Markets Explained

Credit Analysis

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Credit Analysis

The major rating agencies conduct detailed evaluations of bond issues by poring over corporate financial data, meeting with issuers’ management and considering other forecasts and variables prior to assigning their ratings. Each agency applies a methodical process to the analysis of an issuer’s ability to repay interest and principal in a timely fashion, and this process continues through periodic reviews of each issuer. Any major event or news announcement that affects a company’s debt, such as a downturn in sales or a management shake-up, causes rating agencies to review their assigned ratings, and perhaps revise them.

In addition, trained professionals at many investment firms analyze bond credits and issue opinions and recommendations to brokers and investors. Since high-yield bond analysis requires a sophisticated level of knowledge and experience, most prudent investors rely upon both agency credit ratings and the views of analysts who dig beneath the ratings.

A review of high-yield debt investments should cover: (1) analysis of the industry, including growth rates, special risks and leading companies; (2) analysis of the bond issuer, including the company’s position in its industry; new products; management stability; the outlook for growth in revenues and cash flow as captured in Earnings Before Interest, Taxes, Depreciation and Amortization, also called EBITDA; value of corporate assets and the debt maturity schedule; and (3) analysis of the issue, including special provisions in the “bond indenture,” covenants protecting the bondholder, use of the money raised in bond offerings, debt seniority, secondary market liquidity and call provisions.