Module 47.2: Evaluating Credit Quality Flashcards
What is the drawback of using EBITDA for coverage ratios?
does not adjust for capital expenditures and changes in working capital which is not available to debt holders
What is debt to capital?
capital is total liabilities & equity , lower ratio means less credit risk.
What is debt to EBITDA?
higher ratio indicates higher leverage and higher credit risk. ratio is more volatile with firms that have volatile earnings
How does the credit cycle effect an issuers credit spread?
market perception of overall risk is cyclical, depends on the cycle the credit spread can either be high or low
How does economic conditions effect an issuers credit spread?
credit spreads narrow as the economy strengthens and investors expect firms credit metrics to improve.
How does financial market performance effect an issuers credit spread?
spreads narrow in strong performing markets overall.
How does broker-dealer capital effect an issuers credit spread?
narrower when broker-dealers provide sufficinet capital
How does general market demand and suppy effect an issuers credit spread?
narrow at times of high demand.
What are the four main considerations for high yield bonds?
liquidity, financial projections, corporate structure, and covenants
Why is liquidity critical to evaluate for high yield bond issuers?
high yield issuers have limited access to additional borrowings and available funds tend to be more expensive.
What are the six sources of liquidity in order of reliability?
1) cash on hand
2) working capital
3) operating cash flow
4) bank credit
5) equity issued
6) sales of assets
what is often more restrictive, bank covenants or bond covenants?
bank covenants.
Why is it important for an analyst to assess the willingness for a gov to repay debt?
no legal recourse otherwise
What are the five key areas used to assign a credit rating to sovereign debt?
1) institutional assessment - culture of honoring debt, no corruption
2) economic assessment - growth trends, income per capita
3) external assessment - country’s foreign reserves, status in international markets
4) fiscal assessment - ability to cut costs or increase revenue
5) monetary assessment - ability to use monetary policy for domestic objectives
