I have a case study in which I am supposed to provide a credit analysis on a private bond placement. I am given the yield spread as well as all the financial information for tha company in question including all the quantitative analysis (ratios, cash flows, etc.).
What are some important points to focus on when deciding whether or not to suggest the bonds for purchase?
Should I focus heavily on the ratios and cash flow or should I work on telling the story of the company?
I have done a lot of equity analysis type work but never credit so I'm just not positive on what's really important on the fixed income side of the business.
Thanks in advance.
In the fixed income space you are more focused on quantifying the downside. focus on the liquidity and leverage in the company. Since holding the bond has a maximum or capped return, you want to focus on risk of loss. Is the company generating enough cash to make coupon payments? How does the debt fit into their capital structure? I am not sure how detailed the provided info was, but im sure you get the idea.
Focusing on the business "story" is more for equity analysis.
Also, look into the industry the company is in. Is it industrial/mining/metals/energy etc? How cap ex intensive is it? etc etc. Talk about interest rates, whether or not you think the market has mispriced the bond, what catalysts are there to make think the market is over/under. That should be enough to get you started at least.
Some ratios off the top of my head: LTD to Total Capital, EBITDA/Interest, CFFO/Interest, LTM Increase in LTD and LTM increase in STD, average duration of bonds (if significantly leveraged)
Is it secured/senior? How sustainable are the cash flows of the company? If secured by fixed assets, how badly is D&A at the specific company?
Also look into the type of maturity and any additional covenants. As a whole I always found the fixed income valuation/testing for investment grade bonds to be a bit robotic, with a lot of aggregate comps and economics data thrown in for testing. The only interesting parts came in when we had to do covenant testing.
Other external factors such as industry, investor's own current portfolio, and external ratings agencies opinion on the loan should be included as well. It's much more quantitative, and barring financial fraud or gimmicky accounting, the story of a company would play less of a role.
Hi, I'm a corporate credit analyst at a rating agency so here is what I would focus on.
1) This is a private placement bond so chances are you are investing in this thing until it matures which means that your focus needs to be on the potential threats to the business model (which could negatively impact cash flow generation) over the life of the bond. For a 5 year bond this should be relatively easy, for a 15/20 year bond its much harder to quantify this. For example, if its a telecoms company you can see the shift from wireline to wireless and threat of cable and satellite providers.
2) Always make sure you understand who the borrower is, what entity is borrowing and where does this bond sit in the debt structure? Is it secured or unsecured, rank pari pasu, etc. Have you been given any bond docs? If so, read them back to front!
3) Model out the cashflows (until the bond expires), don't worry too much about the balance sheet, just model the income statement and cashflow statement and from this you should be able to project the ratios you need:
4) Ratios: coverage and leverage. You should model out coverage ratios (EBITDA/cash interest, FFO interest coverage, FFO fixed charge coverage) and leverage ratios (total debt/EBITDA, net debt/EBITDA, FFO leverage). Also look at EBITDA margins and revenue growth rates. In credit you want to be conservative and assume margins will come under pressure from competition and growth will converge with the industry average.
5) Look at sources of liquidity - does the company have a revolver to provide a source of cash?
6) Look at the company's debt maturity profile. Do they face a wall of refinancing in the near future or is the debt spaced out?
7) Look at other sources of payback: can the company dispose of assets or refinance and at what ratios will they refinance at?
8) If you want to impress, model out 3 scenarios, a rating case (base case) stress case and a default case and be prepared to explain the scenarios that could lead to each scenario.
9) If you have access to bloomberg you can find a chart matching spreads with ratings. With the spread you have been given and your calculated leverage and coverage ratios you should be able to decide if the bond is cheap/rich.
Best of luck!
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