Module IV·Article V·~2 min read
Credit Analysis
Fixed Income: Advanced Level
Turn this article into a podcast
Pick voices, format, length — AI generates the audio
Credit Analysis
Fundamental Credit Analysis
Credit analysis is the process of assessing the ability and willingness of an issuer to service its debt. For the CIO, it is important to understand the methodology, even if the analysis is carried out by credit analysts.
Framework of Credit Analysis: The 4 C's
| Factor | Questions | Metrics |
|---|---|---|
| Capacity (Ability) | Can they pay? | Cash flow, coverage ratios |
| Capital (Capital) | What is the buffer for losses? | Leverage, net worth |
| Collateral (Collateral) | What do we get in default? | Asset coverage, security |
| Character (Character) | Do they want to pay? | Track record, governance |
Key Financial Metrics
| Metric | Formula | IG norm | HY norm |
|---|---|---|---|
| Gross Leverage | Total Debt / EBITDA | 3.0-6.0x | |
| Net Leverage | (Debt - Cash) / EBITDA | 2.5-5.0x | |
| Interest Coverage | EBITDA / Interest Expense | > 5.0x | 2.0-4.0x |
| FFO/Debt | Funds From Operations / Debt | > 30% | 10-25% |
| FCF/Debt | Free Cash Flow / Debt | > 15% | 5-15% |
| Debt/Capital | Debt / (Debt + Equity) | 50-80% |
Rating Agencies: Scales
| Category | Moody's | S&P | Fitch | Description |
|---|---|---|---|---|
| Investment Grade | Aaa | AAA | AAA | Highest quality |
| Aa1/Aa2/Aa3 | AA+/AA/AA- | AA+/AA/AA- | Very high quality | |
| A1/A2/A3 | A+/A/A- | A+/A/A- | Upper medium | |
| Baa1/Baa2/Baa3 | BBB+/BBB/BBB- | BBB+/BBB/BBB- | Lower medium | |
| High Yield | Ba1/Ba2/Ba3 | BB+/BB/BB- | BB+/BB/BB- | Speculative |
| B1/B2/B3 | B+/B/B- | B+/B/B- | Highly speculative | |
| Caa/Ca/C | CCC/CC/C | CCC/CC/C | Substantial risk / Default | |
| D | DDD | In default |
Split Ratings: Red Flags
When agencies disagree:
- 1 notch — normal, different methodologies
- 2+ notches — requires in-depth analysis
- IG/HY split — critical to understand the reasons
Qualitative Factors
- Business Risk — industry position, competitive advantages
- Management Quality — track record, strategy, capital allocation
- Governance — board independence, minority shareholder rights
- Country Risk — for EM issuers
- ESG Factors — growing influence on ratings
Credit Outlook and Watchlist
| Status | Meaning | Investor Action |
|---|---|---|
| Stable | No rating change for 12-24 months | Hold |
| Positive | Possible upgrade | Consider adding |
| Negative | Possible downgrade | Evaluate position size |
| Watch Positive/Negative | Decision within next 90 days | Immediate assessment |
§ Act · what next
I
Next article — Fallen Angels and Rising Stars
Fixed Income: Advanced Level
Read →
II
Mark as learned
Add this article to your spaced-repetition queue.
III
Ask the AI tutor
Discuss this article with a course-aware AI.
Open →