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= Market Value
= Net Operating Income
= Terminal Value
= Replacement Cost
= Debt Service Coverage
Ratio
CR
Y.S
GO
RE
REITS
1. INTRODUCTION
2. CREDIT RISK
Credit risk risk of loss resulting from the issuer of debt failing to make full &
timely payments of interest &/or principal.
Components of CR
Default Risk
Spread Risk
Risk that yield spread will widen & bond will underperform.
= Credit Risk
= Yield Spread
= General Obligation
= Real Estate
= Real Estate Investment
Trusts
4. RATINGS AGENCIES, CREDIT RATINGS, AND THEIR ROLE IN THE DEBT MARKETS
Major credit agencies (Moodys, S&P, Fitch) play a central role in the credit market.
Some factors that led to the universal use of credit ratings include:
Independent credit risk assessment.
Regulatory & statutory reliance & usage.
Huge growth of debt market & issuer payment for ratings.
Ease of comparison across bond issuers, issues & market segments.
Upper-Medium
Grade
Low-Medium
Grade
Non-Investment
Grade Junk or
High Yield
Low Grade or
Speculative
Grade
Default
Moodys
Aaa
Aa1
Aa2
Aa3
A1
A2
A3
Baa1
Baa2
Baa3
S&P
AAA
AA+
AA
AAA+
A
ABBB+
BBB
BBB-
Fitch
AAA
AA+
AA
AAA+
A
ABBB+
BBB
BBB-
Ba1
Ba2
Ba3
B1
B2
B3
Caa1
Caa2
Caa3
Ca
C
C
BB+
BB
BBB+
B
BCCC+
CCC
CCCCC
C
D
BB+
BB
BBB+
B
BCCC+
CCC
CCCCC
C
D
Capacity
Ability of the borrower to make its debt
payments on time
Covenants
Terms & conditions of lending agreements
that the issuer must comply with.
Collateral
Quality & value of the assets supporting the
issuers indebtness.
Character
Management quality
Industry Structure
Porters Framework
Power of Suppliers
Power of Customers
Barriers to Entry
Substitution Risk
Barriers, risk.
Level of Competition
Competition, credit risk.
Industry Fundamentals
Cyclical or Non-Cyclical
Growth Prospects
Company Fundamentals
Operating history.
Competitive position.
Management strategy & execution.
Ratio analysis.
Leverage Ratios
Coverage Ratios
5.2.2 Collateral
Asset value analysis is typically emphasized more with weaker credit quality companies.
If default probability rises to a sufficient level, the analysts consider the collateral value in
the context of loss severity.
Value & quality of a companys assets are difficult to observe directly.
A market-based signal to impute the quality of a public company is equity market
capitalization.
Key point of collateral analysis to assess the value of the assets relative to the issuers
level & seniority ranking of debt.
5.2.3 Covenants
Covenants are integral to credit agreements & spell out what the issuers
management is obligated to do (affirmative covenants) & limited in doing
(negative covenants).
Covenants are described in bond prospectus for corporate bonds.
Strong covenants protect bond investors from the possibility of
management taking actions that would hurt an issuers credit worthiness.
5.2.4 Character
Management often has little ownership in a corporation so analysis of
character is different than it would be for owner-managed firm.
Judgments about management character includes:
An assessment of management strategy.
Management track record of past strategies.
Accounting policies & tax strategies.
History of fraud or malfeasance.
External Debt
Internal Debt
Both external & internal debts are easy to service if govt. runs a budget & current account
surplus.
Key issues for sovereign analysis:
Govt ability to pay.
Govt willingness to pay (more important).
Specific characteristics that the analysts should expect in a top-quality sovereign credit include:
Political & economic profile.
Institutional effectiveness & political risks.
Economic structure & growth prospects.
Flexibility & performance profile.
External liquidity & international investment position.
Fiscal performance, flexibility & debt burden.
Monetary flexibility.