Credit Analysis for Corporate Issuers
Refresher reading access
Overview
In this learning module, we focus on the relative creditworthiness of non-financial corporate borrowers, building on earlier learning modules on corporate issuers as well as the earlier fixed-income module on credit risk and its components.
In particular, we assess a company’s activities, or its business model, and how this affects the company’s ability to meet its debt obligations. While a company’s probability of default (POD) and loss given default (LGD) are not directly observable, in the first lesson we consider qualitative and quantitative factors that affect these credit risk components. Financial statement analysis and cash flow projections are important tools used to conduct corporate credit analysis. The second lesson applies these tools to calculate and interpret a variety of financial ratios, including profitability, leverage, and coverage metrics, to assess an issuer’s probability of default. The seniority rankings of specific debt issues and use of collateral are of particular importance in determining credit ratings for a corporate issue and assessing the LGD in an event of default, which is addressed in the third and final lesson.
- The credit risk of a borrower can be evaluated using qualitative and quantitative criteria that affect a company’s likelihood of default and the investor’s loss in the event of a default.
- Qualitative factors important in gauging creditworthiness include a company’s business model, its industry, and its competitive position and business risks, as well as its corporate governance
- Quantitative factors in measuring creditworthiness involve financial statement analysis and forecasts, which use profitability, liquidity, leverage, and coverage measures to gauge a company’s ability to meet its fixed debt obligations.
- Financial ratios are a critical tool used to assess the financial health of a company, identify trends over time, and compare companies within and across industries.
- Seniority rankings determine the priority of claims on an issuer’s assets and are important determinants of the loss given default for a specific issue. Rating agencies typically provide both issuer and issue ratings for corporate credit.
- While an issuer credit rating captures the probability of default or expected loss of the issuer’s senior unsecured bonds, an issue rating refers to specific financial obligations of an issuer and takes such factors as seniority into account.
Learning outcome
The candidate should be able to:
- describe the qualitative and quantitative factors used to evaluate a corporate borrower’s creditworthiness;
- calculate and interpret financial ratios used in credit analysis;
- describe the seniority rankings of debt, secured versus unsecured debt and the priority of claims in bankruptcy, and their impact on credit ratings.
1 PL Credit
If you are a CFA Institute member don’t forget to record Professional Learning (PL) credit from reading this article.