Corporate Financing. Credit Risk, Rating, Pricing, and Regulation.

By merging banks’ CLOs/CROs and corporates’ CFOs perspectives, the book provides an overview of concepts, measures, tools and policies that are at the heart of bank lending and corporate borrowing decision making processes. The key question to address is: how to borrow enough at low prices? There are many ways to reach this goal. We will assume, as a backbone, corporate borrowing from banks. Borrowing from financial markets and alternative approaches to corporate borrowing (such as project financing, object financing, and the like) will be considered by comparison. Therefore, the book will cover the following three critical topics and their interconnections: how credit risk management works in banks, and how risk measures are used; the link between corporate finance and corporate creditworthiness; how banking regulations affect size and price of bank lending. In the first part (chapters 1-4), by a simple pragmatic approach, concepts and measure of credit risk will be clarified: default risk (and probability of default, PD), severity risk (and loss given default, LGD), exposure risk (and exposure at default, EAD), migration risk, spread risk, concentration risk, expected and unexpected losses (and value at risk, VaR). Among the tools that produce these measures, special insights will be devoted to agencies’ ratings and statistical-based rating systems used by banks. Some clues will be given on market-implied ratings, that is those ratings derived from financial markets (bond, CDS and equity markets). Among the applications of these measures and tools, special interest will be dedicated to loan pricing and risk-adjusted performance measures of lending (such as Raroc, Eva and the like), loan approval limits rationale, and the link with accounting regulations of banks’ credit losses provisions. In the second part (chapters 5-7), corporate profitability of a typical Equity Approach analysis will be related with the weighted average cost of capital of a typical Entity Approach analysis. Key similarities and differences will emerge, clarifying why it is essential for lenders to properly use the former, and for corporate CFOs to correctly use the latter. It is commonly said that “cash is king”, but the lenders focus is (and must be) on profit, that is king’s father. And often on business sector and company strategy, that are king’s grandfather. In the third part (chapters 8-9), prudential regulations (up to Basel 3+/4) will be analysed for their implications on bank lending and for corporate borrowers’ decisions. Finally, the interconnections of creditworthiness assessment in banks’ lending departments and rating approval in banks’ risk management departments will be outlined, discussing the degree of consistency between different banks’ regulations and management needs, and their implications for old and new models of bank-firm relations (such as commodity-oriented banking, instant lending, smart lending, asset-based lending, relationship-oriented banking).