Since the end of the Dot.com and Telecom bubbles, investors and creditors in both the equity and fixed income markets have been talking about the need to get back to the basics. The basics in DCI aspects seem to be forgotten about within the business bubble. Although a company has many issues concerning “Financial Prosperity,” DCI’s financial policies gave a lot of concern to “Financial Credit” aspects. Financial because this aspect involved the company as a whole, and credit aspects, because providing stability for the institutions that lent DCI funds, would be crucial to DCI success.

                We are emerging from one of the most challenging business cycles in recent memory. While the equity markets received most of the media attention for the “Irrational Exuberance” during the Dot.com bubble, the debt markets had their own debacle in the high yield market. The financial press, regulators and the U.S. Congress focused on Enron, WorldCom, and Global Crossing. In reality, the overall losses in the broader high yield market were widespread and severe.

                In the current environment, when major accomplishments are measured on how businesses perform, versus an index. When Hedge Funds thrive on volatility, and when new instruments have evolved that allow a company to hedge credit risk, it is important that DCI not lose sight of the fundamentals.

                During the past several years, the bond markets exhibited a high degree of volatility and record default levels. To cope with those trends and to enable DCI managers to monitor the Financial Credit quality of their assets, several new techniques and instruments have proliferated. Among them is the increased use of statistical models using market-based indicators. While these tools certainly have their place and role in DCI Financial Credit Analysis, DCI must understand that other factors must supplement decision making as a whole.

                Financial Credit Analysis is not rocket science, yet it can be a mystery to many people. As any DCI Financial Credit Analysts will attest-every speech, every phone conversation and every meeting with corporate executives, investors and financial intermediaries are opportunities to explain how a specific DCI financial credit decision was made. That always includes a discussion on how industry and economic trends and forecasts impact business and financial performance.

                Yet the analytical process and decisions by DCI Financial Credit Analysts are often characterized as “The Black Box,” referencing to a secretive methodology. But there are no secrets, just a comprehensive analysis that isn’t easily explained with “Black and White” statements.

                While this means Financial Credit decisions are highly subjective in nature, it does not mean there is not an organized methodology to help get to a decision. That is what DCI is all about. DCI provides the methodology, and the thought processes all DCI Financial Credit Analysts go through in making a financial decision that will be reviewed for its merits.

                DCI analysts understand that every credit decision is based primarily on three to five of the most critical issues affecting the ability of a company to pay its financial obligations. The trick, of course, is determining what are those essential issues, because it is different for most companies. In fact, this is precisely what DCI Financial Credit Analysts get queried about every day. These documents are intended to help DCI analysts systematically analyze your company and the companies you have exposure to. Thereby identifying the most critical factors and presenting that information so that a financial credit decision can be made, and compliance factors can be met.

                The main question everyone asks is, “Would you lend your money to this?”. This age-old question is asked by loan providers, investors, and credit analysts all over the world as a test of one’s commitment. The reasoning is that if someone is willing to invest their own money, then they must have conducted a full due diligence analysis, vetted all assumptions and verified those facts. Anyone who has the responsibility for your companies “Financial Prosperity” should have the same level of analytical commitment. It is best to have a controlled and systematic approach to the task since the information is often varied and imprecise. These Financial Credit Analysis and Compliance Aspects intend to help future and current DCI Financial Credit Analysts to do their job efficiently and thoroughly for your company.

                Let’s define what DCI means by Corporate Financial Credit Analysis. It is an investigative framework that permits the systematic and comprehensive assessment of your firm’s capacity and willingness to pay its financial obligations in a timely manner. More recently, the focus of Corporate Financial Credit Analysis has been explained to include the assessment of recovery prospects for specific financial obligations, should your firm become insolvent, along with how your company will monitor and audit these assessments through a compliance scale.

                Most financial institutions are involved in Financial Credit Analysis, whether they are banks, insurance companies, pension funds, or even mutual funds (the last three are often referred to as institutional investors). These entities typically have entire departments dedicated to addressing the financial credit standings of the entities they are exposed to.

                Financial Credit Analysis helps to distinguish good borrowers from bad ones. But if DCI analysts are comparing two firms that are neither totally good nor thoroughly bad, DCI needs an analytical framework with more than just two categories. DCI Financial Credit Analysis along with DCI Internal Compliance audit scoring systems will rank Financial Credit Risk along a continuum, with grades going from nonpayment to an (almost) absence of risk. Such a system achieves several goals:

*By assigning marks, scores or ratings on a predetermined scale, DCI Financial Analysts can benchmark financial credit quality across firms from different countries and sectors.

*A particular score indicates the investment premium that would be required for a specific level of risk, assuming that in efficient markets, the higher the risk is, the higher the reward will be.

*For DCI institutions with large portfolios of debt instruments, a scoring system related to a robust analytical framework provides an excellent tool for monitoring the evolution of financial credit risk over time.

Good Corporate Financial Credit Analysis is a lot like building a brick house: There are many blocks and many levels. A strong foundation supports the blocks on top, and organized construction makes it easier to put it all together. That is good Corporate Financial Credit Analysis encompassed by many different factors in analyzing our entities, but if all the right questions are asked and all the factors are sufficiently covered, an analyst can effectively piece together the financial credit puzzle. The reality is that it would be pure insanity to keep any DCI down line entity without a thorough analysis of the entity, the surrounding environment, and its finances. The building block thought process approach helps DCI Financial Credit Analysts to systematically organize and then analyze all the necessary and appropriate factors.

        Most Financial Credit Practitioners have heard about or used one of the very first such systematic approaches to Financial Credit Analysis. It is called the 5C’s of Financial Credit, where the first C, Character, indicates the Financial Credit Analysts must look at the leadership of the firm, its reputation and its strategy: the second C, Capacity, focuses on a firm’s ability to make enough money to honor its obligations; the third C, Capital, reviews how well capitalized the form is or how much money the owner has invested in the venture, the fourth C, Conditions, discusses the competitive environment of the firm and how well the firm fits in; and the last C, Collateral, analyzes other potential sources of repayment of the obligations, if these are supported by collateral security.

        Over time DCI analytical frameworks have evolved to capture two essential types of DCI financial risks:

*Default Risk, which is measured by assessing DCI and DCI’s down line firm’s (subsidiaries) capacity and willingness to service its debt in a timely fashion.

*Recovery Prospects, which provides an assessment of how much a creditor would recoup if DCI and or DCI’s down lines default. This assessment is measured by assessing the characteristics of each debt instrument, and its structure and collateral valuation. When combined, Default Rick and Recover Prospects provide a proper assessment of Rick of Loss, which is essential information for DCI institutions.

The analytical framework DCI proposes in these documents is very much like the building-block approach that DCI mentioned earlier, going from the more general to the more specific. In broad categories, this includes analyzing the risks related to the countries in which that operating entity does business, the sector(s) of activity in which that entity operates, the entity’s competitive environment, its finances and strategy, its organizational structure and its debt structure and actual debt instrument(s). Our company is organized into four parts to assess these different financial risks:

                Part I, “Corporate Financial Credit Risk,” presents the building blocks that help in analyzing our firm’s capacity to pay principal and interest on its debt in a timely fashion. At the end of this first part of our company evaluation, the Financial Credit Analysts should be in a position to identify all the essential risks related to our firms and measure them through benchmarking with peers and through a financial forecast.

                Area 1, “Sovereign and Country Risks,” discusses the risks related to the country and countries in which our firms operate. In particular, it shows the impact on the business activity of the rules and regulations set by countries; the support (or absence thereof) from the political, legal, and financial systems; the infrastructure and natural endowments; and the countries’ macroeconomic policies.

                Area 2, “Industry Risks”, presents the ways in which sector characteristics influence the financial credit profile of our firms in that sector, in particular, sales prospects; whether the sector is growing, mature, niche, or global; patterns of business cycles and sensibility; and industry hurdles and barriers of entry, such as capital intensity, technology, and regulations. DCI finishes this area by determining whether a specific industry risk may limit our company’s financial credit quality.

                Area 3, “Company Specific Business Risks,” DCI offers an approach to assessing the degree of competitiveness of our firms. DCI discusses competitive positions and competitor analysis, market position, sales growth, pricing, and regulations. However, for Financial Credit Analysis, we also show diversity, and how management strategy can affect the growth quality of our firms. DCI recommends that Financial Credit Analysts look beyond general characteristics of competitiveness for our firms and focus on sector-specific aspects.

                Area 4, “The Management Factor,” introduces the impact that management behavior and decisions may have on our firm’s credit profile. In particular, DCI discusses corporate governance and ways to assess it. Also, it shows how our firm’s financial policies should be assessed.

                Area 5, “Financial Credit Risk Analysis,” discusses first the importance of financial policies and how they allow Financial Credit Analysts to understand the risk tolerance of our firm’s management. In this Area, DCI presents credit measures relative to the balance sheet, profitability, cash flow adequacy, and financial flexibility, and shows how to interpret them.

                Area 6, “Cash Flow Forecasting and Modeling,” concludes Part I by introducing a particular approach to creating a financial model for forecasting cash flows and calculating financial credit ratios.

                Part II, “Financial Credit Risks of Debt Instruments”, analyzes the impact of debt instruments and debt structures on recovery prospects, should our firms become insolvent, at the end of Part II, the Financial Credit Analysts should be able to identify all the essential features of debt instruments, recognize debt structures, and measure the recovery prospects of each debt instruments issued by DCI firms.

                Area 7, “Debt Instruments and Documentation,” gives a brief description of the major sources of funding available to DCI firm’s treasures and provides a step-by-step approach to analyzing a loan agreement or a bond indenture that creditors will no look to see if DCI compliance mandates for these areas of concern.

                Area 8, “Insolvency Regimes and Debt Structures,” analyzes the impact our firm’s financial distress had on our creditors. We discuss the different treatment of creditors across various insolvency regimes that DCI deals with and the impact of priority ranking in insolvency. In particular, DCI presents contractual and structural subordination and support through collateral. We conclude this area with an introduction to DCI asset-based transactions, such as those used for real estate, projects, or transportation equipment financing, and a rapid description of DCI leveraged Buyout Transactions (LBO’s).

                Area 9, “Estimating Recovery Prospects,” provides a practical approach to assessing DCI recoveries on particular debt instruments. DCI discusses why businesses fail, how to evaluate discrete collateral, and how DCI would like DCI Financial Credit Analysts to value DCI business and DCI potential business acquisitions.

                Part III, “Measuring Financial Credit Risk”, proposes a scoring system to assess our firm and firm’s that DCI has exposure to that will assess the capacity and willingness of all these entities to service their debt in a timely fashion and to evaluate recovery prospects for debt instruments in the event of our firm’s financial distress.

                Area 10, “Putting It All Together: Financial Credit Ranking,” proposes a scoring system to assess both Default Risk and Recovery Prospects, with guidance relative to the weights between the different scores. This area should permit DCI Financial Credit Analysts to capture all the credit risks discussed in our company in an organized framework resulting in scores reflecting DCI firm’s default probability and the recovery expectations for a particular debt instrument.

                Area 11, “Measuring Financial Credit Risk: Pricing and Financial Credit Risk Management,” discusses the use of credit scoring as a benchmark for the pricing of DCI debt instruments.

                The intellectual debate has always been which is better: The Top-Down approach (i.e. to start by analyzing the country risks, then examine the industry, the company, and the specific debt instrument in that order) or the Bottom-up approach (i.e., analyze first the debt instrument, then the company, industry, and country). DCI believes that the argument is irrelevant because good financial Credit Decisions are made analyzing all factors that affect DCI’s ability to repay its financial obligations in full and on time, and the factors that will affect recovery, should our firms become insolvent. It does not matter where an DCI Financial Credit Analysis starts; what does matter, is what was considered and analyzed to get to a decision.

                DCI managers and Financial Credit Analysts sometimes may not have a long time to make a financial Credit Decision or suggest a course of action, so it is important for DCI Financial Credit Analysts to have the capacity to zero in on the most critical specific factors that drive our company’s and the companies that DCI has exposure too with the ability to pay their financial obligations and prosper. When time permits, however, DCI Financial Credit Analysts should complete their preliminary assessment with a full-fledged review of the entities and of the debt instruments. This Financial Credit Analysis Aspect of our company hopefully shows the way to do that and to keep DCI within COMPLIANCE!