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Opening Credit

A practitioner's guide to credit investment

By Justin McGowan and Duncan Sankey

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About the Authors

Justin McGowan

Justin McGowan's career in finance spans 25 years. His analytical experience covers the full range of both equity and credit instruments and he has worked on the sell- and buy-sides in disciplines ranging from bank loans, corporate bonds, emerging market equities, long/short equity and credit hedge funds, long-only funds and synthetic credit products. After an early apprenticeship in corporate ... Read more on Justin McGowan

Duncan Sankey

Duncan Sankey has 27 years' experience in credit investment and lending in a career spanning commercial and investment banking, a leading rating agency, the origination and management of sell-side research teams and, for the last decade, fund management, including investment in alternative strategies, hedge funds, loans and structured long-only and long-short corporate credit. His analytical ... Read more on Duncan Sankey

Contents Listing

Introduction: Credit: An Insider's View?
- For whom is this book intended?
- Objectives of this Book
- Credit Analysis - The Gulf between Theory and Practice
- What's the Matter with Traditional Credit Analysis as a Means of Making Money?
- Prediction is Very Difficult, Especially About the Future

I. Management and Governance. A Qualitative Overlay to Investment Decisions

- Why does this matter?
- The Nature of the Corporation
- A Fundamental Ambiguity
- The Corporation as a Legal Conceit
- The Relationship between Senior Management and Corporate Identity
- Good Credit Analysis Examines the C-Suite
- Agency Outweighs Ownership
- Alternative Ownership Models - Nothing's Perfect
- Ownership is too Atomised to Exert Control
- A Fundamental Change in the Power Dynamic
- Regulatory Response
- So Far, Largely Ineffectual
- SarbOx - A Tentative Incursion into the Field
- Regulatory Codes
- Focus of Regulatory Responses
- Regulation Likely to Remain Behind the Curve
- Tying these Themes Together from a Credit Perspective

II. Management and Governance Case Studies

- Case Study I: Chesapeake Energy Corp.
- Background
- Changes to the Board
- Boardroom Relationships Hinted at Risk Appetite
- Case Study II. The Royal Bank of Scotland Group plc
- The Shortcomings of Corporate Grandees
- Another Dense Social Network
- Think Global. Hire Local
- Testing the Limits of Compartmentalisation
- Key Governance Conclusions for Credit Assessment
- Separation of Responsibilities
- Remuneration Structures
- Remuneration: Another Yellow Flag
- Board Memberships: Independence and Expertise
- Qualitative Investigation
- Governance: A Crucial Supplement to the Financial Model

III. Traditional Credit Analysis. A Framework for Relative Value

- Overview of the discipline
- 1. Economic Context
- 2. Sovereign Risk
- 3. Company Scale & Cyclicality
- 4. Maturity and Growth Prospects
- 5. Obsolescence and Substitution
- 6. Capital, Asset and Labour Intensity
- 7. Numbers Focus - Key Touchstones of Creditworthininess
- 8. Cash Cycle and Seasonality
- 9. Growth, Margin and Capital Formation
- 10. Shareholders and Shareholder Activism
- 11. Quantitative, Market-based Credit Systems
- 12. Disclosure
- 13. Relative Positioning on a Scale of Creditworthiness

IV. How Managements Present Reality

1) Introduction
- Reducing Credit to a Numbers Game
- "Soft" Factors Can Predominate
- But Numbers Can Still be Revealing

2) Manipulation of the Income Statement
- Application of Management Discretion
- Revenue and Expense Recognition
- Revenue Recognition Red Flags
- Growth of "Other" Assets
- Changing Revenue Recognition Timings
- Other Forms of Revenue Manipulation

3) Depreciation policy
- Conventional Presentation
- Depreciation Policy Abuse
- Waste Management Inc. Garbage in, Garbage Out

4) Capitalisation of Income Statement Items
- M&A Smokescreen
- Royal Ahold

5) Auditors
- Madoff
- Olympus

6) Balance Sheet Analysis
- Inventory Valuation
- Nicor Inc
- Fixed Asset Revaluation
- China Forestry
- First Energy

7) Cash Flow Analysis
- Receivables Sales and Securitisation
- Meritor Inc.
- Leases : Capital vs. Operating
- Cashflow from Asset Churning
- Melia S.A.
- Cash Flow from Goodwill Impairment
- Caterpillar Inc.
- Conclusion

V. Behind the Numbers

- Adjusted Debt, Liquidity and Non-Credit Factors
- Introduction

I. Adjustments for off-Balance Sheet Liabilities
- Pension Deficits and OPEBs
- Leases
- Case Study: Leases. There's No Place Like Home
- From Adjusted Debt to Adjusted Leverage

II. Event Risk
- Case Study: BP and the Macondo Oil Spill

III. Liquidity Analysis
- Case Study I: The Goodyear Tire & Rubber Company
- Case Study II: Clear Channel Communications

IV. Analysis of Non-Credit Factors that Drive Credit
- LBO Case Study I: VNU/Nielsen
- LBO Case Study II: TXU. Take a Walk on the Wilder Side

VI. How Market Considerations Drive Credit

- Why sound fundamental analysis may not make you a penny
- Credit Markets are Large but Illiquid
- Credit Default Swaps (CDS)
- Market Impact of CDOs and CLOs
- The Role of the Ratings Agencies
- Case Study - Lafarge S.A.
- Indexation and Total Return Investing
- New Issues
- Turning Analysis into Alpha
- Instruments available to the Credit Investor
- Relative Value Investing
- Predicting the Default Horizon
- Case Study - Aiful Corporation
- Conclusions

And Finally
Introduction: Credit: An Insider's View?
- For whom is this book intended?
- Objectives of this Book
- Credit Analysis - The Gulf between Theory and Practice
- What's the Matter with Traditional Credit Analysis as a Means of Making Money?
- Prediction is Very Difficult, Especially About the Future

I. Management and Governance. A Qualitative Overlay to Investment Decisions

- Why does this matter? ...

Jacket Text

As a result of prevailing monetary conditions since the global financial crisis, the world has witnessed unprecedented growth in global corporate credit markets. Yet, despite the trillions of dollars put to work in the debt capital markets, corporate credit is still an unfamiliar concept to most investors compared to other asset classes, such as equities and commodities. Every red-top newspaper and 24-hour news service is happy to report the latest twitch in the Dow, FTSE or Stoxx indices but momentous moves in the iBoxx or iTraxx go unmentioned. And whereas many a talking head is happy to pose as an equity analyst, few feel comfortable venturing into the arcana of credit. Yet the corporate credit market, as the authors of this new book show, is both materially larger than its equity peer and has shown more attractive risk/ reward characteristics over the last 90-odd years.

In Opening Credit, career credit professionals, Justin McGowan and Duncan Sankey, aim to redress this by drawing on their more than 50 years' collective experience in the field to elucidate a practitioner's approach to corporate credit investment. Whilst explaining the basics of traditional credit analysis and affirming its value, McGowan and Sankey also caution against its shortcomings. They demonstrate the need both to penetrate the veil of accounting to get to the economic reality behind the annuals and interim numbers and to analyse the individuals that drive them - the key executives and board members. They employ a range of cogent and easy-to-follow case studies to illustrate the value of their executive- and governance-led approach, which places management front and centre in understanding corporate credit.

Opening Credit will appeal to all those seeking a better understanding of corporate credit, including analysts looking to develop their skills, fund managers (especially those with an eye to SRI), bankers, IFAs, financial journalists, academics and students of finance.

Media Coverage

HFM Week

At first glance, this is a good time to be a credit investor. Admittedly, interest rates, which, at least in the US appear to be turning, could force bond prices to crater. However, savvy investors ...

Read more

CFA Society

Author series: Opening credit - A practitioner?s guide to credit investment
Tue 09 Feb 16 at Bloomberg, London

In recent years the world has witnessed unprecedented growth in global corporate credit ...

Read more

CFA Financial Analysts Journal

This book is timely in two respects. First, it arrives at a time when debt markets exceed the size of equity markets worldwide—the authors estimate by a factor of 3 to 1 in the United States based ...

Read more

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