R44. FUNDAMENTALS OF CREDIT ANALYSIS
-Evaluating credit quality-

  1. Financial ratio use in credit analysis
  • Ratio analysis is part of capacity analysis
  • Credit analysts calculate company ratios to assess the viability of a company, to ϐind trends over time, and to compare companies
    to industry averages and peers

Profits and Cash Flows are needed to service debt. Here we examine four proϐit and cash
ϐlow metrics commonly used in ratio analysis by credit analysts

Leverage Ratios:
Nên điều chỉnh một số yếu tố nghĩa vụ của doanh nghiệp như net pension liability, off- balance sheet as operating lease

Coverage Ratios measure the borrower’s ability to generate cash ϐlows to meet interest
payments
higher ratio indicates lower credit risk

EBITDA

Fund from operating (FFO)

Free cash flow before dividends

Free cash flow after dividens

Calculation:operating income plus depreciation and amortization

Drawback: not included Capex ( capital expenditures). Vì Capex là điều cần thiết để duy trì vận hành, và tiền này ko dành cho bondholders

Calculations: net income from continuing operations plus depreciation, amortization, deferred taxes, and noncash items.

FFO is similar to cash ϐlow from operations (CFO) except that FFO excludes changes in working capital

Calculations
Net income + depreciation/ Amortization - Capex + WC

Free cash ϐlow before dividends excludes nonrecurring items

Calculations: Free cash flow before dividends - dividends

If CF >0, it represents cash that could pay down debt or accumulate on the balance sheet => outcome của CF >0, deleveraging (xóa nợ), tăng tin nhiệm (creditworthiness)

Debt/ Capital

  • Capital is the sum of total debt and shareholders’ equity
  • The debt-to-capital ratio is the percentage of the capital structure ϐinanced by debt
  • Nếu có goodwill , an analyst should calculate a second debt-tocapital ratio adjusted for a write-down of these assets’ after-tax value

Debt/ EBITDA

  • A higher ratio indicates higher leverage and higher credit risk
  • Nếu là cty có tính chu kỳ (cyclical industry) thì càng dễ biến động (more volatile) because of their high variability of EBITDA

FFO/Debt Because this ratio divides a cash ϐlow measure by the value of debt, a higher ratio indicates lower credit risk

FCF after dividends/ debt Greater values indicate a greater ability to service existing debt

EBITDA/ Interest expense (được dùng nhiều hơn EBIT/ interest expense)

EBIT/ interest expense

2. Factors affect the level and volatility of yield spread

  • the yield on an option-free corporate bond included: the sum of the real risk-free interest rate, the expected inϐlation rate, a maturity premium, a liquidity premium and credit spread
  • Tất cả các trái phiếu đều chịu ảnh hưởng của 3 yếu tố đầu
  • 2 yếu tố sau là yield spread= liquidity premium + credit spread
  • Yield spreads on lower-quality issues tend to be more volatile than spreads on higher quality issues.
  • Yield spreads on corporate bonds are affected primarily by ϐive interrelated factors:

Credit cycle

  • Ảnh hưởng đến credit spread được thu hẹp lại nếu credit tycle đc improve và ngược lại
  • The market’s perception (sự nhận thức) of overall credit risk is cyclical
  • Đỉnh của credit risk, thì mn sẽ nhận thấy low credit risk và thường tăng giá

Economic conditions:

  • Ảnh hưởng đến credit spread
  • Credit spreads narrow as the economy strengthens and investors expect ϐirms’ credit metrics to improve. Conversely, credit spreads widen as the economy weakens.

Broker-dealer capital:

  • Vì khi giao dịch thỏa thuận, nhà đầu tư cần một tôt chức broker- dealer capital để thị trường trái phiếu hoạt động
  • Yield spreads are narrower when broker-dealers provide sufϐicient capital but can widen when market-making capital becomes scarce (khan hiếm).

General market demand and supply

  • Ảnh hưởng đến credit spread
  • Tùy thuộc vào nhu cầu thị trường, nếu thị trường có nhu cầu cao (high demand) thì sẽ làm hẹp (narrow) credir spread và ngược lại

Issuer’s financial performance

  • Tăng trưỏng dương ( development that are positive) sẽ làm hẹp yield spread và ngược lại

3. evaluating the credit of high-yield, sovereign, and non-sovereign government debt issuers and issues

High Yield Debt ( noninvestment bonds/ junk bonds) are rated below Baa3/ BBB with higher perceived credit risk

  • Reason for noninvestment grade: Đòn bẩy cao, Không có lịch sử phát triển rõ ràng, dòng tiền âm hoặc thấp, ngành kém phát triển có tính chất suy thoái, bị ảnh hưởng mạnh bởi chu kỳ kinh doanh,...

Sovereign Debt

Non-Sovereign Government Bonds

Liquidity: Liquidity or availability of cash is critical for high yield issuers.
Có 6 nguồn để đánh giá tính liquidity: BS, WC, CFO - Operating cash flow, Bank credit, Equity issued and sales of assets
Phân tích liquidity quan trọng vì: high yield debts có 1 số hạn chế khi vay như không đc vay thêm khi thiếu vốn dễ dẫn tới vỡ nợ. Ngoài ra thì các tổ chức high yield financial firms có đòn bẩy cao ( vay nợ cao) và tài trợ ở tài sản dài hạn từ vay ngắn hạn thì phân tích liquidity rất quan trọng

Financial projection Projecting future earnings and cash ϐlows, including stress scenarios and accounting for changes in capital expenditures and working capital, are important for revealing potential vulnerabilities to the inability to meet debt payments

Debt Structure: often include different types of debt with several levels of seniority and hence varying levels of potential loss severity.

  • Capital structures typically include secured bank debt, second lien debt, senior unsecured debt, subordinated debt, and preferred stock
  • calculate leverage for each level of the debt structure when
    an issuer has multiple layers of debt with a variety of expected recovery rates.
  • Top heaven:High yield companies for which secured bank debt is a high proportion of the capital structure => khó vay từ bank nếu trong thời gian khủng hoảng của công ty. Những công ty này dễ vợ nợ và có lower recovery rates for unsecured debt issues.

Corporate Structure

  • Many high-yield companies use a holding company structure. Công ty con trả cổ tức cho cty mẹ, cty mẹ dùng tiền này để trả nợ nhu dòng tiền hoạt động. Khi số này không đủ trả cho các khoản vay, thì làm giảm recovery rate đối với người nắm giữ trái phiếu của công ty mẹ.
  • Despite structural subordination, a parent company’s credit rating may be superior (cao hơn) to subsidiaries’ ratings vì công ty mẹ có nhiều nguồn tiền hơn
  • Đôi khi có một số corporate structure phức tạp hơn khi có 1 công ty trung gian sỡ hữu dưới 100% và phát hành các khoản nợ. Việc này là kết quả của việc mua bán, sát nhập và mua từ vay (leveraged buyout)
  • Khi một công ty con vỡ nợ không gây ra các công ty con khác vỡ nơ hay công ty mẹ. Khi này cần phân tích kĩ hợp đồng và các chứng từ pháp lí khác để có cái nhìn toàn diện
    => analysts should calculate leverage ratios at each level of debt issuance and on a consolidated basis

Convenants

Important covenants for high yield debt include

Change of control put. Cho phép debts holder có quyền yêu cầu mua lại nếu bị sát nhập. (Đối với investment grade bonds chỉ xảy ra khi sự kiện sát nhập làm giảm investment grade.

Restricted payments: The covenant protects lenders by limiting the amount of cash that may be paid to equity holders

Limitations on liens (quyền cầm giữ)The covenant limits the amount of secured debt that a borrower can carry.

  • Unsecured debt holders prefer the issuer to have less secured
    debt, which increases the recovery amount available to them in the event of default

Restricted versus unrestricted subsidiaries: Có thể phân loại công ty là restricted subsidiaries ( dùng tiền và tài sản để trả nợ cho công ty mẹ) và unrestricted subsidiaries. => làm có lơi cho chủ nợ của công ty mẹ vì thay vì là subordinate nhưng giờ có thê là pari passu ( have the same priority claim with senior debt)

  • Tax and regulatory issues can factor into the classiϐication of subsidiary’s restriction status. A subsidiary’s restriction status is found in the bond indenture
  • issued by national governments
  • Sovereign credit analysis must assess both the government’s ability to service debt and its willingness to do so

A basic framework for evaluating and assigning a credit rating to sovereign debt includes five key areas

Institutional assessment: includes successful policymaking, minimal corruption, checks and balances among institutions, and a culture of honoring debts
=> tính chất của viện phát hành

Economic assessment: includes growth trends, income per capita, and diversity of sources for economic growth

External assessment includes the country’s foreign reserves, its external debt, and the status of its currency in international markets

Fiscal assessment: includes the government’s willingness and ability to increase revenue or cut expenditures to ensure debt service, as well as trends in debt as a percentage of GDP

Monetary assessment includes the ability to use monetary policy for domestic economic objectives and the credibility and effectiveness of monetary policy

Credit rating agencies assign each national government two ratings: (1) a local currency debt rating and (2) a foreign currency debt rating

Foreign: higher defalut risk và có lower credit rating so với local

Sovereign defaults can be caused by events such as war, political instability, severe devaluation of the currency, or large declines in the prices of the country’s export commodities

  • is issued by local governments (cities, states, and counties) and quasi-governmental entities
  • Municipal bonds are a signiϐicant part of the overall U.S. bond market. Có 2 dạng của municipal bonds

general obligation (GO) bonds:

  • unsecured bonds backed by the full faith credit of the issuing governmental entity, which is to say they are supported by its taxing power
  • Evaluating :
    *Economic factors included employment, trends in per capita income and per capita debt, tax base dimensions (depth, breadth, and stability), demographics, and ability to attract new jobs (location infrastructure)
    *observe revenue variability through economic cycle Relying on highly variable taxes that are subject to economic cycles, such as capital gains and sales taxes, can signal higher credit risk
    *reporting không thống nhất cũng là vấn đề
    *Các nghĩa vụ khác như underfunded pensions and post- retirement benefits

Revenue bonds:

  • are issued to ϐinance speciϐic projects, such as airports, toll bridges, hospitals, and power generation facilities
  • Higher credit risk than GO vì nguồn thu chỉ duy nhất là dự án
  • Phân tích: phân tích dự án, phân tích nguồn tài trợ và phân tích kỹ thuật như phân tích corporate bond