Bit of context: I'm in fixed income manager research and I've got a decent-ish grasp of the markets but where I want to build knowledge is within individual security analysis (plan is to eventually go buy-side as an analyst)
I'm curious as to what models are used to value a credit, particularly fair value, required yield, probability of default etc. I know there is a ton of information out there on ER although I'm skeptical as to whether much of this applies to FI in terms of the modelling.
I've got a few books on FI but an overview of the analytical process from someone actually in the game would be ideal.
Hi billystern, check out these threads:
I hope those threads give you a bit more insight.
A list of things that a credit analyst may look at: leverage metrics like debt/EBITDA and free cash flow/debt, enterprise value multiples if it is a public company (or public company or private transactions comps if it is a private company), free cash flow conversion, maturity profile (any liquidity problems?), credit ratings, and relative value (yield/spread vs. treasuries, dollar price, expected recovery if the company defaults on the debt).
Some of these are more relevant for different strategies and types of credits. For an investment grade bond investor, you’re more concerned about spread than dollar price for the most part and liquidity/capital markets access, let alone expected recoveries in the event of a default, are not as much of a concern. For high yield/distressed investors, dollar price matters more, as do expected recoveries. Non-investment grade capital structures are generally more complex and analysis of credit agreements/covenants is more important.
For relative value, it ultimately comes down to what you’re willing to get paid to lend to a certain company and relative value is evaluating the risks of one company against another. Industry comps are great but not always perfect, so I like to think about what trades at a similar spread, and compare risks. I might see two companies with 10 year bonds trading at 200 basis points over treasuries. Both are 5x levered after recent acquisitions. One is a food company that sells frozen dinners. The other is an airplane parts manufacturer that has chunky cash flows but is on a couple high growth platforms. Maybe the equity story is better for the airplane parts company with its growth opportunities, but for a bond investor who is worried about downside risk, the more stable frozen food company might be a better risk to underwrite at 200bps of spread.
Hopefully this is helpful. PM me if you’d like to know more on specifics.
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