5 New Year’s Resolutions for Credit Analysts

1) I will think like an equity analyst.  In order to properly assess the credit risk of a company, you must understand what management is thinking.  Since management works for the owners of the company, not its creditors, you must think like an owner.  Is there a viable business plan?  What is the company’s competitive advantage?  What is the company’s plan for growth?  How will the company enhance returns to shareholders? You must understand the pressures management is facing.  Is the share price dropping?  You can bet that management will do something to push it up, like a share buyback, special dividend, divestiture, or acquisition (or even worse, they will “manage” earnings).  Is the owner (whether a private equity shop or a family) interested in selling the company?  Perhaps they will defer capital projects (or, once again, “manage” earnings). 2) I will think like a debt analyst.  OK, you must understand the owner’s perspective, but you must also keep in mind that what is good for the owner is not always good for creditors.  For example, shareholders love high growth companies – they get higher equity valuations (and their managers often get higher compensation).  But high growth often means high risk and, perhaps, low or negative cash flow.  Remember, a business plan can be good and appropriate for the company, and at the same time, high risk from a credit perspective. 3) I will avoid elevator analysis.  No one needs you to tell them if sales (or margins or leverage) went up or down.  People can see that themselves by looking at the numbers.  Your job is describe why the...

My Favorite Bank Ethics Story

The Background: I was a vice president at a global bank, responsible for a diverse group of clients in North America.  One of my clients was considering a major reorganization of its business and restructuring of its balance sheet, and it hired my bank as financial advisor.  Since we were a lender to client and a restructuring could have impacted our position, the bank saw the conflict and (with the consent of the client) set up separate teams.  Given the size of the assignment and the large potential fees, the advisory team was led by the bank’s Vice Chairman, and included the head of my department, who was my boss.  My “team” (really just me and an associate) was responsible for the bank’s balance sheet – our counterparty risk and our lending position, including a large syndicated loan for which we were the agent. The Setup: The advisory assignment went on for several months, during which I could not discuss the client with my boss or anyone else on the advisory team.  This led to some strange situations, like running into people from my bank in the elevator at the client’s headquarters (a very silent ride), or sitting across the table from them in client meetings. Finally, key elements of the restructuring began to emerge.  To make it work, one large asset of the client had to be quickly and quietly sold.  This is when my boss called me into his office and gave me the term sheet showing our bank buying the asset.  But, since he was on the advisory team, he couldn’t buy it.  It was up...

Risks Drive Debt Spreads

The return investors receive for owning a debt instrument, whether a loan or a bond, is driven by the various risks of owning debt.  This Job Aid from Financial Training Partners does a good job in explaining the major risks faced by debt...

MBAs Need Credit Training

The job market for recent MBA graduates has changed dramatically. A recent article in Business Week (MBA Jobs: For Some, a Waiting Game) described how some firms are delaying start dates for MBA hires. Job offers, and even interviews, are hard to get.   Shifting Job Prospects for Finance Majors One of the hardest hit MBA majors has been finance. Business schools are good at teaching traditional corporate finance skills, mostly focused on valuation – cost of capital, discounted cash flow, optimal capital structure, etc. However, with the recession and pull back in capital market activity, not only has the number of finance jobs come down, but the skills needed for the remaining jobs have shifted. While traditional investment banking functions (think mergers and acquisitions, initial public offerings) have pulled back, the focus has shifted to the debt markets – analyzing, structuring, trading and investing in corporate bonds and loans.   Bringing the Credit Training Program to Campus Most large commercial and investment banks have multi-week entry level training programs for their new MBA hires. These programs include credit training – how to analyze and quantify credit risk, and how to structure debt products that satisfy a borrower’s financing needs. Some business schools are now bringing portions of this training to their finance students to help them prepare for the debt-focussed jobs in today’s economy. For example, Financial Training Partners (www.fintrain.com) recently delivered a four-day “boot camp” on credit analysis, products and structuring at a top rated business school. Students were able to develop and hone their credit skills, and learned to speak the language of debt arrangers, issuers...