1. CH.10 CREDIT ANALYSIS AND DISTRESS PREDICTION

2. Credit Analysis
Is the evaluation of a firm from the perspective of a holder or potential holders of its debt.
Key element: the prediction of the likelihood a firm will face financial distress

3. The Market for Credit Suppliers for credit: Commercial banks
Other financial institutions
Public debt markets
Sellers who provide financing

4. The Credit Analysis Process
Step 1: Consider the nature and the purpose of the loan
Step 2: Consider the type of loan and available security
Open line credit
Revolving line of credit
Working capital loan
Term loan
Mortgage loan
Lease financing

5. The Credit Analysis Process
Step 2 (Cont’d): Security
Receivables
Inventory
Machinery and equipment
Real estate

6. The Credit Analysis Process
Step 3: Analyze the potential borrower’s financial status
The emphasis is on the firm’s ability to service the debt at the scheduled rate
Key question is how likely it is that cash flows will be sufficient to repay the loan
Step 4: Utilize forecasts to assess payment prospects

7. The Credit Analysis Process
Step 5: Assemble the detailed loan structure, including loan covenants
Writing loan covenants: specify mutual expectations of the borrower and lender by specifying actions the borrower will and will not take

8. The Credit Analysis Process
Step 5 (Cont’d):
Loan pricing: assuring that the yield on the loan is sufficient to cover (1) the lender’s cost of borrowed funds: (2) the lender’s costs of administering and servicing the loan; (3) a premium for exposure to default risk; and (4) at least a normal return on the equity capital necessary to support the lending operation

9. Financial Statement Analysis and Public Debt
Debt rating
Factors that drive debt ratings: profitability, leverage, firm size

10. Prediction of distress and turnaround
Factors most useful in predicting bankruptcy year in advance: profitability, volatility, financial leverage
Altman Z-Score model