Volume 4 — Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 7 SIC). Having assigned a rating to the counterparty, the credit manager should be able to risk weight the portfolio and determine exposure concentration within a particular credit category. As a best practice, a consistent rating mechanism should be established based on the credit analysis performed according to guidelines given in the previous section and should achieve at least three objectives: • Assign an internal rating to all counterparties, thus ensuring a consistent risk profile for all credits in conjunction with the credit policy guidelines • Adjust the ratings based on the direction, magnitude, and timing of a counterparty’s credit changes. Financial analysis should be performed with some scheduled regularity—at least annually or as circumstances demand to manage the dynamic credit environment • Facilitate the establishment of portfolio default probabilities based on the portfolio’s risk weighting. (See the Valuation and Risk Metrics White Paper Section III on Sensitivity Analysis, Scenario Analysis, and Stress Testing.) As with traditional credit analysis, scoring models should have the flexibility to adapt and take into account counterparty-specific characteristics. A scoring model may include some of the key financial metrics listed below (at the discretion of the credit manager): • Revenues • Gross profit • EBIT • EBITDA • Gross profit margin • EBIT margin • EBITDA margin • Current ratio • Quick ratio • Current portion of long-term debt • Total debt • Total funded debt (total debt adjusted for leases, off balance sheet debt, mandatorily redeemable preferred). • Funded debt to capital • Funded debt to EBITDA • EBIT to interest • EBITDA to interest • Funds from operation (FFO) • Operating cash flow (OCF) • FFO to debt • OCF to debt The model or process that is adopted for credit risk management should be reviewed by the Risk Oversight Committee or its delegate at least once a year and understood so that it is not simply a “black box.” There are many commercially available rating models. There are also well-regarded consultants in the field, including consulting groups within the rating agencies, who will help a firm build its own credit scoring models.