Level I · Fixed Income

Learning Module 16
Credit Analysis for Corporate Issuers

Key Outcomes Summary & Practice Problems

Learning Outcomes

What you must be able to do

Curriculum Year: 2026

LOS 1

Describe the qualitative and quantitative factors used to evaluate a corporate borrower's creditworthiness — business model, industry, competitive position, corporate governance, profitability, leverage, coverage, and liquidity.

LOS 2

Calculate and interpret financial ratios used in credit analysis — EBIT margin, EBIT/interest expense, Debt/EBITDA, RCF/Net Debt, FFO/Debt, and other key credit metrics.

LOS 3

Describe seniority rankings of debt, secured vs. unsecured debt, priority of claims in bankruptcy, and their impact on credit ratings — including issuer vs. issue ratings and notching.

1 · Qualitative Factors in Corporate Creditworthiness

Business model: Stable and predictable cash flows, low business risk → higher capacity to use debt, lower likelihood of default.
Industry and competition: Less competitive pressures, higher barriers to entry → stronger creditworthiness.
Business risk: Execution risk, technological changes, supplier bargaining power, customer concentration.
Corporate governance: Management quality, treatment of debtholders vs. shareholders, accounting policies, red flags (changing auditors/CFOs, aggressive accounting, off‑balance‑sheet financing).
Collateral quality: Secured lenders prefer tangible assets (hard collateral) over intangible assets (soft collateral).

2 · Quantitative Factors and Financial Ratios

Key Credit Metrics

📊 Profitability

Higher profitability → higher credit quality

EBIT Margin = EBIT / Revenue

🛡️ Coverage

Higher coverage → lower credit risk

EBIT / Interest Expense

⚖️ Leverage

Higher leverage → higher credit risk

Debt / EBITDA

💵 Cash Flow Leverage

Higher ratio → lower leverage (better)

RCF / Net Debt

💰 Cash Flow Coverage

Higher ratio → better coverage

FFO / Debt

🏦 Liquidity

Higher liquidity → lower near‑term default risk

Current ratio, quick ratio

EBIT margin: Operating income / Revenue. Focus on operating profits and recurring revenues, not one‑time gains.
EBIT to interest expense: Measures degree to which operating profit covers periodic interest payments. Higher is better.
Debt to EBITDA: Leverage ratio. Higher indicates more leverage and thus higher credit risk. Volatile for cyclical industries.
Retained Cash Flow (RCF) to Net Debt: RCF = Net cash from operating activities − Dividends. Net Debt = Debt − Cash and marketable securities. Higher is better (lower leverage).
FFO (Funds From Operations): Net income from continuing operations + depreciation + deferred taxes + other non‑cash items. Used in FFO/Debt coverage ratio.
Cash flow measures are more conservative than earnings measures for credit analysis.

KEY CREDIT RATIOS

EBIT Margin = Operating Income / Revenue
Interest Coverage = EBIT / Interest Expense
Debt/EBITDA = Total Debt / EBITDA
RCF/Net Debt = (CFO − Dividends) / (Debt − Cash)
FFO/Debt = (Net Income + D&A + Deferred Taxes + Other Non‑Cash) / Debt

3 · Seniority Rankings, Recovery Rates, and Credit Ratings

Seniority Rankings (Highest to Lowest Priority)

First Lien / Mortgage

Highest priority — claim on specific pledged assets

Senior Secured

Secured by specific assets; lower LGD

Senior Unsecured

General claim on assets; higher LGD than secured

Senior Subordinated

Rank below senior unsecured

Subordinated

Lower priority; paid after senior claims

Junior Subordinated

Lowest priority among creditors; paid before equity

Recovery Rates

Recovery rates vary by seniority — senior secured bonds have higher recovery rates than senior unsecured, which have higher than subordinated.
Recovery rates also vary by industry (e.g., utilities have higher recovery than retail) and credit cycle (higher during economic expansions).
Expected loss (EL): EL = POD × LGD where LGD = (1 − Recovery Rate).
Structural subordination: Debt at operating subsidiaries is serviced before funds can be upstreamed to the holding company.

Issuer vs. Issue Ratings

Issuer rating (Corporate Family Rating / Corporate Credit Rating): Applies to senior unsecured debt; reflects overall creditworthiness (POD).
Issue rating: Refers to specific debt obligations; reflects seniority and LGD differences.
Notching: Rating adjustment process where issue ratings are moved up (for secured debt) or down (for subordinated debt) from the issuer rating.
For investment‑grade issuers, notching adjustments are smaller (lower risk of default). For high‑yield issuers, notching adjustments are larger (greater importance of LGD).

4 · Quick Reference — Corporate Credit Analysis

Factor	Measure	Higher Value →
Profitability	EBIT Margin	↑ Better credit quality
Coverage	EBIT/Interest Expense	↑ Better credit quality
Leverage	Debt/EBITDA	↑ Lower credit quality
Cash Flow Leverage	RCF/Net Debt	↑ Better credit quality
Seniority	Secured vs. Unsecured	↑ Secured → lower LGD
Recovery Rate	% of principal recovered	↑ Higher recovery → lower LGD
Notching	Issue rating vs. issuer rating	Secured bonds are notched up; subordinated notched down