A Pragmatist's Guide to Leveraged Finance

Credit Analysis for Below-Investment-Grade Bonds and Loans

Robert S. Kricheff

• Publisher: Harriman House
• Year: 2021
• ISBN:
  9780857198501
• Edition: 2
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

The high-yield leveraged bond and loan market is now valued at $4+ trillion in North America, Europe, and emerging markets. What's more the market is in a period of significant growth.To successfully issue, evaluate, and invest in high-yield debt, financial professionals need credit and bond analysis skills specific to these instruments. This fully revised and updated edition of A Pragmatist's Guide to Leveraged Finance is a complete, practical, and expert tutorial and reference book covering all facets of modern leveraged finance analysis. Long-time professional in the field, Bob Kricheff, explains why conventional analysis techniques are inadequate for leveraged instruments, clearly defines the unique challenges sellers and buyers face, walks step-by-step through deriving essential data for pricing and decision-making, and demonstrates how to apply it. Using practical examples, sample documents, Excel worksheets, and graphs, Kricheff covers all this, and much more: yields, spreads, and total return; ratio analysis of liquidity and asset value; business trend analysis; modeling and scenarios; potential interest rate impacts; evaluating leveraged finance covenants; how to assess equity (and why it matters); investing on news and events; early-stage credit; bankruptcy analysis and creating accurate credit snapshots. This second edition includes new sections on fallen angels, environmental, social and governance (ESG) investment considerations, interaction with portfolio managers, CLOs, new issues, and data science. A Pragmatist's Guide to Leveraged Finance is an indispensable resource for all investment and underwriting professionals, money managers, consultants, accountants, advisors, and lawyers working in leveraged finance. It also teaches credit analysis skills that will be valuable in analyzing a wide variety of higher-risk investments, including growth stocks.

Chapter 1: Common Leveraged Finance Terms and Trading Parlance

What’s in this chapter:

• definitions of general terms
• duration, spread, and yield definitions
• a pragmatic comment on yields, prices, and trading terminology

Just as specialties from firefighting to neurosurgery have their own lingo, so does the leveraged finance market. Understanding the terminology that is common to this marketplace will help analysts to operate effectively.

This chapter outlines commonly used key terms. Some definitions are fairly generic to the securities business; others tend to be specific to the leveraged finance market. In many cases, there are several different words that describe the same thing. Even the market itself goes by several names: leveraged finance, high yield, and the junk market. There are also cases where the same word is used to describe a number of different things. Throughout the book, we will repeat some of these definitions and concepts with examples.

Definitions of General Terms

• Amortization: Generally refers to spreading some type of payment over time. When it is used in reference to a bond or loan, it usually refers to the required paydown of a debt instrument. On company financial statements, it refers to the depletion in the value of intangible assets on the balance sheet, whereas the term depreciation refers to depletion of tangible assets.
• Basis points: There are 100 basis points (often abbreviated as bp or bps) in 1 percentage point. As an example, 0.5% = 50 basis points, 2% = 200 basis points.
• Bullet bond: A bond that is not callable, meaning the company that issues it cannot require the holder to sell the bond back to the company. These are also sometimes labeled NCL, an acronym for the term noncallable for life.
• Call: The right to purchase a bond or loan at a set price for a set period of time. When leveraged finance debt is issued, the company that issues it will often have the right, for certain periods of time, to call the bonds at a price above where they were sold.
• Collateralized loan obligation (CLO): A securitized structure (typically below investment grade), in which loans are packaged together and used to secure a series of bonds that the collateralized loan obligation issues. There are numerous structural rules around the securitization collateral. The bonds issued by the collateral pool are tiered in seniority.
• Corporate bank loan: A loan to a company that, legally, is not a security but a financing. It usually takes the form of a term loan (typically, not reborrowable), or a revolver (can be repaid and then reborrowed). Loans have a coupon and a stated maturity. The coupon is usually a floating rate. Other terms often used to describe a bank loan include leveraged loan, bank debt, and syndicated loan. Traditional bank loans are held by banks. Loans sold to the institutional investment community are sometimes called an institutional tranche or a term loan B.
• Corporate bond: A loan to a company in the form of a security. Bonds are also called debentures or notes.
• Covenant: A rule laid out in the bond indentures and/or loan documents by which the company agrees to operate as part of the terms of the loan or the bond. Affirmative covenants (typically more of these are in loans than in bonds) are something the company must do. This can include items such as a requirement to report financials or maintain a minimum level of cash flow. Another term for an affirmative covenant is a maintenance covenant. Negative covenants typically prevent or restrict what a company can do. They may include requirements that must be met before a dividend is paid or more money is borrowed.
• Credit: Typically refers to the issuer of the bond or loan, not a specific issue of debt. It can be used to refer to the overall credit quality of an issuer of debt, too, such as, “That is a good credit,” or “That credit is in decline.”
• Default: When the company that issues a bond or loan fails to make a required payment on time. A technical default occurs when a maintenance/affirmative covenant is violated. Most bond and loan agreements allow the company a grace period in which it can try to cure the default.
• Direct lending: Usually refers to a loan made privately with an investor and not syndicated among buyers. Typically, this means there is no market to buy or sell this debt. Direct lending is also sometimes called private debt.
• Equity: The accounting value of the company, shown on a balance sheet, after debt and other obligations are subtracted from the total value. It is also referred to as book value and can refer to a company’s common stock as well. The term equity value can refer to the balance sheet equity value or the value of a company’s stock. In leveraged finance, it can refer to new money being invested in a company that is not debt, or the excess value that the company has above the value of the debt.
• Grace period: Most loan agreements and bond indentures have a set period of time in which they are allowed to cure a nonprincipal default before the borrowers can accelerate and force a bankruptcy. This grace period is usually thirty days.
• Indenture: A legal document containing all the terms that the issuer of a bond agrees to.
• Interest rate: Interest required to be paid on the bond or loan. This is sometimes called a coupon or referred to as the rate when discussing a new financing.
• Issuer: The company that issues the loan or bond; often referred to as the credit.
• Leverage: A company’s level of debt. In some countries this is referred to as gearing. To be clearer when referring to the amount of debt, the full term is financial leverage (gearing). Leverage can indicate the total amount of debt or some ratio of a company’s debt. In business analysis there is also operational leverage, which measures how much an improvement in a company’s revenue will increase its profits.
• LIBOR: London interbank offering rate—an interest rate based on the cost that banks pay to borrow money overnight. It is often used as the base rate for floating-rate notes and is similar to the US prime rate. If the floating rate is +1% and LIBOR is at 2%, the borrower would have to pay 3%. If LIBOR were 1%, the borrower would pay 2%. In this case, LIBOR is the base rate. LIBOR is expected to be phased out and various rates are expected to replace it around the globe. In the USA, the main contender is SOFR (secured overnight financing rate).
• Loan book or bank book: A summary of a new loan offering that can be given to a potential investor. Sometimes it is private, sometimes public, and sometimes there is both a private and a public version. Generally, it is a bank loan version of the bond prospectus.
• Maturity: The date on which the bond or loan must be repaid. Another term for this is due date.
• Money terms: Refers to the principal due, maturity, and interest...