CREDIT RISK MANAGEMENT

A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM

Company Analysis
There are many subjective or non-quantitative factors that create default risk. These factors are important to the process of credit evaluation and can make a big difference to the actual risk score of the company.

1. Management Competency
The competency of the management of the company is one of the most important factors in deciding how the company fares over the next few years. Though it is impossible to include all the factors of management into a score, some basic factors can be considered: a) Professional qualifications of senior management like CEO, MD & heads of business units. b) The experience of the management within the same industry more experience within the domain of the company is a key strength for many companies and reduces operational risk of the company. c) Any ownership (ESOPs, shares etc.) that the management has in the company. Any management tends to more proactive and involved when they have a stake in the profits of the company. d) Past track record of senior management e) Decisions taken in the past 2-3 years and their impact (if relevant)

2. Promoter and Management Track Record

The basic things to consider when evaluating the promoters of the company remain the same as for management. But there are a few extra points we need to consider for the promoters: a) Reputation of promoter Especially relevant for countries like India, credit evaluation experts are always keen on finding out the reputation of the promoters among suppliers/vendors etc. This factor is especially important for smaller companies, where the financials might not show the real picture. b) Promoter Shareholding Banks are typically wary of both very tightly held companies and companies that have a very low promoter stake. When promoters have a low stake their involvement in the company and its well being is likely to be low, too. In cases where the promoter stake is too high (say >80%), the company does not go through the rigour of having to answer to investors; the corporate governance structure is not well tested.

3. Concentration Risk
Concentration Risk is the risk that arises from the company being too dependent on either customers or suppliers; or, in some cases, on revenues from certain geographies. Customer Concentration - This is the risk of having too much dependence on a single or group of customers. Heres an indicative table with risk scores for the customer concentration for any company. The actual weight or range would differ in banks/rating agencies

Finitiatives Learning India Pvt. Ltd. (FLIP), 2010. Proprietary content. Please do not misuse!

CREDIT RISK MANAGEMENT

A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM Parameter % contributed by top customer % contributed by top 5 customers No. of customers who form 80% of the companys revenue base. Weighted Risk Score Input 35 65 12 Risk Score(/10) 7 6 5 6

Supplier Concentration - A strong vendor base and supply chain can be a make or break factor for a lot of companies, esp. in highly competitive sectors like automobiles. For credit analysis of a company this is one of the most important factors, that dictates how much the company is affected by fluctuations in prices of its raw materials. Heres an indicative table with risk scores for the supplier concentration for any company. Parameter % contributed by top customer % contributed by top 5 customers No. of customers who form 80% of the companys revenue base. Weighted Risk Score Input 35 65 12 Risk Score(/10) 7 6 5 6

4. Operational Profile
In the operational profile, you will have to analyze: The Basic Business Profile Scale in comparison to average industry size calculate Capacity/Average Capacity of top 5 players Maturity of the company within the industry how far is the company on its learning curve? Diversification How diversified is the company? How correlated are the products of the company? For e.g a textile company might have various product lines from polyester to cotton, but all these products will have a similar fate in case of a demand shrinking in textile export markets. Cost efficiency How cost efficient is the company, as compared to similar companies in the industry? We can judge this by looking at the COGS (cost of goods sold) of the company as a ratio of the sales, and comparing it to its peers. This is a direct comparative measure.

Product Strength The need for the product How strong is the need for the product? Has the company identified product development streams? (new innovations/ further development of product and expansion of target audience)

Finitiatives Learning India Pvt. Ltd. (FLIP), 2010. Proprietary content. Please do not misuse!

CREDIT RISK MANAGEMENT

A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM Differentiation How differentiated is the company from other companies within the same industry? This is a key factor that lends a lot of credibility to company projections. Is there any other unique competitive advantage the company has? This could be, for example, location, or any similar advantage difficult to emulate. Any such advantage will lead to a lower risk score for the company.

Production Profile Technology We need to see how technologically advanced the company is in terms of production or core work. One needs to judge the risk of the technology being used by the company, becoming obsolete. Patents/Licenses As a credit analyst, you need to look into whether the company has any patents or licenses that give it a competitive edge. We also need to know if any patents are expiring in the immediate future. This could be a risk to the revenue flows/pricing of the companys products. Labour Issues can be a big problem for manufacturing companies with strong labour unions. The lender needs to be aware of any labour issues that the company is facing or has faced, which could recur. Past Track Record The companys past performance in terms of delivering on time, and its capability to produce advanced products needs to be looked at as a risk, especially if the company is foraying into new business or in case of capacity expansion.

Utilization and realization Utilization, realization and their trends can be a big differentiator. The company would get a strong rating if its capacity utilization as well as realization is higher than industry standards. Value chain strengths There are two key strengths that one has to judge as a credit analyst Customer relationships Customer relationships that are strong and have been steady over time, are intangible but important assets to any company. These need to be evaluated and the company rated on its ability to form and consolidate customer relationships. Backward integration - Any backward integration is considered a strength in the value chain as the company is assured of support in times of need. Also, in many cases it reduces costs and makes the company more competitive. Cost structure and control For any lender, the best borrower is one who is frugal in his use of money. This holds for any corporate big or small, mature or new in the industry. The RM/credit analyst needs to look at how the company has been controlling costs and what are the trends in this respect. Finally, a rating has to be given to this aspect based on industry benchmarks and trends.

Finitiatives Learning India Pvt. Ltd. (FLIP), 2010. Proprietary content. Please do not misuse!