R44. FUNDAMENTALS OF CREDIT ANALYSIS
-Credit risk and bond rating-
credit risk and credit-related risks affecting
corporate bonds
Credit risk is the risk associated with losses stemming from the failure of a borrower to
make timely and full payments of interest or principal
Default risk is the probability that a borrower (bond issuer) fails to pay interest or repay principal when due
Loss severity (loss given default) is the value a bond investor will lose if the issuer defaults
(đơn vị có thể là tiền hoặc % of bond's value)
Expected loss = Default risk x loss severity
(đơn vị có thể là tiền hoặc % of bond's value)
Recovery rate = 1 - loss severity
Recovery rate is the percentage of a bond’s value an investor will receive if the issuer defaults
Yield Spread
The difference in yield between a credit-risky bond and a credit-risk-free bond of similar maturity is called its yield spread
For example, if a 5-year corporate bond is trading at a spread of +250 basis points to Treasuries and the yield on 5-year Treasury notes is 4.0% the yield on the corporate bond is 4.0% + 2.5% = 6.5%
The size of the spread reϐlects the creditworthiness of the issuer and the liquidity of the market for its bonds.
Spread risk
is the possibility that a bond’s spread will widen due to one or both of these factors
Credit migration risk or downgrade risk is the possibility that spreads will increase because the issuer has become less creditworthy
Market liquidity risk is the risk of receiving less than market value when selling a bond and is reflected in the size of the bid-ask spreads
seniority rankings of corporate debt
Definition:
Each category of debt from the same issuer is ranked according to a priority of claims in the event of a default. A bond’s priority of claims to the issuer’s assets and cash ϐlows is referred to as its seniority ranking
Structure
secured debt
(được đảm bảo bằng tài sản) và có quyền đòi nợ
higher priority then unsecured debt
- first lien or first mortgage (where a speciϐic
asset is pledged), senior secured, or junior secured debt
unsecured debt/ debentures:
(chỉ có quyền đòi nợ)
- senior, junior, and subordinated gradations
general seniority rankings
1.First lien/senior secured.
2.Second lien/secured.
3.Senior unsecured.
4.Senior subordinated.
5.Subordinated.
6.Junior subordinated
Credit rating
Credit rating agencies(Moody, Standard & Poor's and Fitch) assign ratings to categories of bonds with similar credit risk.
Chấm điểm cả issuer và chỉ khoản vay ( the debt issues)
corporate family rating (CFR) ~ issuer credit rating
corporate credit rating (CCR) ~ issue credit rating
Issuer ratings are based on the overall creditworthiness of the company
rated on their senior unsecured debt
Issue ratings refer to specific financial obligations of an issuer and take into consideration such factors as ranking in the capital structure (e.g., secured or subordinated)
When a company defaults on one of its several outstanding bonds, provisions in bond indentures may trigger default on the remaining issues as well. Such a provision is called a cross default provision
Notching
Definition: Khi có 1 khoản debt có khoản credit rating khác với credit rating của cả công ty khi xảy ra hiện tương cross default provision do có điều chỉnh.
Although cross-default provisions, whereby events of default (such as non-payment of interest) on one bond trigger default on all outstanding debt, imply the same default probability for all issues, specific issues may be assigned different credit ratings—higher or lower—due to a rating adjustment methodology known as notching.
Xem xet thêm Structural Subordination khi notching.
Đối với công ty có cấu trúc holding company structure ( Parents and subsidairy). Vi khi vỡ nơ, công ty con sẽ phải ưu tiên trả trước các khoản của công ty con, rồi mới tiếp tục trả nợ cho cty mẹ. Vì thế, đối với subsidiary, parent company's bonds are subordintaed.
Less important for highly- rate issuers than lower-rated issuers
Relying on ratings from credit rating agencies has 4 risks:
Credit rating are dynamic. Thường xuyên thay đổi, có thể đổi nhiều lần trong khoản thời gian vay. Higher credit ratings more stable than lower credit ratings.
Rating agencies are not perfect.
Event risk is difϐicult to assess. Những sự kiện khó có thể dự đoán như thiên tài, khủng hoảng , mua bán sát nhập công ty.
Credit ratings lag market pricing. Market prices and credit spreads can change much faster than credit ratings. Market prices reϐlect expected losses, while credit ratings only assess default risk.
the four Cs (Capacity, Collateral, Covenants, and Character) of traditional credit analysis
CAPACITY : refers to a corporate borrower’s ability repay its debt obligations on time. Capacity analysis entails three levels of assessment
COLLATERAL Issues to consider when
assessing collateral values include:
CONVENANTS Covenants are the terms and conditions the borrowers and lenders agree to as part of a bond issue
CHARACTERISTICS refers to management’s integrity and its commitment to repay the loan Character analysis includes an assessment of:
industry structure can be described ϐive forces: threat of entry, power of suppliers, power of buyers, threat of substitution, and rivalry among existing competitors
industry fundamentals focuses on
company fundamentals: A corporate
borrower should be assessed on
Industry cyclicality: Ngành có tính chu kỳ thì risk hơn ngành ko tích chu kỳ. Cyclical industries tend to have more volatile earnings, revenues, and cash flows. Cyclical industries sensitive to economic performance
Industry growth prospects: Creditworthiness is most questionable for the weaker companies in a slow-growing or declining industry
Industry published statistics : Industry statistics provided by rating agencies, investment banks, industry periodicals, and government agencies can be a source for industry performance and fundamentals
Competitive position: Market share changes over time and cost structure relative to peers are some of the factors to analyze
Operating history The performance of the company over different phases of
business cycle, trends in margins and revenues, and current management’s tenure
Management’s strategy and execution: Xem xét thêm về kế hoạch, cách thức triển khai và sự ảnh hưởng của ban quản trị
Ratios and ratio analysis : leverage and coverage ratios are important tools for credit analysi
Intangible assets
- Patent: high-quality vì có thể bán và tạo ra dòng tiền
- Goodwill: not high-quality vì khi công ty đi xuống phần này có thể bị ghi giảm
Depreciation
Nếu công ty có depreciated expense lớn thì công ty không đầu tư đủ, chất lượng của tài sản kém có thể dẫn tới làm giảm operating cash flow và potentially high loss severity
Equity market capitalization A stock that trades below book value may indicate that company assets are of low quality
Human and intellectual capital These are difϐicult to value, but a company may have intellectual property that can function as collateral
Affirmative covenants require the borrower to take certain actions
- paying interest, principal, and taxes; carrying
insurance on pledged assets; continuing in its current business activity
Negative covenants restrict the borrower from taking certain actions that may reduce the value of the bondholders’ claims
- Restrictions on the payment of dividends and share repurchases, for example restricting distributions to shareholders to a certain percentage of net income
- Restrictions on the amount of additional debt the borrower can issue, for example,
setting a maximum debt-to-equity ratio or minimum interest coverage ratio
.... Xem tiếp trong sách
Soundness of strategy. Management’s ability to develop a sound strategy
Track record Management’s past performance in executing its strategy and operating the company without bankruptcies, restructurings, or other distress situations that led to additional borrowing
Accounting policies and tax strategies Use of accounting policies and tax strategies that may be hiding problems, such as revenue recognition issues, frequent restatements, and frequently changing auditors.
Fraud and malfeasance record. Any record of fraud or other legal and regulatory problems
Prior treatment of bondholders Beneϐits to equity holders at the expense of debt holders, through actions such as debt-ϐinanced acquisitions and special dividends, especially if they led to credit rating downgrades