Fundamentals of Credit Analysis

Question 1

Why do credit analysts focus on EBIT?

Answer 1

It is useful to determine a company’s performance PRIOR to costs arising from it’s capital structure.

Question 2

Earnings Before Interest, Taxes, Depreciation, and Amortization
(EBITDA)

Answer 2

Profitability and CF. A measure of cash flow that takes operating income and ADDS BACK depreciation and amortization because they are non-cash items

Question 3

Free Cash Flow Before Dividends (FCF Before Divi)

Answer 3

Profitability and CF. A measure of excess cash generated by the company (excluding non-recurring items) before payments to shareholders or that could be used to pay down debt/pay divi’s.
Net Income + Depreciation and Amortization - increase/decrease in non-cash working capital - expenditures

Question 4

Funds From Operations (FFO)

Answer 4

Profitability and CF. Net Income from operations + depreciation + amortization + deferred income and other non-cash items

Question 5

Free Cash Flow After Dividends (FCF After Divi)

Answer 5

Profitability and CF. A measure that takes FCF Before Divi and subtracts divi payments.

Question 6

Debt/Capital

Answer 6

Leverage. Calculated as Total Debt + Shareholders Equity. Represents a % of a company’s capital base that is financed with debt. Lower percentile of debt indicates lower credit risk.

Question 7

Debt/EBITDA

Answer 7

Leverage. Used to look at trends over time and at projections to compare company’s in any given industry. Higher ratio indicates more leverage and thus a higher credit risk.

Question 8

FFO/Debt

Answer 8

Leverage. Higher ration indicates greater ability to pay debt by funds from operations.

Question 9

FCF After Dividends/Debt

Answer 9

Leverage. Higher ratio indicates that a greater amount of debt can be paid off from free cash flow after dividend payments.

Question 10

EBITDA/Interest Expense

Answer 10

Coverage. A measure of interest coverage that is a bit more liberal due to the non-subtracting of D and A. A higher ration indicates a higher credit quality.

Question 11

EBIT/Interest Expense

Answer 11

Coverage. A measure of interest coverage that is more conservative but used less frequently than EBITDA/Interest Expense.

Question 12

The Four C’s of Credit Analysis

Answer 12

1. Capacity
2. Collateral
3. Coverage
4. Character

Question 13

Capacity

Answer 13

Ability of the borrower to make it’s debt payments on time

Question 14

Collateral

Answer 14

Quality and value of the assets supporting the issuer’s indebtedness

Question 15

Covenants

Answer 15

Terms and conditions of lending agreements that the issuer must comply with

Question 16

Characters

Answer 16

Quality of management

Question 17

Prospectus

Answer 17

Document that is part of a new bond issue and includes covenants/bond indenture

Question 18

Bond Indenture

Answer 18

Governing legal credit agreement