Credit and Risk Analysis PDF

4 CREDIT AND RISK ANALYSIS Credit Analysis Specificities There are as many analyzes as there are analysts Never forget that each analyst conducts his study according to his own research angle The report must always make an objective judgment on an overall situation without forgetting the specific po...

4 CREDIT AND RISK ANALYSIS Credit Analysis Specificities There are as many analyzes as there are analysts Never forget that each analyst conducts his study according to his own research angle The report must always make an objective judgment on an overall situation without forgetting the specific positions and missions of each A banker will tend to favor the structure, the CEO rather the profitability of the invested capital and the commercial partners the mode of management of the components of the Working Capital in the perspective of influencing it... The number of financial ratios used can often be inversely proportional to the analyst's experience, except in particularly complex cases (companies listed on the stock market... Groups made up of a multitude of subsidiaries) Expectations of financial resources providers Shareholder side Main concern: Ensure optimal profitability by having the proof that the project in which he is going to invest will be a “Value creation” Mission of the Entrepreneur What measure to succeed in giving hope? Watch the return on invested capital (Equity) thanks to Return On Equity which compares the Net Result versus the Equity made available to the company Positive if ROE * Equity including shareholders' contribution and the accumulated result !! If the use of debt suggests a return on equity for the shareholder significantly higher than the economic return generated by other financial products, it also provides a heavier financial RISK... Specificities of its Risk They expect a higher risk than that of the lender banker. Yes but why? The banker is the only one, through the construction of the monthly loan repayment process, which benefits each month from the reduction of its debt over time according to the bank calculation formula: A= Qote-part de capital + Intérêt = K * [i / 1 – (1+i)^-n] A= Annuité de l’emprunt K= Capital de l’emprunt N: Durée i: Taux d’intérêt Risk of uncollectability decreases over time And is covered by guarantees from the manager While the shareholder comes last in the event of bankruptcy of the company, he will be thus the last compensated after liquidation of the assets, so he knows that he will get nothing... Its interests… Estimation of an economic risk linked to the volatility of the activity and the profitability of the company Annual: If dividend distribution ARBITRAGE DOUBLE REMUNERATION Estimation of bankruptcy risk due to the impact of the level of debt on the financial structure of the capital employed on the balance sheet Deferred: With the expectation of capital gain on the resale value of the security Compensation at least equal to 15% is generally accepted by shareholders Bankers expectations Remuneration of their contributions of financial resources in the form of loans Materialized by an increase in the cost of debt depending on its maturity: ST / MT / LT Prerogatives of banks By applying a spread spread on the cost of money (Euribor...)... Increases with the estimation of the risk incurred and the provisions calculated … By which the bank provides itself in cash to lend whose rate can be Fixed or Variable Lender's logic Ø In return for the capital borrowed, the manager of the company undertakes to pay regular flows of reimbursement independent of the evolution of the results from operations Ø To grant a loan, the banker issues 2 conditions represented by 2 ratios "playing" together: Debt capacity / Financial autonomy The repayment capacity Debt capacity Ø The banker wants to determine if the company still has the capacity to go into debt without compromising its proper functioning and to avoid Overheating Ø Equity = Shareholder contributions + Accumulated results Ø Equity called Internal which naturally serve as the first guarantee for banks to grant credit to the company Ø Risk Sharing Rule according to which, for the sake of caution, all funding must be fairly distributed between Shareholder and Bank Risk sharing by a fair necessary balance between equity and debt Debt capacity Ø Commonly expected ratio is less than or equal to 1 Ø Same proportion of equity as debt is preferred Ø Acceptable ratio of up to 2 in some cases: Bank covered by a dedicated financial organization OSEO-type Forecast cash flow sufficient to repay debt When the structure Organization/Market is reassuring Mature market promising low volatility of results 1/3 of equity and 2/3 of debt The repayment capacity Ø Beyond risk sharing -> Objective: Ensure the banker to repay the loan and interest every month Ø Determine the calculation of the forecast CAF and EBITDA Ø We can estimate the repayment capacity by the joint use of 2 ratios: Amount of the ratio which is expressed in number of years the capacity of the company to repay its debts by means of its EBITDA Annual repayment ratio of financial debts on CAF measures the weight of annual loan maturities on the ability to generate cash Financial Debt EBITDA Except in special cases, a loan weight greater than 3 or 4 years of EBITDA would translate into too heavy a debt with regard to the creation of its wealth Desirable that this ratio is 67%. Beyond this, statistics show an excess of debt with regard to its self-financing capacity Loan annuities Cash Flow Risk of default because Cash flow would be mainly oriented to repay credit neglecting elements such as dividends, growth and exceptional Expected Investors Revenues and Debt ratios Intrinsic rating that can improve if the Group's rating - Mother House - is considered as a guarantee Short-term risk Analysis Ø In risk analysis, the manager's problem will be whether the assets financed with the resources of the company produce enough cash to repay the financial debts Ø Reminder : Cash is the balance of resources on uses and appears on the balance sheet "below" in the assets or liabilities Increase in financial debts temporarily relieves cash flow Increase in equity increases cash flow and decreases risk of liquidity disruption BUT It will be necessary quickly thanks to the increase in business that it allows to release enough cash to repay! Increase in assets such as investments or Working capital deteriorates cash flow The Golden rules to convince the Bank To improve its profitability and limit its risk of bankruptcy, the company must constantly have in mind: Ø Rule 1: Decrease the amount of economic assets (Fixed asset + WCR) For example, by reducing stocks and reducing customer settlement times to reduce economic assets Ø Rule 2: Reduce debt This will be possible if less economic assets are to be financed. Indeed, for example less fixed assets to finance = less funding = less repayment = lower risk of bankruptcy! Ø Rule 3: Reduce consumption of materials, goods or services This healthy decrease will improve operating profit and also self-financing capacity (FCF) which will enable longterm financial debts to be raised to ensure development. Ø Rule 4: Improve the operating profit by improving the gross margin In the same spirit, developing the turnover will be possible by focusing on innovation and the know-how of the company and by choosing its products judiciously and the segmentation of its market. Non Financial diagnosis of the company Non Financial and sectoral diagnosis of the company Analysis Main objective: Appreciate the dynamics of the company Before studying the accounting documents, the analyst must understand the internal environment and external of the company. For this he examines: The organization of the company Means used to achieve its production Markets positions Its Products 3 lines of investigation: 1) The Company The key points of appreciation: Legal Structure Structure Implantation Tools of production External and Internal Image Strategic axis Shareholding Structure Risk management and governance Ability to adapt to the environment 3 lines of investigation: 1) The Company The key points of appreciation: Questions to ask : ü What is the legal status and distribution of capital? ü Membership in a group and / or the presence of a commercial partnership? ü What organization in decision-making? ü The commercial location? The location and adaptation of infrastructure? ü Social liabilities (litigation, etc.)? Environmental risks? ü Development prospects? ü Is there an activity forecast? Are there dashboards for monitoring activity? 3 lines of investigation: 2) The Human Factor Credibility Pragmatic vision Dynamism and creativity Managing style Adaptation ability Social policy 3 lines of investigation: 2) Questions to ask : ü Who are the shareholders? The leaders ? What coaching? Which employees? ü What are the age, experience and education of the shareholders? What about leaders? ü Do shareholders and managers have a realistic vision? ü Are Key people identified? Are they insured? ü What social policy? What social climate? ü Team stability? Training ? ü Are the actors creative? ü Are the actors attentive to their environment (customers, employees, etc.)? ü Are the players capable of mastering the development of their business (particularly with regard to technological developments) and ensuring its sustainability? 3 lines of investigation: 3) Products and Market The key points of appreciation: Adequacy of products to markets Competitive advantage Innovation Market share and main competitors International opening 3) Product and Market Questions to ask : ü What are the quality, seasonality and risk of product obsolescence? ü How have products and customer expectations evolved? ü Is their a potential in the market (expansions, maturity, decline)? ü Are products subject to special protection (patent applications)? Or a competitive advantage (price, quality, etc.)? ü Is the company in a subcontractor position? S yes, for what part of its activity? ü Is the company innovative? Does it invest in research? ü What is its market share? What are competitors' products and business practices? ü Is the company dependent on suppliers? Customers? ü Does the company export? How much of its turnover? Is this determining for her? Focus on sector analysis The interpretation of accounting indicators must be completed with an analysis of companies' projects and their environment. The widening of the forecast field of financial analysis requires information that will allow the construction of scenarios relating to competitive, commercial and technological environments. Belonging to a sector configures the structure and weight of economic assets due to the influence of the sector on the level of equipment, the nature of the technologies used and the amount of working capital requirements. Carrying out a sectoral analysis generally follows the following standard plan: Ø Activity (products, distribution) Ø Market analysis and outlook (determinants of activity, environmental analysis, cyclical analysis of the sector, presentation of a forecast scenario) Ø Structure of the competition (offer and positioning of leading groups, geographic location of the activity, trade balance, ranking of competitors according to several criteria) Ø Margins (determinants of margins, analysis of the productivity and performance of actors grouped by size class) Sectoral analysis scheme (adapted from Porter) Rivalry between competitors Threat of new comers Threat of substitute products Price Level Sector Profitability Ability to master the margin Bargaining power of customers and suppliers