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Group Project: Credit Risk Analysis The purpose of this project is to assess the credit risk of a listed US company (avoid financial institutions, insurance companies, etc). Credit risk analysis looks at four Cs of credit: character (management competence, corporate governance issues, etc.), covenants, collateral, and capacity (borrower’s ability to pay). When analyzing the overall credit risk of a company, rating agencies look at default risk, credit spread risk, and downgrade risk. You will concentrate on default risk though all three risks are related. Not all information is available on a single source/document in a very convenient manner. You may have to consult many sources, including Bloomberg, Compustat, FACTSET, and CapIQ. Your analysis incorporates these data to come up with your assessment of the firm's overall rating. The report should be of professional quality. *The project is all about analysis. Explain. Every data point tells a story. As an analyst, you should focus on the story. What is the data telling you? Practical benefits of this project: Developing Bloomberg expertise; understanding credit risk analysis; industry practices; job opportunities as a fixed income analyst. Report Structure: Suggested format of the report (10-15 pages, single space): I. Overview of the project: Provide a roadmap; Summarize your findings; Your rating of the firm II. Introduction (basic introduction of the firm; Bloomberg DES; why did you select the firm) III. Macro and micro risks in the operating environment and implications for financial distress a. Regulatory, interest rate, and global economic outlook implications for this firm b. Management and ownership; Corporate governance; reporting; state of incorporation and bondholder protection c. Competitive landscape; market share; demand; growth potential. Using the sales based Herfindahl index, examine whether the firm operates in an industry characterized by fierce competition? IV. Capital structure: Funding sources - public debt, bank debt, non-bank private debt, domestic versus foreign debt. How large is the firm’s trade credit relative to total debt? What does a large trade credit as a fraction of total debt signify? Does the maturity structure relate to the firm’s overall business strategy? In particular, what portion of total debt matures in less than one year? Two years? Three years? Four years? Five years? Beyond five years? Does the debt maturity structure suggest a corporate agenda? How does the debt maturity structure affect the firm’s competitive position in the industry? Is liquidation risk lower or higher now in comparison to the years past? Is the firm more likely or less likely to be constrained in its activities due to the debt maturity structure? Discuss how the incentives of short-term versus long-term creditors might affect the firm’s constraints. V. Basic financial analysis to detect financial distress (balance sheet and income statement analysis) – examine liquidity, solvency, flexibility, asset tangibility (property+plant+net equipment)/assets, and operating profitability. VI. Analysis of covenants: pick a recent bond issue. Identify 1) positive, 2) negative, and 3) financial covenants. How close is the firm to violate any of the covenants? Did the firm violate any of these covenants in the past? VII. Estimate the probability of financial distress using Altman’s old Z-score; and Option pricing model (KMV). You will need to download monthly equity returns for most recent 5 years and estimate the inputs to the KMV model. How do these measures of distress probabilities vary over time? Is there a link between equity analyst ratings and bond ratings for the firm? VIII. Perform DRSK and YAS analysis on Bloomberg (Duration, convexity, spread analysis; OAS, distance to default; CDS on the firm) IX. Overall: What is your overall credit rating? How does your assessment differ from the Bloomberg or other published reports? Explain the discrepancy. X. Conclusions XI. Supporting materials -appendix; graphs; references Final Note: Avoid plagiarism at all costs. Edit your report before submission to avoid grammar mistakes, etc. I will use Turnitin.com to estimate the similarity index with all previous work (published and or unpublished). Also, note that copying and pasting SEC filings, analyst reports from Bloomberg/Factset etc is strictly prohibited and is considered plagiarism. 1 2