Thursday, September 09, 2004

10 Hiding Places for Business Credit Risk

For some of us this article will only confirm what you already know, but I happened to like convenient shopping lists (provided they are good). And I believe this one from Atradius Trade Credit Insurance may come useful for credit managers better manage risk following the recent wave of corporate reporting irregularities. Recent collapses have demonstrated the crucial need for credit professionals to look beyond the figures issued in corporate financial statements. Atradius suggests credit managers should be sure the following areas are evaluated when assessing business credit risk:
1. Capitalization - Evaluate how the firm is capitalized and if it has access to future capital. Determine sources of capital and how the capital is structured.
2. Loss on Derivatives - Find out if complex hedging strategies are in place that may not be actual hedges. Determine if derivatives used are liquid and if there are "naked" positions.
3. Mark-to-Market Accounting - Ensure derivative positives in place are valued correctly and find out valuation rationale. Determine if rationale has material impact on financials.
4. Managing Leverage with New Forms of Debt - Determine if convertibles that look like equity actually act as debt triggers.
5. Goodwill and Intangible Valuations - Assess if valuations are accurate and what assets are being valued and at what price. Check to see if big write offs are coming.
6. Off Balance Sheet Transactions - Determine if there are operating leases that should be capital leases or capital leases that should be operating leases.
7. Calculating Pension Liability - Reconcile estimated needs with the projected returns and see if projections are realistic. Evaluate how options are treated.
8. Financial Engineering with SPE's and JV's - Find out if companies are being set up to assist in product financing to customers of the parent and determine the effect on the parent if the entity fails.
9. Engineering with Mergers and Acquisition Activity - Establish if any mergers or acquisitions impacted the firm's overall debt/risk ratio.
10. Revenue Recognition and Measurement - Determine if company is booking future revenue in current periods for long-term contract deals and if unrealized revenue is being calculated correctly. Check to see if swap transactions overstate revenue and add no realized value. Assess how currency value affects earnings.
A further white paper is available on