We will be considering the special cases in credit analysis of three different types of issuers, i.e. High Yield, Sovereign, and Municipal Bond Issuers.

1.1.         High Yield Bonds

a.  These are the bonds issued with a rating below Baa3 or BBB- by Moody’s or S&P and Fitch respectively.

b.  While doing the credit analysis of these bonds, the main focus is on the loss severity and loss recovery, then on the probability of a loss There is also a greater focus on liquidity at the time of cash flow analysis.

c.  We need to analyze the debt structure in detail and also calculate Debt/EBITDA ratio for each level of debt.

d.  One also needs to look at the corporate structure and look for structural subordination. The corporate structure may consist of a parent company with one or more than one subsidiary.

e.  The covenant analysis of the high yield bonds should include the analysis of the following terms:

     i.  Change of control put: In the event of an acquisition, the bondholders may require full payment at par.

    ii.  Restricted Payment: This covenant puts a limit on the amount of cash that can be paid to the shareholders.

   iii.  Limitations on Liens: This covenant limits the amount of secured debt that can be issued so that the unsecured debt does not have to face a downgrade in rating each time a higher tranche bond is issued.

   iv.  Restricted Vs. Unrestricted Subsidiaries: When the holding company issues the bond, the subsidiaries that are restricted are obligated to service these loans in case of default by the holdings, whereas, the unrestricted subsidiaries do not face any such obligations. Thus the unrestricted subsidiary may be able to issue the debt at a lower yield because their debt is not subordinated, like the debt issued by the restricted subsidiary.

1.2.         Sovereign Debt

a.  There may be two types of offerings of the sovereign debt, i.e. the external offering and the internal debt.

The external offerings are the debt issued by governments of different countries, usually in a hard currency such as the U.S. Dollar. The internal offering, on the other hand, is issued in the issuing country’s local currency. The internal offerings, thus also have the currency risk associated.

b.  While making an analysis of the sovereign debt, the analyst needs to look at the two important aspects:

     i.  The ability to pay, and

    ii.  The willingness to pay

The willingness to pay needs the special attention of the analyst, as most of the sovereign bonds have sovereign immunity. The investors cannot force payment to the governments.

c.  Thus, the most important consideration, while analyzing the sovereign debt is the political and economic profile of the issuing authority.

For the political profile, one needs to look at the effectiveness, stability, and predictability of the issuing government.

The economic profile, on the other hand, requires the analysis of per capita income, growth prospects, demographic situation, stability & sources of revenue, the ratio of government spending to consumption, etc.

1.3.         Municipal Debt

a.  These are general obligations, unsecured bonds issued by the local municipalities of different countries.

b.  The municipalities must balance their budget. That is, their revenues must always match the expenditure. But, if the revenues fall short of the expenditure, the municipalities issue bonds.

c.  There are two types of bonds issued by the municipalities, i.e. the general obligation bonds, and the revenue bonds. The revenue bonds are issued for specific project financing. Therefore for these bonds, we need to look at the debt service coverage ratio, i.e. if the revenue is sufficient to cover the principal and the interest.