Credit Risk – Default Probability and Loss Severity
Credit risk is the risk of loss resulting from a borrower’s failure to make full and timely payments of interest and/or principal. Credit risk is made up of 2 components: default risk or default probability: probability that a borrower will…
Seniority Rankings of Corporate Debt
Capital structure is the composition of a company’s debt and equity, such as bank debt, bonds of all seniority rankings, preferred stock, and common equity. Various debt obligations can have different seniority rankings. This, obviously, implies different priority of payment….
Corporate Issuer Credit Ratings
The major credit-rating agencies, Moody’s, Standard & Poor’s (S&P), and Fitch Ratings (“Fitch”), play an essential role in the credit markets. For a majority of bonds, at least two of the agencies provide ratings. Credit rating agencies use similar symbol-based…
Risks in Relying on Ratings from Credit Rating Agencies
Investors overwhelmingly believe that credit rating agencies do a good job assessing credit risk. In fact, with a few exceptions (e.g., too high ratings on US subprime mortgage-backed securities issued in the mid-2000s that turned out to be much riskier…
Capacity, Collateral, Covenants, and Character
Traditionally, many analysts evaluated creditworthiness based on what is called the “Four Cs of credit analysis”. Capacity Capacity is the ability of a borrower to service their debt. To be determined, an industry analysis should be conducted. Afterwards the specific…
Financial Ratios Used in Credit Analysis
Key credit analysis measures fall into 4 different groups: Profitability and Cash Flows It is from operating cash flows that companies can service their debt payments. The operating income can be obtained by subtracting operating expenses from operating revenues, and…
The Credit Quality of a Corporate Bond Issuer
To illustrate how to evaluate the credit quality of a corporation, we will look at CVS, a US-based healthcare company. You will be in the shoes of a banker that needs to assess the creditworthiness of CVS. Using the financial…
Factors That Influence the Level and Volatility of Yield Spreads
As we saw previously, the yield on a government bond (the benchmark) is: $$\text{Goverment bond yield = Real risk-free interest rate + Expected inflation rate + Maturity premium}$$ To this benchmark yield, we need to add the yield spread, the…
Credit of High Yield, Sovereign, and Non-sovereign Government Debt
Special considerations are important when evaluating the creditworthiness of debt issuers in 3 market segments: high-yield corporate bonds, sovereign bonds, and non-sovereign government bonds. High-yield (non-investment-grade or “junk”) corporate bonds are those rated below Baa3/BBB- by the major rating agencies….
