Question

In: Finance

1. Explain how you would rank the 5 C’s of credit analysis in order of importance...

1. Explain how you would rank the 5 C’s of credit analysis in order of importance and explain your rankings?

2. What are the most important covenants for creditors to include in loan agreements with borrowers and why?

3. There is a fundamental flaw in the credit rating agency process – the issuer of securities pays for the rating? How can this fundamental flaw be repaired going forward and why is that the best solution compared to other alternatives?

4. If you were the CEO of a financially-troubled company, what changes would you make in the operating and financial strategies to avoid bankruptcy and improve future performance?

Solutions

Expert Solution

1. Ranking of 5 C's of credit analysis :

Character: It summarily means credit history. It is most important by far even if a person has capacity or collateral if he doesnt have the intention to repay the loan amount of banks will be in doledrums

Capacity : History of lender is still fine but banks need to assured if the lender as capacity or cash flow to do so.

Collateral: It is needed to know if the business plan fails as a contingency measure bank has assets which can be sold off and amount be recovered.

Capital: To know how confident loanee is in his own plan. How much he is investing in the business and what does he feel about the future of the project

Condition: The condition or the covenants of the loan are also important as anything. Like interest rate, repayment period if there's no clarity on this any body can circumvent the agreement and do away from repaying the money.

2. Most important covenants

A loan agreement needs to be full proof of any possible circumvention, for this all types of contingencies should be taken into accord while drafting the agreement rules. Like interest rate, principal repayments, collateral in case of default, personal guarantee of the directors or founders. Frequency of debt servicing. Capital which will be invested by promoters himself (reflects on confidence of promoters).

3. Flaw in credit rating agencies

Its said, He who pays the piper calls the tune. Agencies will always bend favorable towards those who will pay them. This is a flaw that has been going on since long and will continue in future as well. I propose two methods one is Investor pay model. Here the investor will pay for the company's rating to be done. But thus there will be numerous customers and this will lead to extra non legit earnings for rating agencies.

One better conceived idea is to have a central govt appointed org to mediate the process between companies and agencies. They can charge the issue with fixed reasonable fees and then compensate the agencies accordingly. Also reward the agencies whose rating prove to be better. Like this conflict of interest will be avoided totally.

4. CEO of financially troubled company:

Operating business way -

Here company can look to slash their expenses or increasing their revenue by diversifying to other businesses as the current business line is not working for sure/evidently. They can also look to acquire more customers by employing cheaper marketing techniques like social media marketing etc. They can also look towards selling some of their less needed assets to have better investment funds.

Financially -

Best way is to get on top of your debts, they are the main reason why a company goes through bankruptcy that's a lesson for future as well look towards maintaining most optimal debt equity ratio for your business line to avoid future chances of bankruptcy. Can also look towards selling some stake of business to new investors and try to pay off the looming debtors. Also can look towards convincing part of their debt for now so that business can flourish again and survive to live another day. Their might be a case business picks up again and benefits all alike again.


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