Standard & Poor’s Fundamentals of Corporate Credit Analysis

Guide authored by the two Standard & Poor’s experts Blaise Ganguin and John Bilardello explaining key aspects of credit analysis

Author: Punit Manjani
Punit Manjani
Punit Manjani
Punit Manjani is a highly skilled professional with experience in VC, contributing to strategic investments, Market research, and deal sourcing. Currently, Punit works at Loka Capital demonstrating expertise in financial modeling, due diligence, and market research. Known for negotiation and leadership prowess, Punit has a proven track record of successful leadership and entrepreneurial endeavors.
Reviewed By: Josh Pupkin
Josh Pupkin
Josh Pupkin
Private Equity | Investment Banking

Josh has extensive experience private equity, business development, and investment banking. Josh started his career working as an investment banking analyst for Barclays before transitioning to a private equity role Neuberger Berman. Currently, Josh is an Associate in the Strategic Finance Group of Accordion Partners, a management consulting firm which advises on, executes, and implements value creation initiatives and 100 day plans for Private Equity-backed companies and their financial sponsors.

Josh graduated Magna Cum Laude from the University of Maryland, College Park with a Bachelor of Science in Finance and is currently an MBA candidate at Duke University Fuqua School of Business with a concentration in Corporate Strategy.

Last Updated:October 4, 2023

What Is Standard & Poor’s Fundamentals Of Corporate Credit Analysis?

Standard & Poor’s Fundamentals of Corporate Credit Analysis, authored by the two Standard & Poor’s experts Blaise Ganguin and John Bilardello, is a book that covers all the intricacies of the key aspects of credit analysis.

In recent decades there has been an increase in the need for understanding risk in the equity and fixed-income markets. For investment purposes, we move to the basics of lending and investing. 

There is a systematic approach for complete due diligence analysis, vetting assumptions, and verifying the facts. We first look at the meaning of Corporate Credit Analysis. It is a framework for an investigation that enables a systematic and thorough evaluation of a company's ability and willingness to meet its financial obligations on time. 

In recent years, the scope of corporate credit analysis has widened to encompass the evaluation of the possibility that certain financial obligations will be recovered if the company goes bankrupt. 

A system must oversee and assess the decision-making process and the company's credit quality. One of the first robust processes for credit analysis is called the 5 Cs of Credit - Character, Capacity, Capital, Conditions, and Collateral.

Key Takeaways

  • Corporate credit analysis evaluates a company's ability to meet financial obligations systematically.
  • Sovereign and country risks are important considerations in credit analysis.
  • Industry risks should be analyzed to understand sector-specific challenges.
  • Business risks include factors that impact a company's financial performance and management decisions.
  • Financial risk analysis focuses on understanding risks associated with a company's financing methods.

Components of Fundamentals of S&P’s Corporate Credit Analysis

The components of Fundamentals of S&P's corporate credit analysis are divided into three main parts.

1. Corporate Credit Risk

In this first part, it talks about the different things that affect how well a company performs financially and how reliable it is when it comes to borrowing money. It starts with looking at the overall economy and the industry the company operates in.

Then, it examines the company's assets and how well they are managed. Finally, it considers the financial results that come from these assets. The chapters in Part I cover all the important aspects that an analyst needs to consider, and the last chapter gives a practical example of how to model cash flow.

2. Credit Risk of Debt Instruments:

In the second part of this book, it talks about the risks associated with the debt that companies use to get money. These risks are not just about how well the company is doing but also depend on the kind of debt they use, how it compares to other debts they have, and the rules for borrowing and lending.

There are also other risks related to the company's ability to make money, which affects how likely it is that each debt will be repaid if the company faces financial trouble.

3. Measuring Credit Risk

In the last section of this book, it combines discussions about credit risks related to companies and debt instruments, which were the main topics in the first two sections of the book.

Part I Corporate Credit Risk

Starting with our first step of credit analysis - Corporate Credit Risk. In this process, we try to find various risks involved in loan repayment. We get to know if the firm or an individual would be able to meet its loan obligations, i.e., both the principal and loan. 

For the analysis of the financial position as part of the creditworthiness assessment, the current and projected financial position, including the

These are required to meet contractual obligations, such as debt-servicing capacity, including under potential adverse events (see also sensitivity analysis) - items to be analyzed should include but not be limited to free cash flow.

Apart from these, analysts also need net operating income and profitability.

It is important to look at various factors that determine the operating and financial condition of the firm. In addition, it is also essential to understand the macroeconomic conditions concerning the company.

After that, it is advisable to understand the quality of business, assets, and company management details. To conclude, financial performance is evaluated based on the above details. Finally, let us look at the risks inherent to corporations.

Chapter 1: Sovereign and Country Risks

In many cases, we think the sovereign risk is a declining weak substitute for country risk.

We anticipate that credit risk modeling that relies on sovereign debt ratings may not accurately represent the state of the economy.

This needs identifying the country risk variables and working up effective scoring methods for them from the information accessible in the market.

To further increase the effectiveness of our corporate credit risk models, S&P Capital IQ implemented a new national risk index in 2012. This is especially true as we expand the scope of some models to include emerging economies.

We believe that by demonstrating the ease with which national risk can be calculated, we can assist other credit analysts and modelers. Moreover, as sovereign and country risks continue to diverge in emerging and developed economies, we believe this work will soon become unavoidable.

  • Country risk: The uncertainty connected to investing in a particular nation is referred to as country risk, and more particularly, the possibility that this uncertainty may result in losses for investors.  Numerous factors, such as political, economic, exchange rate, or technical effects, can contribute to this unpredictability.
  • Corporate risk indices: Corruption Perceptions Index(CPI), Doing Business rankings, Global Competitiveness Index(GCI), Gini coefficient, UN Human Development Index(HDI), and World Bank Political Risk Indicator.
  • Sovereign risk: Sovereign risk is the possibility that a country's central bank or treasury may fail to make due payments on its governmental debt or enact foreign exchange regulations or limitations that will drastically lower or eliminate the value of its forward contracts.

Chapter 2: Industry Risks

By analyzing and scoring inter-industry risk, the specified industry risk standards improve the comparability and transparency of ratings across sectors. The methodology considers the main business risk variables that businesses must deal with.

The two criteria are used to determine a worldwide industry risk assessment

  • Cyclicality and Growth
  • The danger in the marketplace

    Cyclical risk is the possibility that business cycles will negatively impact an investment's returns, an asset class's returns, or a specific company's profits. Marketplace risk consists of data privacy, global laws, data breaches, and higher class action risk.

    Each of the two criteria is given a rating between 1 (extremely low risk) and 6 (high risk) (very high risk). The global industrial risk assessment is created by combining various analyses and using the 1–6 scale. The cyclicity evaluation of the industry scenarios is calibrated.

    The effectiveness of industry entry barriers, the level of industry profit margins, the risk of secular change and substitution of products, services, and technologies, and the risk in growth trends are all covered in the analysis of a sector's overall competitive risk and growth.

    The examination of a firm's competitive situation takes into account the hazards within various industry subsectors.

    Chapter 3: Company-specific Business Risks

    Business risks include all elements that impact a company's financial performance and management's chosen course of action. The basic hazards present in the sector or nation where a specific company operates serve as the foundation for the risks.

    By using the building-block process, analysts can pinpoint the crucial aspects of a company to concentrate on before settling on the most crucial problems. 

    They use market position, company stability, and laws in addition to competitor analysis and an entity's competitive position, which are crucial to examine.

    An essential component of credit research is determining the strength of a company's market position. It aids in assessing the constancy of sales demand and pricing power, two essential elements of solid credit.

    Market share analysis might be useful, but it's crucial to avoid falling for market share tricks. Although most businesses claim to be industry leaders, this does not necessarily imply that they have solid reputations or are profitable.

    It can matter how marketplaces are defined and how their share is computed. Narrow definitions of market share are useless because most businesses offer a wide range of goods and services. 

    It's essential to keep up with market, customer, and rival trends. The quality of a company's products determines how consistently it performs.

    Chapter 4: The Management Factor

    The importance of management, its strategies, implementation methods, and outcomes cannot be overstated. Although it might be difficult to gauge a management team's true influence on a business, its influence on the success and failure of a business is undeniable. So naturally, the credit analyst assesses management's actions to determine how much they promote credit quality. 

    Shareholders, not creditors, own companies. Thus, credit analysts assess management's risk tolerance and performance, involving studying the management team and its tendencies.

    Although there are many opportunities to learn about management's tactics, but trust takes time to develop. Integrity-driven executives operate their businesses with integrity, ensuring the propensity to meet financial obligations completely and on schedule. One technique to assess management's credibility is to look at how well-coordinated proclaimed strategies are with actual actions. 

    However, corporate governance research goes beyond simply assessing a management team's honesty; it's also crucial to keep an eye on the pressures put on a business, as these pressures can and often do affect management's decisions. 

    Managers may be forced to behave badly by shareholders' demands for earnings growth, such as aggressively pursuing expansion or vigorously accounting for revenues or expenses. Therefore, analysts must be aware of the various red flags that indicate governance issues.

    Financial policies set the tone for all next choices. The company's financial philosophy will continue to serve as the foundation for management's decisions, which are still anticipated to be based on strong economic research.


    No corporation can be fully risk-free, but the financial risks that management accepts should be reasonable given the company's inherent business and industry hazards.

    Credit analysts will have finished their qualitative analysis of a company and all of its risks at this time. Whether a corporation is considered high, average or low-risk depends on the overall impact of industry, business, and sovereign/country risks and the management's influence. 

    Although a credit analyst will find this study very helpful, the full picture of risk has not yet been revealed. So now, the analyst should assess the entity's profile and financial performance. 

    Without knowledge of the level of risk involved, a careful credit review of a company's financial performance and profile cannot and should not be conducted on the entity's qualitative risk.

    Chapter 5: Financial Risk Analysis

    Financial Risk is the risk related to a company's method of financing its operational/business activities.

    If a business uses debt to support its operations, it is under the legal obligation to repay the sums that make up its debts when they are due. 

    The firm raises its financial risk by taking on fixed obligations like debt and long-term leases. However, a firm does not have fixed commitments if it finances its activities using common stock (equity) through operations (retained earnings) or by issuing additional common shares

    Hence higher the fixed cost obligations, i.e., debt, the higher the risk associated with that firm.

    It's critical for credit risk and portfolio managers to keep track of an Income-Contingent Repayment plan's stability or change.

    It is possible to understand how Business Risk factors can affect future modifications to a Corporate Income-Contingent Repayment by using the newly added Business Risk and Financial Risk factors offered in RatingsXpress. 

    Knowing the historical frequency of Income-Contingent Repayment plan upgrades or downgrades for particular Business Risk and Financial Risk combinations can be a useful reference tool when managing bond or loan portfolios.

    Risk managers could benefit from regular updates to the (Business Risk and Financial Risk) tables for the following reasons and more:

    • Establish risk appetite tolerance thresholds by calculating the average percentage of IG-rated businesses in a portfolio that experience downgrades over a given period.
    • Conduct a stress analysis to better control the risk of a downgrade amid anticipated economic downturns. Look for upgrade possibilities for a particular (Business Risk, Financial Risk) combination for high-yield opportunities.

    Chapter 6: Cash Flow Forecasting and Modeling

    Credit analysts create financial projections to validate their theoretical predictions regarding a company's creditworthiness. But, as emphasized earlier, cash is not getting around the fact that cash is king when it comes to credit and debt servicing.

    Credit analysts must measure operating cash flow before working capital adjustments and debt service (interest and principal payments). This amount may be compared to future debt service to assess a borrower's capacity to pay off debt.

    A corporation's most crucial operating variables should be the driving forces behind a cash flow model, whether it be a price-volume equation, market share, costs, or other factors that affect a firm's competitiveness.

    Assumptions concerning potential sources of cash should also be included, such as:

    • Adjustments to working capital
    • Potential investments
    • Dividends or other distributions

    In addition, included should be debt and debt service assumptions, as well as any potential liabilities.

    Credit analysts should prepare a base case, a stress case, and a default case. In most cases, a base case should be based on assumptions from the previous three to five years.

    In cyclical industries, assumptions should take into account the likelihood of ongoing fluctuations in supply and demand. 

    Stress scenarios should include assumptions that indicate the degradation of the business model, such as market share loss or product substitution, or should illustrate the worst-case scenario for the company, such as a protracted recession

    At this point, suffice it to say that it simulates a scenario in which cash flow is insufficient to pay off the firm's debt.

    Part II Credit Risk Of Debt Instruments

    Firms rely on debt instruments for financing their operations/business activities. A debt instrument is a fixed-income asset that enables the issuer (or taker) to raise money at a cost while allowing the lender (or giver) to receive a fixed interest rate and the principal back.

    Debt creates a contractual responsibility on the side of the issuer (or taker) to promptly pay back the borrowed amount plus interest to the lender.

    There are three types of risks associated with debt instruments. These variations/risks can affect the firm's ability to raise capital and repay the principal and interest:

    1. Interest rate risk

    Interest rate volatility can affect debt instruments. Interest rates and bond prices have an inverse relationship. Bond prices decline when interest rates rise and vice versa. Only those instruments that are listed on the exchange and have a live market price are impacted by this volatility.

    2. Inflation risk

    Many debt instruments have fixed interest rates. In this case, if a firm needs to issue bonds for a longer duration, it will have to pay a higher interest rate. There is always a possibility that the interest rate might become equal to the inflation rate

    3. Call risk

    Callable instruments give issuers the right to execute before maturity. In case the interest rate of instruments changes, the issuer will redeem his bond and issue new bonds at a lower rate. This leads to calling risk. Investing in a lower interest rate market is called reinvestment risk. 

    The investor can redeem early under a put option, which is the opposite of this. Following the time period indicated in the offer document, call and put options become active. Typically, the present bond becomes costlier for the issuer when future interest rates are expected to decline.

    If the firm continues to pay the old interest rate, it will bleed a lot of money. So in this instance, the corporation exercises its call option, returns the investor's money, and has the opportunity to issue a new bond at the then-currently-applicable lower interest rate. 

    This gives rise to buying back the bonds, which might need a lot of capital, and raising capital through new issues. It is important to keep in mind that not all bonds have call options.

    In this section, "Credit Risks of Debt Instruments," we examine how debt instruments and structures affect the probability of a firm's ability to recover its debts in insolvency

    By the end of this section, you will be able to understand and list

    • All the important characteristics of debt instruments
    • Identify debt structures, and
    • Estimate the likelihood that each debt instrument issued by a firm will be repaid.

    We have different debt instruments that specify the conditions of the contract and the relationship between the issuer and borrower. Some of the risks in the case of debt instruments are determined by the firm's cash flow.

    Chapter 7: Debt Instruments and Documentation 

    There are many different types of debt in addition to common debt instruments like loans and bonds, such as:

    • Medium-term notes
    • Private placements
    • Convertible debt
    • Hybrid debt-equity instruments
    • Commercial paper

    Each instrument serves a different purpose, whether to finance short-term or long-term needs, to appeal to various investor groups, to finance particular asset kinds, or to suit a specific company position.

    The base prospectus, supplements, final terms, and/or any other document or agreement that specifies the terms and conditions of a particular debt instrument are called debt instrument documentation. 

    Depending on the specific debt instrument, a loan agreement or bond indenture governs the relationship between the borrower and creditors. Therefore, credit analysts must be knowledgeable about these papers' structure, content, and methods of interpretation. 

    They should also know the interest rate, how and when the proceeds are used, and whether or not the debt instruments are being repaid in full or in advance are all factual issues.

    Credit analysts must be knowledgeable about the various corporate funding options to comprehend corporate credit's unique financial requirements better. Let us look at these Debt structures, insolvency regimes, and recovery prospects.

    Chapter 8: Insolvency Regimes and Debt Structures

    Creditors will be concerned about getting their money back if a company faces financial issues or goes bankrupt:

    When determining how much and when creditors might expect to get their money, insolvency regimes and the form of a certain loan instrument are crucial factors to consider.

    Not all insolvency regimes are created equal. However, some of them allow for quick enforcement of collateral when a debt instrument is secured and provide the more senior creditors with significant involvement in the insolvency process. 

    Other jurisdictions subject creditors to severe legal risks and drawn-out recovery procedures, and the courts make important judgments with little involvement. 

    In some emerging nations, where corporate, political, and judicial interests may be connected, the insolvency regimes are untested, making it challenging for foreigners to assert their rights in a respectable court of law.

    Depending on the type of collateral and the insolvency system, secured creditors may benefit from different types of collateral, which may offer more or less credit assistance.Credit analysts should, in any case, make sure that the documentation reflects that the collateral has been duly given and finalized.

    Asset-based transactions, which make up a sizable portion of the fixed-income market, rely on secured lending strategies. In addition, these transactions rely on legal strategies that allow the cash flow-generating company to be protected from third parties and have a specific purpose. 

    Credit analysts should use cash flow modeling to determine how much debt this organization can handle and what other legal safeguards need to be implemented.

    From an analytical perspective, leveraged buyout (LBO) transactions are highly intriguing because, unlike other asset-based transactions, they use secured lending approaches to businesses that are not truly homogeneous or limited in purpose. 

    Due to the size of the LBO industry, credit analysts should feel at ease studying such arrangements.

    Chapter 9: Estimating Recovery Prospects

    There are several causes for company defaults. Some default because they have too much debt; others do so because they have the wrong business model or work in a particularly challenging industry; some do so for a mix of the first two causes, and a few are vulnerable to internal or external shocks.

    Credit analysts must start their recovery study by identifying which of these four probable outcomes will most likely result in a firm's insolvency. This will impact the analytical method used. 

    The credit analyst must have a gloomy attitude for this analysis section. As the previous chapter (Insolvency Regimes and Debt Structures) covers, the next step is establishing the debt instruments' priority rankings. 

    For secured debt, credit analysts must determine whether the asset securing the debt, such as real estate, transportation equipment, or financial assets, is likely to have a value independent from that of the business. If so, the asset should be assessed on a stand-alone basis. 

    Credit analysts should value the company regardless of whether the debt is unsecured, subordinated, or secured by a pledge over all or only certain assets.

    In the latter case, assuming the company can be reorganized, a market value approach should be combined with a discounted cash flow assessment. 

    The basic presumption in this situation is that the value will correspond to what a willing buyer and seller would be prepared to provide, reflecting the business's value as of right.

    Part III Measuring Credit Risk

    In "Measuring Credit Risk," a scoring system is suggested for determining a firm's ability and willingness to pay off its debt on schedule as well as the probability that debt instruments would be recovered in the case that a corporation has financial difficulty.

    The possibility of default arises from three major risks:

    1. Business Risk

    Business risk is the potential for any unfavorable event to occur, which has the potential to maximize loss and minimize gain for a company. Business risks are, to put it simply, those elements that make it more likely for a company to suffer losses and less likely for it to make profits.

    These factors are beyond the company's control and have a negative impact on its profits.

    2. Financial Risk

    Financial Risk is the possibility of losing money on an investment or business enterprise. Financial risk is a threat that may result in a loss of capital. It has to do with the chances of losing money.

    It is possible that a company's cash flow won't be sufficient to meet its obligations in the event of financial risk. Credit, operational, foreign investment, legal, equity, and liquidity risks are a few typical financial hazards.

    3. Operating Risk

    Operational Risk is the danger of suffering losses as a result of poor or ineffective procedures, rules, plans, or circumstances that interfere with business operations. Operational risk can be due to internal as well as external factors:

    • Employee mistakes
    • Criminal activities like fraud
    • Natural disasters

    The majority of firms recognize that mistakes will inevitably be made by their personnel and operational procedures. Practical corrective measures should be highlighted in the evaluation of operational risk in order to eliminate exposures and guarantee effective responses.

    Operational risk can result in financial loss, a competitive disadvantage, issues with employees or customers, and even business failure if it is not addressed.

    We will bring together risks that are part of corporate as well as debt instruments. Below is a proposed scoring system for credit risk assessment.

    "In today's world of risk management, a credit risk ranking system must be able to capture both default risk and recovery expectations." —Bill Chew, Managing Director, Standard & Poor's.

    Chapter 10: Putting It All Together: Credit Ranking 

    The goal of credit analysis is to be able to assess and contrast the relative risks of various investments; thus, it is not undertaken in a vacuum. To combine the numerous dangers mentioned throughout this book, a scoring system is needed for this. 

    Here, it is suggested a scale from 1 to 10 where five categories of risk are represented. To evaluate credit risks, there should be a range of scores.

    The first should demonstrate a company's ability to pay its debt on schedule. Negatively, this score will show the likelihood of a given firm defaulting. 

    The business credit score is what we refer to. Credit analysts should first determine the borrower's country and industry characteristics before assessing its competitive position concerning peers in the same industry. 

    A financial risk score that takes into account factors including profitability, cash flow sufficiency, balance sheet stability, and financial flexibility should be compared to the resulting business risk score. 

    If management risk is judged to be higher than would be expected due to subpar governance, strategy problems, aggressive accounting, or a combination of these elements, the resulting corporate credit score should be moderated.

    The recovery that a creditor would anticipate should a default occur, should be reflected in the second score. Recovery expectations depend on the debt instrument's seniority, the type of collateral, if any, and the insolvency regime. 

    Although recovery expectations are best reported as a percentage of the outstanding balance of a certain debt instrument upon default, it is suggested that recovery expectations should be expressed as a scale to better monitor migration over time.

    Chapter 11: Measuring Credit Risk: Pricing and Credit Risk Management

    The probability of net loss is a potent instrument in the field of credit since it combines the likelihood of default with the likelihood of recovery. Consequently, participants in the debt market utilize this data for both pricing and portfolio monitoring.

    The risk-free rate and a risk premium, often known as a spread, define a debt instrument's price. The latter depends on the borrower's likelihood of default, the likelihood of a given debt instrument being recovered, and the current supply and demand dynamics in the debt markets. 

    Despite certain outliers, spreads typically have a positive relationship with credit ratings from rating agencies. Additionally, lenders could demand that loan prices change depending on the borrower's credit score. 

    Although recovery ratings are still in their infancy, it is anticipated that they will soon become just as crucial to the pricing of debt instruments. To monitor a portfolio, credit scoring is equally crucial. 

    The Basel II Accord permits banks to employ internal scoring systems and promotes stability for the global banking system through a standardized capital allocation method. 

    The Basel II scoring approach is far more intricate and precise than the one suggested in this book. Still, its core principles—and emphasis on default likelihood and recovery expectations—remain the same. 

    Banks can keep an eye on the credit risk associated with their portfolios once a reliable mechanism is in place. Without including the innovative work that credit rating agencies have done throughout the years, a book on corporate credit analysis would not be complete. 

    Since they were established about a century ago, their main job has been to determine the possibility of default, or what we refer to as a corporate credit score in this book. 

    Studies that examine the behavior of rating pools over a specific period and are released yearly provide evidence of the predictive value of credit ratings. 

    These studies reveal several things, including the fact that there is a definite relationship between credit rating stability and default frequency. However, higher credit ratings are more stable than lower ones.

    Research & Authored by Punit Manjani LinkedIn  

    Reviewed and Edited by Aditya Salunke LinkedIn

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