GCIB Credit Assessment Pre-Reading

Question 1

In GCIB credit, what is the major product provided to clients?

Answer 1

In GCIB Credit, a loan is one of the primary products we provide to our clients.

Question 2

What are loans used for by companies?

Answer 2

Loans are generally used by companies to finance either:

(i) day-to-day business activities

or

(ii) major transactions such as acquisitions.

Question 3

How long do bofa provide loans for?

Answer 3

We provide these loans for a fixed term, usually from 1-year up to 5-years.

Question 4

What is the purpose of performing a credit analysis?

Answer 4

When we are considering whether or not to make a loan, we perform credit analysis to answer one very important question: “Do we think the client can pay us back in time?”

Question 5

What are some questions that a qualitative analysis of credit may answer?

Answer 5

Are the current trends in the client’s industry positive or negative, particularly in light of any susceptibility to economic cycles? What is the company’s position relative to its competitors? Is the management team strong? What are the company’s strategic objectives and do we agree with them? Are there any major events, e.g. acquisitions that are likely to impact the company’s risk profile?

Question 6

What are some questions that a quantative analysis of credit may answer?

Answer 6

Do we expect the company’s sales to decline, remain flat or grow? Will the revenue trends support increasing profitability? Will cash flow be sufficient to pay for investment in the business, with enough left over to pay debt obligations, including our loan? In order to answer these quantitative questions, we conduct detailed analysis of the financial statements.

Question 7

What information does the income statement provide?

Answer 7

Provides a detailed analysis of how a company has generated its profit (or loss) for the accounting period (e.g. one year)

Question 8

In the income statement, what do ‘sales’ represent in principle?

Answer 8

In principle, sales represents volume multiplied by price of goods and services sold to customers.

i.e.

Sales = Volume of goods * Price of goods

Question 9

In the income statement, how is EBIT/Operating Profit calulated, and what is it?

Answer 9

Below sales, costs are subtracted to get to operating profit or Earnings Before Tax and Interest (EBIT). This is a measure of profit on the underlying, day-to-day business activities of the company.

Question 10

In the income statement what does EBIT get adjusted for?

Answer 10

After this, profit is adjusted for financial income and costs that depend on how the company manages its cash and debt, i.e. they reflect financial policy rather than business prospects.

Question 11

What is the balance sheet?

Answer 11

The balance sheet is the statement of a company’s financial position at a specific point in time (e.g. year-end).

One side shows what the company is worth to its shareholders (liabilities + owners’ equity). The other side shows us how the value is created (assets).

Question 12

What is a Non-current asset?

Answer 12

Non-current assets/long-term assets are assets which are expected to last longer than a year.

Question 13

What is an intangible non-current asset/

Answer 13

Assets with no physical form like: brands, goodwills, R&D etc.

Question 14

What is a Current Asset?

Answer 14

A Current Asset is one whihc can be liquidated within a year.

Question 15

What is a Cash Flow Statement and what does it show?

Answer 15

Provides a detailed analysis of how a company has generated and used its cash during an accounting period.

In the cash flow statement, note the three key categories: cash from or used in:

(i) operating activities,
(ii) investing activities and
(iii) financing activities

The sum of these results in the change in cash for the period. Note that the ending cash balance for 2018 matches the amount shown on the balance sheet above.

Question 16

What is Amrotization?

Answer 16

The accounting process of allocating the cost of intangible assets to current expense in a systematic and rational manner in those periods expected to benefit from the use of the asset.

Question 17

What is Working Capital?

Answer 17

The amount of capital invested into your company’s operating cycle (day-to-day operations).

Question 18

What are the 5 key metrics that bofa use to analyse financial statements?

Answer 18

1. Sales Growth
2. EBITDA
3. Total Debt
4. Capital Expenditures
5. Free Cash Flow

Question 19

What is Sales growth and how is it calculated?

Answer 19

Indication of whether demand for a company’s goods/services is increasing or declining over time.

(Sales in the current year/Sales in the prior year - 1) * 100%

The sales in the current year and the sales in the prior year can be found in the income statement.

Question 20

What is EBITDA and how is it calculated?

Answer 20

Similar to operating income, but adjusted to reach a number that is closer to cash earnings. The primary adjustment is to add back non-cash depreciation & amortisation costs (D&A).

EBIT + Depreciation + Amortisation

EBIT or Operating Profit can be found in the income statement.

Depreciation and Amortisation can be found in the Cash Flow Statement (sometimes in the notes to financial statements).

Question 21

What is the Total Debt and how is it calculated?

Answer 21

All borrowings that a company must repay in time, e.g. bonds and bank loans.

Short-Term (or Current) Borrowings + Long-Term (or non-Current) Borrowings (also called financial liabilities) = Total Debt

Short/Long-Term debt can be found in the Balance Sheet.

Question 22

What are Capital Expenditures and how are they calculated?

Answer 22

Cash outflow that is used to support the business. Example: a company invests cash on production capacity to support growth. A company may also expend cash to keep existing facilities operating well.

Capital expenditure (also known as Purchases of property, plant and equipment + Purchases of intangible assets)

Found in the Cash Flow Statement

Question 23

What is Free Cash Flow and how is it calculated?

Answer 23

Net cash generated from or used in a company’s major operating and investing activities. Gives an estimate of cash available to make debt repayments and pay dividends to shareholders. The number used for cash from operating activities should be after tax and interest payments.

Net cash from operating activities – capital expenditures

Found in the Cash Flow Statement.

Question 24

What is a Profability ratio?

Answer 24

Profitability ratios measure a company’s return on sales, assets or equity. These ratios help us with risk analysis because they provide good information on a company’s operating management. They can also provide some indication of a company’s ability to generate consistent cash flow in order to meet financial obligations.

For purposes of the case study, we will look at an example of a return on sales ratio (or sales margin). This type of ratio measures how well a company manages its costs relative to its generation of sales.

Question 25

How is a return on sales ratio calculated, and what is it?

Answer 25

Percentage measurement of how much of its sales a company is able to convert to cash earnings. The higher this ratio is, the better success the company demonstrates in managing its costs relative to the price of its products/services.

EBITDA/Sales * 100%

Question 26

What is a Leverage Ratio and what is it used for?

Answer 26

Leverage ratios measure a company’s total debt relative to its earnings, cash flow, or equity. Leverage ratios are critical in credit risk analysis because they provide a measure of a company’s ability to meet its financial obligations in an acceptable amount of time.

For purposes of the case study, we will consider a leverage ratio based on earnings.

Question 27

What is a Leverage Ratio based on earnings and how is it calculated?

Answer 27

Measures the company’s ability to repay all of its outstanding debt from its cash earnings. It is better for this number to be small, i.e. for total debt to be a lower multiple of cash earnings.

Total Debt/EBITDA * 100%

We can also think about the leverage ratio as an estimate of the number of years it would take to pay back all debt using cash earnings (EBITDA). However, we know that cash earnings will also need to be applied to other expenses such as interest, taxes, capital expenditures, etc. so this is not a perfect measure.

Question 28

What is tenor?

Answer 28

Tenor refers to the length of time remaining before a financial contract expires.

Question 29

What is Debt Maturity?

Answer 29

Maturity is the agreed-upon date on which the investment ends, often triggering the repayment of a loan or bond, the payment of a commodity or cash payment, or some other payment or settlement term.

Question 30

What do bofa prefer to see when determining tenor?

Answer 30

When determining tenor, we prefer to see most of a company’s debt maturing after our loan. If there is too much debt due before our loan, or even in the same year, there is a risk that the company repays the other debt then doesn’t have sufficient cash to repay us.

We can find information on the debt maturity profile in the notes to the financial statements.

Question 31

When does Pro Forma analysis become critical?

Answer 31

If a company is undertaking a major change in its business, “pro forma analysis” becomes critical to determining expected future performance. For example, if a company is acquiring a new business, you must calculate the key metrics and ratios including any additional sales, EBITDA and/or Debt associated with the acquisition.

Question 32

What are Credit Ratings?

Answer 32

Credit ratings measure the risk that a company will not be able to meet its financial obligations when contractually required. These obligations include period interest payments on debt as well as repayment of that debt when it is ultimately due.

As with all credit analysis, assigning a credit rating involves both qualitative and quantitative analysis.

Question 33

What is the nature of credit ratings?

Answer 33

Ratings are “forward-looking.” Although analysts start with a thorough review of historical performance, the ultimate rating will always reflect the outlook for the company’s expected financial performance in the future.

Question 34

How do Credit Ratings express levels of risk?

Answer 34

Ratings use a scale to express the level of risk from least to most risky. In order to facilitate comparison between companies of different industries or countries, ratings use a standard scale. For example, if a South American bottle manufacturer and a UK cable company have the same credit ratings, they should have the same degree of risk.

Question 35

How do analysts determine whether a credit rating should increase or decrease?

Answer 35

Credit ratings are constantly monitored in order to help analysts determine whether there should be a change upward or downward. Monitoring focuses on economic outlook, conditions in the industry and the company’s individual performance and financial condition. Ratings may also change due to a major event such as an acquisition or disposal that changes the company’s earnings profile and/or level of total debt.