Module 62: Credit Analysis for Corporate Issuers

Question 1

What qualitative factos do analysts use when evaluating the credit worthiness of a corporate bond issuer?

Answer 1

Business Model: Corporate issuer with high credit quality will have a business model with stable cash flows
Industry competition: Less intensive competition is better for credit quality
Business risk: Low risk of deviation from exp revenues and margins (this can be issuer specific, industry specfic or external)
Corp Governance: Issuer with high credit quality should have sufficient processes in place to treat debtholders

Question 2

What are two corp governance factors that are to be considered?

Answer 2

Covenants:
Investment grade issuers looking at positive covenants, relating to the compoliance of rules and laws, and looking at the potential of management to issue additional debt.
High-Yield issuers, have negative covenants, restricting the issuers ability to pay dividends or issue further debt
Also need to look at past actions of management to see if equity investors are preferred over debt investors

Accounting Policies:
Evidence of using aggressive accounting policies that accelerate revenue recognition, or off balance sheet financing, or use of capitalising are warning signs of the character of management.

Question 3

What are quantitative factors

Question 4

What are the main financial Ratio’s for credit analysis

Answer 4

Profitability: EBIT margin, EBIT/Revenue, High ratio means higher credit quality

Coverage: EBIT to interest, EBIT/Interest Expense, High Ratio means higher credit quality

Leverage: Debt to EBITDA, Debt/EBITDA, Lower ratio means higher credit quality

Leverage: Retained Cash Flow (RCF) to net debt, RCF/(debt - cash and marketable securities), higher ratio means higher credit quality

Question 5

What is the general seniority of debt rankings

Answer 5

Secured
1.First lien/mortgage
2.Senior secured (second lien)
3.Junior secured

Unsecured
4.Senior unsecured
5.Senior subordinated
6.Subordinated
7.Junior subordinated

Question 6

What’s the difference between Corporate Family Ratings and Corporate Credit Ratings?

Answer 6

Corporate Family Ratings: Credit Ratings levied on the issuer
Corporate Credit Raings: Credit ratings on the specific debt issues (bonds)

Question 7

What is notching? When is it more of an issue

Answer 7

• When a specific bond has a higher/lower credit rating than the corporation who issued it.
• This is happens more often for lower-rated issuers as it is more important than highly rated issuers. Differences in recovery rates are more signfiicant so higher probabilities of default and notching are more likely to be issues