Credit Investing - Covenant Analysis and Valuation

Hi guys,

Not sure where this topic should go so I thought this might be the (another) route to go.

When assessing relative value of private [fixed and floaters] corporate bonds (all grades with a lean towards IG), do any of you take covenants into consideration? I would assume that many of you do....however, is there a methodology to assign a value ($ or bps of incremental spread) to the value of the covs (leverage, coverage, distribution, etc)?

Tried looking through Moody's and S&P website but couldn't find anything. Would appreciate it if anyone can point me to the right direction/give some insight.



Comments (4)

Best Response
Apr 14, 2016 - 6:51pm
mrb87, what's your opinion? Comment below:

IG bonds don't really have covenants...but in any case, I would probably do something like this:

1) Look at bonds that have these covenants 2) Look at how they trade vs. comps (or other bonds issued by that company) that don't have those covenants 3) Figure out how much of that spread is credit/duration and thus how much is covenant

Alternatively you can just call up the IG syndicate desk.

Apr 14, 2016 - 9:16pm
6rings, what's your opinion? Comment below:

Apologies, I forgot to add that I'm solely looking at private deals in the USPP market. That's a big oversight on my part. Regardless, your insight if very helpful and I will definitely keep it in mind. Thank you.

Apr 14, 2016 - 9:17pm
mohammad.belaal, what's your opinion? Comment below:

Role of Covenants in credit analysis (Originally Posted: 11/19/2011)

Indenture is referred to as the lending agreement which contains terms and conditions. These terms and conditions are referred to as covenants. They deal with limitations and restrictions on the borrower's activities and play an important part in minimizing risk of creditors. Covenants could be termed as either Affirmative or Negative.

Affirmative covenants are those which require debtors to do certain set of activities to improve the credit quality of the issuer. Common examples include:

-To pay all taxes and other claims when due -To maintain all properties used in the borrower's business in working order and good condition -To pay interest, principal, and premium, if any on timely basis -To submit periodic certificates to the trustee stating whether the debtor is in compliance with the loan agreement.

Negative covenants are the limitations which restrict borrowers not to take certain actions. Common examples include:

-Limitations on the company's ability to incur debt -Use of cash flow tests and working capital maintenance provisions -Limitations on dividend payments and stock repurchase -Use of interest or fixed charge coverage test to reduce the default risk of creditors. The two common tests are:

  1. Maintenance Test: This test requires the borrower's ratio of earnings available for interest or fixed charges to be at least a certain minimum figure on each required reporting date

  2. Debt Incurrence Test: Debt incurrence tests are generally considered less strict than maintenance provisions.

Indentures often classify subsidiaries as restricted or unrestricted. The former are considered for financial test purposes while the later are not. If a firm has unrestricted subsidiaries they are allowed to used outside sources of funds and they are excluded from the covenants of the parent.

Covenants are among the other Cs of Credit Analysis. They are given equal preference while checking the credit quality of an organization. If organizations fail to abide by the covenants then creditors feel reluctant in lending money to such organizations.

Apr 14, 2016 - 9:18pm, what's your opinion? Comment below:

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