, enabling it to borrow at the lower rates reserved for higher-quality borrowers.

Investors in structured credit products can potentially earn higher returns, diversify their portfolios, and gain the ability to tailor credit risk exposures to best serve their investment goals. Repayment to investors is supported by the contractual obligation of the borrowers to pay. For example, an individual takes out a loan from a bank to buy a home, and this mortgage agreement – the contractual obligation to pay – can become part of a securitization pool. The payoff derived from the performance of the underlying asset (i.e., the loan as well as others in the same pool) in a sense replaces traditional fixed-income payment features such as interest coupons.

Structured finance is a decades-old concept dating from the 1970s, when home mortgages were bundled and sold off by U.S. government-backed agencies.

 

The advantages of structured credit

For investors with a traditional stock and bond portfolio, an allocation to structured credit offers diversification. Not only are yields historically low on investment grade bonds, but they also are vulnerable to capital losses in a portfolio should interest rates rise.

Structured credit funds may compliment a traditional allocation by providing incremental yield as well as the potential for capital appreciation. Many structured credit funds purchase floating rate bonds, which have interest rates pegged to benchmark interest rates. A floating rate component further diversifies a structured credit fund because it offers a different interest rate profile than a traditional bond.

Mutual funds that invest in structured credit invest in bonds backed by hundreds or thousands of pools of loans. Each of those loan pools contains hundreds of loans. That

SAMPLE WORK

Complete copy of CCP CORPORATE CREDIT ANALYSIS Study text is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP only) 

Phone: 0728 776 317

Email: info@masomomsingi.com

CHAPTER FIVE

THE MANAGEMENT FACTOR

 The management factor is a critical aspect of corporate credit analysis because the decisions and actions of a company’s management team can significantly impact its financial performance and creditworthiness. Effective management is essential for a company to operate efficiently, generate profits, and maintain a healthy balance sheet.

When conducting corporate credit analysis, lenders and credit rating agencies evaluate various aspects of a company’s management, such as their experience, skills, and track record. They also assess the management team’s strategic vision, corporate governance, and risk management practices. For example, lenders may analyze the management’s ability to navigate industry-specific challenges, implement cost-cutting measures, or adapt to changing market conditions.

 

Furthermore, lenders and credit rating agencies typically evaluate the management team’s transparency and communication practices. They may review the company’s financial disclosures, earnings calls, and other public statements to gauge the management’s credibility and trustworthiness. The management’s past performance and decision-making processes may also provide insights into their future behaviour.

Overall, the management factor is a crucial element of corporate credit analysis, and lenders and credit rating agencies carefully scrutinize a company’s management team to determine its creditworthiness. A competent and effective management team can help a company weather economic storms, maintain financial stability, and strengthen its credit profile, while a weak or ineffective management team can increase the company’s credit risk and decrease its ability to repay debt obligations.

 

Managerial behavior and corporate’s credit profile

Managerial behavior plays an important role in credit analysis as it can impact a company’s financial performance and creditworthiness. The behavior of a company’s management team can influence a wide range of factors, including financial reporting, financial forecasting, risk management, and strategic decision-making, all of which can affect a company’s creditworthiness.

Here are some examples of how managerial behavior can impact credit analysis:

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CHAPTER SIX

CORPORATE FINANCIAL RISK ANALYSIS

The term risk analysis refers to the assessment process that identifies the potential for any adverse events that may negatively affect organizations and the environment. Risk analysis is commonly performed by corporations (banks, construction groups, health care, etc.), governments, and nonprofits. Conducting a risk analysis can help organizations determine whether they should undertake a project or approve a financial application, and what actions they may need to take to protect their interests. This type of analysis facilitates a balance between risks and risk reduction. Risk analysts often work in with forecasting professionals to minimize future negative unforeseen effects.

 

What Are the Main Components of a Risk Analysis?

Risk analysis is sometimes broken into three components. First, risk assessment is the process of identifying what risks are present. Second, risk management is the procedures in place to minimize the damage done by risk. Third, risk communication is the company-wide approach to acknowledging and addressing risk. These three main components work in tandem to identify, mitigate, and communicate risk.

 

Why Is Risk Analysis Important?

Sometimes, risk analysis is important because it guides company decision-making. Consider the example of a company considering whether to move forward with a project. The decision may be as simple as identifying, quantifying, and analyzing the risk of the project.

Risk analysis is also important because it can help safeguard company assets. Whether it be proprietary data, physical goods, or the well-being of employees, risk is present everywhere. Companies must be mindful of where it most likely to occur as well as where it is most likely to have strong, negative implications.

 

The Bottom Line

Risk analysis is the process of identifying risk, understanding uncertainty, quantifying the uncertainty, running models, analyzing results, and devising a plan. Risk analysis may be qualitative or quantitative, and there are different types of risk analysis for various situations.

SAMPLE WORK

Complete copy of CCP CORPORATE CREDIT ANALYSIS Study text is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP only) 

Phone: 0728 776 317

Email: info@masomomsingi.com

CHAPTER SEVEN

CREDIT RISK ON DEBT INSTRUMENTS

 

Debts instruments

A debt instrument is any form of arrangement that is essentially categorized as debt. Debt instruments give money to a company that pledges to pay it back over time.

 

Debt is a legal responsibility on the side of the issuer (or taker) to return the lender the borrowed amount plus interest on a timely basis. A debt instrument can be printed or stored electronically. Debt instruments include bonds, debentures, leases, certificates, bills of exchange, and promissory notes.

 

These debt instruments also allow market players to shift debt liability ownership from one person to another. Throughout the life of the instrument, the lender receives a specified amount of money as a form of interest.

 

Advantages of Debt Instruments

If a company properly invests borrowed funds through debt instruments, it can increase profitability. The process of financing through creditors to maximize shareholder wealth is referred to as leverage.

If the investment returns are greater than the interest payments, the debtor will be able to generate profits on the debt financing. In the field of private equity, companies make investments through leveraged buyouts that are built around the investment to provide greater returns than the interest payments.

 

Disadvantages of Debt Instruments

Debt financing can be a great source of risk for businesses, primarily through increased liquidity and solvency risk. Liquidity is hindered because interest payments are classified as a current liability and represent a cash outflow within one year.

Liquidity and solvency are important factors to consider, especially when assessing a company based on the going-concern principle. Debt financing is popular among individuals, companies, and governments.

 

Types of debt instruments

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CHAPTER EIGHT

INDUSTRY CREDIT RISKS

 Credit profiles of various industries and sectors

The credit profile of an industry or sector refers to the overall creditworthiness of companies within that industry or sector, as well as the specific risks and factors that can impact the ability of companies within that industry or sector to meet their financial obligations. Different industries and sectors can have vastly different credit profiles, depending on the unique characteristics and challenges of the industry or sector.

Here are some examples of the credit profiles of some common industries and sectors:

• Technology: The technology sector is known for its rapid innovation and high growth potential, but companies within this sector can also be highly leveraged and can have volatile earnings. Technology companies may also have a high amount of intellectual property, which may make them less vulnerable to competition, but also make it hard to value them.
• Healthcare: Healthcare companies generally have stable cash flow and a high demand for their products and services. However, healthcare companies can also be highly regulated and subject to reimbursement risks.
• Energy: Energy companies are exposed to commodity price risk and political and regulatory risk. Those that are involved in exploration and production can be highly capital intensive, making them vulnerable to changes in commodity prices. Those involved in renewable energy may also be exposed to technology risk and changes in subsidy policies.
• Retail: Retail companies are exposed to competition and changes in consumer behavior. e-Commerce and online sales have had a huge impact on the traditional brick and mortar stores. Companies operating in this sector may be highly leveraged, with a large amount of fixed costs and inventory.
• Real estate: Real estate companies can have a relatively stable cash flow, however, they are exposed to fluctuations in property values and rental income, as well as interest rate risk. The capital intensive nature of the industry and the use of leverage can amplify these risks.
• Infrastructure: Infrastructure companies can have a relatively stable cash flow, as they are often regulated utilities or have long-term contracts in place.

SAMPLE WORK

Complete copy of CCP CORPORATE CREDIT ANALYSIS Study text is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP only) 

Phone: 0728 776 317

Email: info@masomomsingi.com

CHAPTER NINE

ANALYSIS OF SOVEREIGN AND COUNTRY RISKS

 

Impact of countries’ rules and regulations business activity and credit risk

The rules and regulations of a country can have a significant impact on the business activity and credit risk of companies operating within that country. These regulations can affect a company’s ability to generate revenue, maintain profitability, and meet its financial obligations, which can ultimately affect its creditworthiness.

Here are a few examples of how country-specific rules and regulations can impact business activity and credit risk:

• Taxation and government policies: Taxation and government policies can impact a company’s profitability and cash flow, which can affect its ability to meet its financial obligations. High tax rates and unfavorable government policies can make it difficult for companies to remain competitive and increase their credit risk.
• Labour laws and regulations: Labor laws and regulations can affect a company’s ability to manage its workforce, which can in turn impact its profitability and cash flow. Stringent labor laws and regulations can make it difficult for companies to manage their labor costs and increase their credit risk.
• Environmental regulations: Environmental regulations can affect a company’s costs and ability to operate, which can impact its profitability and cash flow. Strict environmental regulations can increase a company’s operational costs and limit its ability to generate revenue, which can increase its credit risk.
• Financial regulations: Financial regulations can affect a company’s access to capital and ability to borrow, which can impact its ability to meet its financial obligations. Restrictive financial regulations can make it difficult for companies to secure financing, which can increase their credit risk.
• Political instability: Political instability can create uncertainty and unpredictability for companies, which can impact their ability to plan and make investment decisions. This can affect their revenues and increase the risk of non-payment, ultimately leading to an increase in credit risk.

It’s important to note that these are just a few examples and different countries can have different regulations and legal environments that can have a different level of impact. Understanding the rules and regulations of a country can be critical when it comes to assessing the credit risk of companies operating within that country.

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CHAPTER TEN

CREDIT MONITORING AND CONTROL

 

Managing loan portfolio

Managing a loan portfolio involves the identification, assessment, and management of the risks associated with a portfolio of loans. This typically involves the ongoing monitoring and management of the creditworthiness of the borrowers, as well as the terms and conditions of the loans.

Here are a few key steps involved in managing a loan portfolio:

• Identification of loans: The first step in managing a loan portfolio is to identify the loans that make up the portfolio. This typically involves reviewing loan agreements, credit applications, and other relevant documentation to identify the key terms and conditions of each loan.
• Assessment of credit risk: The next step is to assess the credit risk associated with each loan. This typically involves reviewing the creditworthiness of the borrowers, the terms and conditions of the loans, and the collateral pledged to secure the loans.
• Management of risk: Once the credit risk associated with each loan has been assessed, the portfolio manager can take steps to manage that risk. This may include taking steps to reduce the credit risk, such as by requiring additional collateral or adjusting the terms and conditions of the loans.
• Monitoring of the portfolio: Ongoing monitoring of the loan portfolio is necessary to ensure that the credit risk remains within an acceptable range. This typically involves monitoring the performance of the borrowers, the collateral pledged to secure the loans, and the terms and conditions of the loans.
• Portfolio reporting: Regular reporting on the loan portfolio is necessary to provide management and stakeholders with a clear picture of the portfolio’s performance, risk and key metrics.
• Repayment management: Effective management of the repayments is crucial to ensure that loans are being serviced as per the terms and conditions agreed. This may include monitoring cash flow, keeping track of borrowers’ creditworthiness and working with borrowers in case of financial difficulties.

It’s important to note that these are general guidelines and specific strategies and techniques may vary depending on the type of loan portfolio and the institution.

SAMPLE WORK

Complete copy of CCP CORPORATE CREDIT ANALYSIS Study text is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP only) 

Phone: 0728 776 317

Email: info@masomomsingi.com