Credit Analysis

Question 0

What are four C’s of credit

Answer 0

Character (of the issuer - ^corp gov)
Covenants (affirmative/negative)
Collateral (security backing debt)
Capacity (CF, liquidity)

Question 1

List three credit risks

Answer 1

Default risk
Credit spread risk (^spread, v value)
Downgrade risk (v rating = v price)

Question 2

Key profitability ratios

Answer 2

ROE = NI / equity

= NI/sales * sales/assets * assets/equity

Question 3

Liquidity ratios

Answer 3

Quick = curr assets - inventory
———————
Current liabilities

Current = current assets
—————-
Current liabilities

Question 4

Leverage ratios

Answer 4

LTD-to-cap = LT debt
———————
LTD + min int + sh equity

Question 5

Coverage ratio

Answer 5

EBIT coverage = EBIT
————–
Annual int exp

Question 6

How to calc funds from operations

Answer 6

Net income
+ depreciation
+- other non cash items
= funds from operations

Question 7

How to calc operating cash flow (S&P)

Answer 7

Funds from operations
+ decrease (increase) in non cash current assets
+ increase (decrease)
= operating cash flow

Question 8

How to calc free op cf

Answer 8

Op cash flow
- capital expenditures
= free operating cash flow

Question 9

How to calc discretionary cf

Answer 9

Free operating cash flow
- cash dividends
= discretionary cash flow

Question 10

How to calc prefinancing cash flow

Answer 10

Discretionary cash flow
- acquisitions
\+ asset disposal
\+ other sources (uses)
= prefinancing cash flow

Question 11

S&P CF ratios

Answer 11

Funds from ops / total debt
Funds from ops / cap spending req’t
FOCF + int / int

Question 12

Debt service coverage

Answer 12

Int + annual principal repayment

Question 13

Debt payback period

Answer 13

Discretionary cash flow

Question 14

Key considerations for high yield corp bond issuers

Answer 14

Corporate structure - analyze sub cf and parent company

Debt structure - existing bank debt means floating rate (multi scenario), short term, senior

Question 15

Focus on these four areas when assessing asset backed securities

Answer 15

Collateral quality
Servicer quality (like an agent)
Cash flow stress/payment structure 
Legal structure (SPV keeps collateral away from other creditors)

Question 16

What are two types of municipal bonds and what to analyze for each

Answer 16

Tax backed debt - look at debt structure, budgetary policy, local tax availability, socioeconomic enviro

Revenue bonds - specific project - depends on adequate cf and reliable bond covenants

Question 17

What is sovereign debt and two risks

Answer 17

National govt debt - local and foreign currency rating

Economic risks (ability to pay)
Political risks (willing to pay)

Question 18

Two most important factors in assessing corporate issuers

Answer 18

Capacity to pay. (Cash flow)

Corporate governance structure