What Drives Risk Premium in Corporate Bonds Flashcards
What causes some companies to have a higher cost of debt?
-probability of default
-loss given default
expected loss
= probability of default * loss given default
what would need to occur for the Company to generate insufficient cash to service its debt?
Reported EBITDA
Adjusted EBITDA
Reported EBITDA
earnings before interest, tax, depreciation, and amortization
Adjusted EBITDA
is meant to capture the core operating performance of the company
negative EBITDA is a problem- negative cash flow, burning cash
EBITDA
revenue * gross margins - operating expenses
risks to volume
-customer relationships
-contractual revenue
-macro risk
-competitive moat
customer relationships
why do customers choose to work with this business over a competitor?
who are the company’s largest customers? how much volume do those customers represent?
how long have they had a relationship? how “sticky” is the relationship?
if the company lost a major customer, could management easily find replacement volume?
contractual revenue
-average tenor, relative to the maturity of your debt
-minimum volume guarantees?
macro risk
what macroeconomic factors impact demand for the company’s products?
where does the company sell its products? if its in one geographic area, how would the company manage through a downturn in that specific area?
competitive moat
barriers to entry
switching costs
barriers to entry
how difficult would it be for a new competitor to enter the market place?
switching costs
how costly would it be for a customer to switch to an existing competitor
three ways your market can decrease
- aggregate market decreasing
- people switching to an existing competitor
- new competitor entrace
risks to price
how important is price to the customer ?
what portion of the customer’s cost structure is our borrower’s product?
what would occur if the quality or timeliness declines? (airplane)
is the company’s product commodity or commoditized
(commoditized: customer’s main decision point is on price)
are prices volatile? if so, why?
risks to gross margin
supplier relationship
margin by segment
supplier relationship
what portion of the company’s purchases are from its largest supplier? largest 5?
if the company has a material concentration, how long has it worked with said supplier?
is the company the supplier’s largest customer? is the company able to pass raw material price increases on to customers?
operating expense implications
aggregate spend
degree of operating leverage
aggregate spend
what percent of revenue does the company spend on opex per annum?
degree of operating leverage
what portion of the Company’s cost structure is fixed vs variable?
during a period of compressed demand what levers could the company pull to maintain profitability on a lower revenue base?
financial policy
how likely is management to use leverage to seek shareholder returns?
-debt financed capital expenditures
-debt financed distributions
-debt financed acquisitions, depending on multiple
can be mitigated by covenants
liquidity
cash on balance sheet and line of credit availability
debt maturing profile
when are the largest pieces of the capital structure maturing?
if you are investing in a smaller tranche, you want it to mature inside of that maturity
access to capital markets & bank financing
how likely is the company to be able to refinance
Other key PD factors
size and scale
strategic importance to state & local governments
size and scale
size intrinsically helps a company manage through negative operating trends
walmart vs cornerstore
strategic important to state & local governments
likelihood of government support?
defects and war*
loss given default
if a company defaults, what is the loss that the lender would expect on its specific transaction?
large driven by structure
lending on specific assets
asset based lending
equipment finance
asset based lending
working capital lending (AR & inventory)
advance 85% on AR and 60% on inventory
equipment finance
lending for the express purpose of purchasing fixed assets
structure driven by useful life of the assets
enterprise value lending
in a hypothetical default, senior creditors are paid out before stockholders
-if the business is worth more than outstanding debt at default, creditors are paid out in full
