Reading 62: Credit Analysis for Corporate Issuers

Book 3: Fixed Income

Qualitative Factors in Evaluating Impact of Default

business model

industry competition

business risk

corporate governance

Are the covenants primarily affirmative or negative for Investment-Grade Unsecured debt?

affirmative

What are the Financial Ratios used to understand the impact of default?

EBITDA
CFO

Funds from Operations (FFO)
FCF

Retained Cash Flow (RCF_

Drawback of EBITDA

does not adjust for capex and changes in WC

this cash is baked into the EBITDA figure when it is not actually available for debtholders

CFO =

net income + noncash expenditures - increase in WC

FFO =

net income from continuing operations + D&A + deferred taxes + noncash items

• excludes WC

FCF =

CFO - fixed investments + net interest expense

RCF =

OCF - dividends

General Seniority Ranking

1.) first lien/mortgage

2.) second secured/second lien

3.) junior secured

4.) senior unsecured

5.) senior subordinated

6.) subordinated

7.) junior subordinated

Corporate Family Ratings (CFRs)

issuer credit ratings

What are CFRs based on?

senior unsecured debt

Corporate Credit Ratings (CCRs)

issue specific ratings

Notching

individual ratings that are higher or lower than the issuer

Structural Subrodination

in a holding company, when the parent company becomes subordinate to the subsidiary’s cash flows due to restrictive covenants on the subsidiary’s debt that restricts repatriation before all debt is serviced

Can junior debtholders get paid before senior liens in reorganization or liquidation?

yes, to speed up the bankruptcy process