Lesson 1 of 6 · 13 min
Qualitative factors: business, industry and governance
Before any ratio is calculated, a credit analyst asks whether the business model, industry, business risks and management make the timing and size of future cash flows reliable enough to meet each debt payment.
In short
- Creditworthiness rests on the company's ability to generate profits and cash flow large enough to pay interest and principal. Analysts judge both the chance of default (POD) and the loss if it happens (LGD).
- Qualitative factors: the business model, the industry and competition, business risk (issuer-specific, industry-specific and external) and corporate governance.
- Stable, predictable cash flows, low business risk and weak competitive pressure mean a higher capacity to carry debt and a lower POD.
- Debt has a finite life, so the analyst asks how risks evolve over each issue's tenor: long-dated debt is most exposed to strategic change.
- Secured lenders prefer tangible (hard) collateral to intangible (soft) collateral; collateral matters most for weaker credits.
- Governance: use of proceeds, covenants, management's track record with bondholders, and accounting red flags such as frequent changes of auditor or CFO.
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