As I had mentioned before,

there are rating agencies. The credit rating agencies which S M P and Moody's most
notably that
will provide a rating. And then as analysts we
separately will do a rating. Part of the reason we do the analysis
because of which S M P and Moody's do not analyze every company. They analyze
selected companies. And so we still have to have some
capability of looking at companies that are non rated. The conventional approach is
to look
at these different categories and then rate each category and
then wait each category. So some categories depending
on the industry and the business are weighted more
highly than some of the others. And then we come up with one rating and
then the outlook. And then as they had said that's
going to help us understand the probability of default. Now for the purpose of this
course is
I'm looking at it in terms of a 1 to 10 rating and then I kind of map a 1
to 10 rating with a qualitative rating. And then how that rating would be as it
relates to the credit rating agencies. So, if I do my analysis and
it comes up with the three, that might mean that it's a somewhere
between excellent, strong and good. And that might map into a single A. Or double A
rating with
the rating agencies. Now what we're going to do is that
what we're trying to do is that we're trying to derive
a probability of default. So as we go down this rating scale,
the probability of default will be high. Now you see the D rating or 10 rating, the
company is already in default is
in bank rate structure, so that's 10. But as we go down the probability
of default, that's how we measure. This.
Credit risk will be high as we be hired. Now as we wrap up this
lesson one of module one, let's just take a quick
look at some cases. This is Goodyear Tire and Rubber company. So when I'm analyzing
this company and
looking at credit risk, I'm looking at the debt obligations. This is one way of
analyzing credit
risk of Goodyear, is that first of all, I want to know what
are the debt obligations? This is where I have true credit risk. Goodyear has an
obligation to meet the
principal and interest payments on debt. That is now 6.4 billion. As part of the
analysis, what I'm doing
is that I'm looking at trends over time. I see that for several years Goodyear
was pretty flat in terms of debt outstanding and
then it increased last year. So, I want to know what is
the debt being used for? What is it really being used for now? Quite obviously for
a company like Goodyear Tire and Rubber company, is most likely
being used for plant property and equipment renovations,
upgrades, possible expansion. And then what are the sources of payback,
is going to be operating cash flow? And if they do don't have sufficient
operating casual, they might have to sell off certain assets or use cash
that's already on the balance sheet. I want to look at the types of
structure secured, unsecured, long term and short term. And then I'm going to go
and look at
the analysis Goodyear to see can it continue to make sure that it's
going to meet the obligations. On what we see now is an increasing
amount of debt on the balance sheet. 6.4 billion. What is the likelihood that it
can
continue to make the principal interest payments? What is the probability that it
might default on this debt and then, is their capacity to go to seven or
8 billion dollars in debt? Now, as I said,
most likely with corporate, what will happen is that that
debt will be refinanced? So, Goodyear will say when it's due, if
I can, I'm not going to pay it all down, I'm going to try to refinance it. So
therefore, I'm going to say,
what's the likelihood that Goodyear will be able to refinance that
debt from period to period. Here's another example of
a cases Freeport McMoRan. It is a commodity production company, most
notably it is involved in copper mining. And copper production and
it sells the carpet, I'm sorry, copper into the marketplace. So similarly, what we
do is that we
look at the trends of credit risk or credit exposure. You can see that at one
point it was 20 billion and now they've brought it down to 10 billion. So, the debt
is in decline. And so as I analyze this, I'm going to see how was it able to
come up with that decline and debt? Did it use operating cash flow,
cash reserves or didn't resort to secondary sources
of payback to pay down that debt? And then I want to understand also, can the
company continue to
perform in terms of operations? Can it continue to sustain performance to
be able to not just looking at the past, but going beyond 2020 next 5, 6, 7 years?
Can it continue to meet its obligations
of principal and interest on that debt? And so, that does mean that
we've got to analyze Freeport. We're also going to kind of understand
how will it look as we go forward. How will we looked at for forward because
there's a $10 billion
dollars in debt on the balance sheet. As we said with corporate, corporate tend not
to necessarily
pay down all of that debt. They refinance significant portions. So my assessment
will be,
can the company refinance that debt? Can they refinance that
debt without difficulty. Another popular company, we can look at been in the news
quite
a bit over the past several years. It has debt on the balance sheet. I asked,
what's the purpose of that debt? Very likely, of course,
for production purposes, we all know Tesla, of course,
as the electric car company. And it's sort of ramped up aggressively
production of electric cars over the last three or
four years, especially in 2020. So a lot of the proceeds of that debt
is to support the operations and plant property and equipment. And you can see that
the debt has sort of
gradually increased over the last several years. And so, as I'm assessing that as
they're
taking on that, I want to make sure I understand what's going to pay
the principal and interest on that debt. Now we can say cash on the balance
sheet operating cash flow, or is there another source? Now one source equity Tesla
has used
is that it has issued more stock. The proceeds of that stock cash has and
can be used to put more cash on the balance sheet to get financial
analysts and credit analysts comfortable with the increasing amount of debt
that we see on this balance sheet. So, now I've got to assess, is there
room for Tesla to take on more debt? I've got to go back and
look at the operations cash flows, the ability to grow revenues. The ability to
maintain and manage costs effectively
on a predictable basis. And so that's where I get inside
the numbers a little bit more. To assess what's the likelihood
that it can perform and then what's the probability
that that debt might default. Now, let's wind up lesson one. So what we've done is
that we've gone
through some of the basics of credit risk, credit risk management, credit
exposures. We've gone over a few debt products. We've talked about the purpose of
credit analysis and financial analysis. Why it helps us to come up with a final
credit rating and then how that credit rating is mapped into a risk strategy,
risk decisions and credit structuring. We've looked at some of the analytical
approaches to determining a credit rating, profitability, earnings, cash flow,
balance sheet, debt, capital structure. And so, in essence, what we really want to
do is we analyze the company is that what are the resources to be
able to pay down that debt? And we would like for the primary
source to be operating cash flow? This concludes lesson one.