Module 1: Fundamentals of corporate credit analysis
Types of lending
- Different types of credit facilities
- The bond markets - high grade and high yield
- Overview of current volumes and trends in the major credit markets
- Credit default swaps
Analysing and interpreting the P&L account
- Background to ratio analysis
- Analysing the income statement as the earning source for interest payments
- Revenues and earnings sources, sustainability, growth outlook, main risk factors
- Key accounting factors revenue recognition (IFRS 15), deferred revenue, expense allocation, derivatives (IFRS 9)
- Understanding the nature of the cost base
- Calculating finance income and expense, including derivatives and quasi debt
- Adjusting for exceptional and non-core items restructuring, provisions, impairments, discontinued items, MTM of financial assets and liabilities, disposal gains/losses, employee benefits (IAS 19), business combinations (IFRS 3), leases (IAS 17), customer loyalty programmes (IFRIC 13)
- Use of EBITDAR, EBITDAX, EBITDA and EBIT underlying and adjusted
- Pitfalls of using EBITDA or adjusted EBITDA
- Joint venture/associate earnings and NCI
- Ratio analysis: margins (gross, EBITDAR, EBITDA, EBIT, pre-tax, net), interest cover, basic and enhanced dividend cover
Case studies: establishing underlying EBITDA(R)
Other case studies to analyse underlying operating performance
Analysing and interpreting the cashflow statement
- Analysing the cash profile of the firm can the cashflow service the debt obligations?
- IFRC layout operating cashflow, NWC, investment & financing
- Differences between operating earnings and operating cashflow
- Impact of NWC movements on cashflow considering seasonality
- Deriving operating and net operating cashflow
- Does operating cashflow cover tax, interest, investment spending, dividends?
- Analysing the main sources and uses of cash
- What are the main cash sources of debt service and debt repayment?
- Primary and secondary sources of debt repayment
- Reorganising the cashflow statement to show CADR
- Cashflow based lending versus asset based lending
- Ratio analysis: Interest and investment coverage; debt service and debt repayment coverage (DSCR), cash conversion ratios, dependence on external financing, cashflow based ROIC, dividend coverage
Case studies: establishing underlying operating cashflow, sources of funding and reliance on external funding
Other case studies to analyse underlying cashflow generation
Quantitative analysis continued
Analysing and interpreting the balance sheet
- Analysing the balance sheet as the asset source for principal payment
- Consolidation policies
- The nature of the asset base and asset valuations
- What constitutes debt, including derivatives, quasi-debt, pension deficits
- Off balance sheet liabilities - adjusting for securitised receivables, operating leases, vendor funding, recourse financing, contingent liabilities, letters of credit, performance guarantees etc
- Provisions, deferred tax, deferred revenues
- Analysing net working capital
- Liquidity analysis
- The equity base and reserves
- NCI, joint ventures and equity accounting
- Ratio analysis: various leverage ratios, liquidity, current ratio, quick ratio, cash ratio, asset coverage, working capital ratios (inventory turnover, accounts receivable turnover, accounts payable turnover), ROIC, ROE, asset turnover, Dupont analysis
Case studies: analysis of a range of balance sheets from different sectors, as well as of off balance sheet liabilities
Other topics in financial analysis
- Analysing the notes to the financial statements
- Assessing debt capacity: balancing growth with asset turnover and financial policy
- Accounting factors; how results can be manipulated
Modelling and forecasting in Excel
- Creation of full financial forecasting models
- Creation of assumptions what are the critical value drivers?
- Return analysis
- Creation of covenant package
- LBO model
- Sensitivity analysis base case, management case, downside cases
- Case studies: modelling with Excel of historic accounts, creation of forecasts, calculation and analysis of ratios, creation of covenants. Creating a refinancing package for a cyclical company. Modelling different scenarios in one worksheet.
- The advantages and disadvantages of leverage: debt versus. equity
- Suitability for leverage
- Determinants of leverage
- Impact of shareholder value considerations on credit quality
Business risk analysis (qualitative factors)
- What are the key business risks faced by the firm and are there any mitigating factors?
Analysis of the sovereign and macro-economic conditions
- What are the levels of and trends in sovereign credit ratings where the firm has its main areas of activity?
- What are the macro-economic conditions, including currency, inflation, interest rates, growth rates, political risks etc?
- Key themes for 2017/18
Analysis of the industry and market
- What is the competitive landscape - Porters five forces
- What is the growth outlook? - Industry life cycle and cyclicality
- What is the earnings quality?
- What are the leading indicators?
- What are the pricing dynamics;? demand versus. supply
- Is the business environment changing?
- Capital intensity and the cost base
Case study: review credit of company in changing industry environment
Analysis of the companys specific characteristics
- Management, the Board and corporate governance
- Operating, capital and corporate finance strategies
- Competitive advantages and cost position does the firm create value?
- Product/service offering, differentiation and pricing power
- Diversification versus focus;
- Vertical integration versus sub-contracting
- Buyer power and supplier power
- The 7 Ms
Impact of corporate finance transactions on credit quality
- Mergers, acquisitions, disposals, breakups, demergers, LBOs, etc
- Is the impact positive, negative or neutral ?
- Case studies: impact of M&A on credit quality
- Rating scales and definitions
- Definitions of key financial variables and ratios
- Recovery ratings
- Relevance of sovereign ratings
- Advantages and limitations of the rating agencies
Pricing for bonds and loans
- Review of pricing trends?
- What are the factors that determine credit pricing?
- Are credit investors earning enough to cover their risks over the credit cycle?
Debt structuring, acquisition finance and LBOs
- Structural factors
- Shareholder structure
- Ownership and support
- Structural and contractual subordination
- Double leverage
- Risks from related parties and from lending to a group structure
- Impact of structural issues on ratings
Debt structuring - techniques and principles
Reviewing the cashflow forecasts
- Matching debt to cashflows and the asset base
- Cashflow based lending versus asset based lending
- Structuring the debt to include flexibility for different cashflow outcomes
- Debt repayment and roll-over strategy
- Debt maturity profile
What type of debt?
- Review of the advantages and drawbacks of bonds, term loans, RCFs, working capital funding, private placements, commodity linked debt, convertible debt, equity linked debt etc
- Secured versus unsecured; recourse versus non-recourse; bullet versus amortising; fixed versus floating; currency factors
- Diversifying sources of funding
- Certain debt features - accordians; variable pricing; cashflow based covenants
- Recourse versus non-recourse
The capital structure
- What is an acceptable or optimal capital structure?
- WACC considerations
- Shareholder and ROE considerations
The market for acquisition finance
- The main participants
- Market size and developments
What type of acquisition?
- Full control, partial control, minority stake
- Asset purchase versus company purchase
Types of finance
- Bridge facilities
- Acquisition finance for sub investment grade deals
- Acquisition finance for investment grade deals
- Loans and investment grade bonds - main features
- Leveraged loans, mezzanine, junior debt and HY bonds main features
- Recent transaction examples
- Vehicles for acquisition finance
- Regulated and listed entities
- Structures and documentation
- Rationale to LBOs
- Structuring an LBO
- Reviewing a comprehensive LBO model and applying scenario analysis
- Quick method of modelling and analysing an LBO
- Assessing returns to equity and subordinated lenders
Documentation and covenants
- What is the purpose of the loan and is it related to the repayment sources?
- What is the structure of debt facilities?
- Reps and warranties, conditions precedent, negative pledge
- MAC clauses, events of default, cross default, equity cures etc
- Covenant definitions (financial), including off-balance sheet liabilities
- Covenant definitions (nonfinancial)
- The nine key covenants for event and recapitalisation risks