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R44: FUNDAMENTAL OF CREDIT ANALYSIS, Pari passu Recover rate - Coggle…
R44: FUNDAMENTAL OF CREDIT ANALYSIS
CREDIT RISK & BOND RATING
Credit risk
Default risk
Loss severity % = 1 - Recovery rate %
Expected loss = Default probability x Loss severity given default
Spread risk
Downgrade risk ≈ Credit migration risk
Market liquidity risk (Bid-ask spread)
Seniority rankings
Secured debt
First Lien Loan – Senior Secured
Second Lien Loan – Secured
Unsecured debt
Senior Unsecured
Senior Subordinated
Subordinated
Junior Subordinated
Ranked according to a
priority of claims
Recovery rates
are
highest
for debt with the
highest priority of claims
and decrease with each lower rank of seniority
Exception ≈ In fact
In many cases
lower-priority
debt holders may
get paid
even if
senior debt
holders are
not
paid in full.
By such a vote or by order of the bankruptcy court, the final plan may differ from absolute priority.
Credit ratings
Rating agencies rate:
• the issuer
• the debt issues
• the bonds themselves
Cross default provision
Notching adjustment
Risks in relying on ratings from
credit rating agencies
(
DO NOT TRUST THE 3RD GUY
)
Rating agencies are
not perfect
Event risk is difficult to assess
Credit ratings change over time
Credit ratings is later than market pricing
4 Cs of credit analysis
:
Capacity
Collateral
Covenants
Character
Collateral
Depreciation
Equity market capitalization
Intangible assets
Human & intellectual capital
Character
(quality and integrity of management board)
Accounting policies & Tax strategies
Fraud and malfeasance (lạm quyền) record
Track record
Prior treatment of bondholders
Soundness of strategy (Chiến lược chắc chắn)
Covenants
Affirmative (Bắt buộc phải làm)
Negative (Cấm không được làm)
Capacity
(Ability to pay on time)
Industry fundamental
Cyclical (Chu kỳ)
Growth prospects (triển vọng)
Published industry statistics
Company fundamentals
Operating history
Management strategy
Ratio & ratio analysis
Leverage
Coverage
Profitability
Competitive position
Industry structure
(Mô hình 5 Forces)
Supplier
Rivalry competitors
Customer
Substitutes
Barrier of entry
EVALUATING CREDIT QUALITY
Yield spread
= Liquidity premium + Credit spread
Factors that
narrow
yield spread (Thị trường ổn định, mọi thứ tốt => ít rủi ro)
Sufficient
funding availability
in financial sector
High market
demand
+ Low market
supply
Broader
economic conditions
strengthen
Positive
financial performance
of issuer
Credit
cycle improve
Credit Risk vs. Return: The Price Impact of Spread Changes
Yield spread nhỏ => dùng ModDur
Yield spread lớn => dùng Convexity
Special considerations
High yield ≈ junk bonds
Debt structure
Corporate structure (parent - subsidiary comp)
Financial projections (Nó đã rác rồi mà còn làm project gì nữa)
Covenants
Liquidity
Enterprise value = Market capitalization + Debt - Cash
Dùng EV/EBITDA vì cty rác not public traded
Non-sovereign debt
Employment (Dân đi làm mới có tiền trả tax)
Trends in per capita income and per capita debt
Tax base dimensions (depth, breadth, and stability)
Demographics
Ability to attract new jobs
Revenue variability through economic cycles
Sovereign debt
(comment)
local currency debt rating
foreign currency debt rating
Pari passu
Recover rate