Corporate Credit Analysis Essentials | CFA Level I Fixed Income

This lesson is dedicated to uncovering the critical aspects that influence a corporation’s credit quality, from its business model to the quantitative metrics that signal its financial health.

Qualitative Factors Influencing Creditworthiness

Understanding a company’s creditworthiness involves a deep dive into various qualitative factors:

• Business Model: A stable and predictable business model is pivotal. It includes an analysis of demand for the company’s products or services, expected revenue, and profit margins.
• Business Risk: This aspect covers the potential deviations in demand, revenue, or margins due to issuer-specific, industry-specific, or external changes.
• Competition Analysis: Employing Porter’s five forces framework helps assess the competitive environment and its impact on the company.
• Corporate Governance: Governance policies towards debtholders play a crucial role, focusing on management’s historical actions and policies regarding debt management.

Quantitative Measures of Credit Quality

Quantitative analysis provides a more objective view of an issuer’s creditworthiness, focusing on:

• Probability of Default: Factors affecting the likelihood of a borrower failing to meet its debt obligations.
• Loss Given Default: The expected monetary loss in the event of default, influenced by the nature and seniority of claims.
• Top-Down Analysis: Considers macroeconomic factors, industry size, and potential external shocks.
• Bottom-Up Analysis: Focuses on issuer-specific factors such as profitability, leverage, debt service coverage, and liquidity.

Scenario Analysis and Event Risk

Assessing the impact of various economic scenarios and potential external shocks is vital for comprehensive credit analysis. Scenario analysis helps estimate the consequences of macroeconomic changes on a corporation’s ability to service its debt.

Accounting Policies and Debt Covenants

Analyzing a company’s accounting policies for aggressive revenue recognition or off-balance-sheet financing, along with the nature of debt covenants, provides insights into its financial management practices.

Conclusion

Credit analysis for corporate issuers is a multifaceted approach that requires a blend of qualitative judgment and quantitative evaluation. Understanding the factors that impact a company’s ability and willingness to meet its debt obligations is crucial for investors to make informed decisions.