Welcome to our

Presentation
On

GENERAL
PRINCIPLES OF
CREDIT ANALYSIS

Group Members
Name
Md. Mehedi Hasan
Radiul Parvez
Tahmina Haque Nisha
Shohed Alom
Mahmudul Hasan Rubel
Moonzarin Mahmood
Nazir Ahmed Zihad

I.D.
14053
17002
25033
25081
29060
29019

Introduction
The credit risk of a bond includes:
1. The risk that the issuer will default on its obligation and
2. The risk that the bonds value will decline and/or the bonds price
performance will be worse than that of other bonds against
which the
investor is compared because either
(a) The market requires a higher spread due to a perceived
increase in the
risk that the issuer will default or
(b) Companies that assign ratings to bonds will lower a bonds
rating.
The first risk is referred to as default risk. The second risk is
labeled
based on the reason for the adverse or inferior
performance. The risk
attributable to an increase in the spread,
or more specifically the credit
spread, is referred to as credit
spread risk the risk attributable to a lowering of the credit rating (i.e.,
a downgrading) is referred to as
downgrade risk.

Introduction
Credit analysis of any entity (Continued)
a corporation, a municipality, or a

sovereign government involves the analysis of a multitude of

quantitative and qualitative factors over the past, present, and
future. There are four general approaches to gauging credit risk:
1.Credit ratings
2.Traditional credit analysis
3.Credit scoring models
4.Credit risk models

Credit Rating
A credit rating is a formal opinion given by a specialized company
of the default risk faced by investing in a particular issue of debt
securities . The specialized companies that provide credit ratings
are referred to as rating agencies. The three nationally
recognized rating agencies in the United States are _
1. Moodys Investors Service,
2.Standard & Poors Corporation, and
3. Fitch Ratings.

Rating Process, Surveillance,

and Review
The rating process begins when a rating agency receives a formal

request from an entity planning to issue a bond in which it seeks a

rating for the bond issue. A rating agency may also be requested
to provide a rating for a company that has no public debt
outstanding. This is done for companies that are parties in
derivative transactions, such as swaps, so that market participants
can assess counterparty risk.
Once a credit rating is assigned to a corporate debt obligation, a
rating agency monitors the credit quality of the issuer and can
reassign a different credit rating to its bonds. An upgrade occurs
when there is an improvement in the credit quality of an issue; a
downgrade occurs when there is a deterioration in the credit
quality of an issue. In the announcement, the rating agency will
state the direction of the potential change in rating upgrade or
downgrade.

Rating Process, Surveillance,

and
Review
(Continued)
Rating agencies will issue rating outlooks. A rating outlook is a
projection of whether an issue in the long term (from six months to
two years) is likely to be upgraded, downgraded, or maintain its
current rating. Rating agencies designate a rating outlook as either
positive (i.e., likely to be upgraded), negative (i.e., likely to be
downgraded), or stable (i.e., likely to be no change in the rating).

Gauging Default Risk and

Downgrade Risk
The information available to investors from rating
agencies about credit risk are: (1) ratings,(2) rating
watches or credit watches, and (3) rating outlooks.
Moreover, periodic studies by the rating agencies
provide information to investors about credit risk. Now
we describe how the information provided by rating
agencies can be used to gauge two forms of credit risk:
default risk and downgrade risk.

Gauging Default Risk and

Downgrade Risk
For long-term debt obligations, a credit rating is a
forward-looking assessment of (1) the probability of
default and (2) the relative magnitude of the loss should
a default occur. For short-term debt obligations (i.e.,
obligations with initial maturities of one year or less), a
credit rating is a forward-looking assessment of the
probability of default. Consequently, credit ratings are
the rating agencies assessment of the default risk
associated with a bond issue.

Gauging Default Risk and

Downgrade Risk
Periodic studies by rating agencies provide information about
two aspects of default riskdefault rates and default loss
rates. First, rating agencies study and make available to
investors the percentage of bonds of a given rating at the
beginning of a period that have defaulted at the end of the
period. This percentage is referred to as the default rate. For
example, a rating agency might report that the one-year
default rate for triple B rated bonds is 1.8%. These studies
have shown that the lower the credit rating, the higher the
default rate. Rating agency studies also show default loss
rates by rating and other characteristics of the issue (e.g.,
level of seniority and industry). A default loss rate is a
measure of the magnitude of the potential of the loss should a
default occur.

TRADITIONAL CREDIT
ANALYSIS
In traditional credit analysis, the analyst considers the four Cs of
credit:
Capacity: Capacity is the ability of an issuer to repay its obligations.
Collateral: Collateral is looked at not only in the traditional sense of
assets pledged to secure the debt, but also to the quality and value
of those unpledged assets controlled by the issuer. In both senses
the collateral is capable of supplying additional aid, comfort, and
support to the debt and the debtholder. Assets form the basis for the
generation of cash flow which services the debt in good times as
well as bad.

TRADITIONAL CREDIT
ANALYSIS
Covenants: Covenants are the terms and conditions of the
lending agreement. They lay down restrictions on how
management operates the company and conducts its financial
affairs. Covenants can restrict managements discretion. A
default or violation of any covenant may provide a meaningful
early warning alarm enabling investors to take positive and
corrective action before the situation deteriorates further.
Character: Character of management is the foundation of
sound credit. This includes the ethical reputation as well as the
business qualifications and operating record of the board of
directors, management, and executives responsible for the use
of the borrowed funds and repayment of those funds.

Different aspect of Bond

rating

bond rating is a grade given to a bond that indicates its credit

quality. Private independent rating services provide these
evaluations of a bond issuer's financial strength or its ability to pay
a bond's principal and interest in a timely fashion.
Bond ratings are expressed as letters ranging from "AAA," which is
the highest grade, to "C" or "D" ("junk"), which is the lowest grade.
Different rating services use the same letter grades, but use
various combinations of upper and lower-case letters to
differentiate themselves.

Bond Rating (Continue)

Thebond ratingsystem helps investors determine a company's
credit risk. Think of a bond rating as the report card for a
company's credit rating.Blue-chipfirms, which are safer
investments, have a high rating, while risky companies have a low
rating.
The chart below illustrates the different bond rating scales from
the major rating agencies in the United States:
1.Moody's,
2.Standard and Poor's and
3. Fitch Ratings.

Rating Chart

When to trust rating

agencies?

Institutional and individual investors rely onbond ratingagenciesand

their in-depth research to make investment decisions. Rating agencies
play an integral role in the investment process and can make or break
a company's success in both theprimaryand secondary bond market.
While the rating agencies provide a robust service and are worth the
fees they earn, the value of such ratings has been widely questioned
after the 2008 financial crisis,and the agencies' timing and opinions
have been criticized when dramatic downgrades have come very
quickly. Any good investment firm, whether it's amutual fund, bank
orhedge fundwill not rely solely on the bond rating agency's rating
and will supplement their research with their own in-house research
department. This is why it's important for an individual investor to not
only question the initial bond rating, but frequently review the ratings
over the life of a bond and constantly question those ratings, as well.

A high-yield corporate bond is a type of corporate bond that

offers a higher rate of interest because of its higher risk of default.
Also known as "junk bonds". Generally, investors in high-yield
corporate bonds can expect at least 150 to 300 basis points
greater yield compared to investment-grade bonds at any given
time.

Special Considerations for

High-Yield Corporate Bonds:

High-Yield Bond Market

Performance
Recently, central bank of USA as the Federal Reserve has taken
measures to inject liquidity into their economies and keep credit
readily available, thereby lowering the costs of borrowing and
eating into the returns of lenders. As of February 2016, $9 trillion
worth of sovereign bonds, or government debt, offered a yield
between 0 and 1% and $7 trillion offered a negative yield, after
accounting for expected inflation.

Advantages and
Advantages:
Disadvantage

1. They offer a higher payout compared to traditional investment grade

bonds:
2. The High Yield Corporate bond may appreciate as well.
3. Bondholders get paid out before stockholders when a company fails.
4. They offer a higher payout than traditional bonds.
5. Recession-resistant companies may be under rated .

Disadvantages:
1. Higher default rates.
2. They are not as fluid as investment-grade bonds.
3. The value/price of a high-yield corporate bond can be affected by a
drop in
the issuers credit rating.
4. The value/price of a high-yield corporate bond is also affected by
changes in the interest rate.
5. High-yield corporate bonds are the first to go during a recession.

Factors of High-Yield
Corporate Bonds:
Analysis of debt structure.
Analysis of corporate structure.
Analysis of covenants.
Equity Analysis Approach.

Factors of High-Yield
Corporate Bonds (Cont.):
1. Analysis of Debt Structure:

Bank debt.
Brokers loans or bridge loans.
Reset notes.
Senior debt.

2. Analysis of Corporate Structure:

High-yield issuers usually have a holding company structure.
The assets to pay creditors of the holding company will come
from the operating Subsidiaries.

Factors of High-Yield
Corporate Bonds (Cont.):
3. Analysis of Covenants:

Analyst should of course consider covenants when evaluating any

bond issue (investment grade or high yield), it is particularly important
for the analysis of high-yield issuers. The importance of understanding
covenants was summarized by one high yield portfolio manager.

4. Equity Analysis Approach:

Historically, the return on high-yield bonds has been greater than that
of high-grade corporate bonds but less than that of common stocks.
The risk (as measured in terms of the standard deviation of returns)
has been greater than the risk of high-grade bonds but less than that
of common stock. Using an equity approach, or at least considering
the hybrid nature of high-yield debt, can either validate or contradict
the results of traditional credit analysis, causing the analyst to dig
further.

Thank you for

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