lev-os Analyzing High Yield Credit
When To Use
- Evaluating a new-issue high-yield bond for purchase or pass
- Reassessing an existing holding after a credit event, earnings miss, or covenant breach
- Estimating recovery rates for distressed or defaulted debt
- Comparing relative value across high-yield issuers within the same sector
- Building a credit opinion to support a trade recommendation (long, short, or hedged)
Inputs To Gather
- Issuer financials: Last 3 years of income statements, balance sheets, and cash flow statements; most recent interim period
- Capital structure: Full debt stack with seniority, maturity dates, coupon rates, call schedules, and outstanding amounts
- Bond terms: Indenture highlights — covenants (incurrence vs. maintenance), restricted payments baskets, change-of-control provisions, permitted liens
- Industry context: Sector fundamentals, competitive positioning, cyclicality, and comparable issuer spreads
- Market data: Current bid/ask, OAS, yield-to-worst, CDS spreads (if available), and recent trading volume
- Rating agency reports: Current ratings and outlooks from Moody's/S&P/Fitch; any recent rating actions [VERIFY availability per issuer]
- Event catalysts: Pending M&A, litigation, regulatory changes, refinancing windows, or maturity walls
Workflow
Map the capital structure
- Rank all debt obligations by seniority: secured → senior unsecured → subordinated → mezzanine → preferred equity
- Note any structural subordination from operating-company vs. holding-company debt
- Calculate total leverage, secured leverage, and net leverage ratios
- Identify nearest maturity and any springing maturities or cross-default triggers
Assess credit fundamentals
- Compute key ratios: Debt/EBITDA, Interest Coverage (EBITDA/Interest), FCF/Debt, Fixed Charge Coverage
- Normalize EBITDA for one-time items; flag add-backs exceeding 15% of reported EBITDA as aggressive [VERIFY add-back legitimacy]
- Evaluate revenue concentration (customer, geography, product) and margin trajectory
- Stress-test cash flows under a downside scenario (e.g., 20% EBITDA decline) and check covenant headroom
Analyze covenants and structural protections
- Classify covenant package strength: tight (maintenance-based with restricted baskets) vs. covenant-lite (incurrence-only)
- Identify leakage risk: permitted investment baskets, unrestricted subsidiary designations, collateral release provisions
- Flag any J. Crew / Chewy-style trapdoor provisions that allow asset stripping [VERIFY against actual indenture language]
Estimate recovery in a default scenario
- Select recovery methodology: enterprise-value waterfall approach for going-concern or liquidation analysis for asset-heavy issuers
- For enterprise-value waterfall: apply a distressed EBITDA multiple (typically 4x-6x for HY, sector-dependent) to estimate firm value, then distribute per the priority-of-claims stack [VERIFY appropriate multiples for the sector]
- For liquidation: haircut assets by category — cash (100%), receivables (70-85%), inventory (50-70%), PP&E (30-60%), intangibles (0-20%) [VERIFY against industry-specific benchmarks]
- Compute recovery rate per tranche and implied loss-given-default (LGD)
Perform relative value assessment
- Compare OAS and yield-to-worst against same-rating/same-sector peers
- Assess spread compensation relative to estimated default probability and recovery rate
- Calculate breakeven spread widening: how much can spreads widen before total return turns negative over the holding period?
- Consider optionality: if bond is callable, compute yield-to-call vs. yield-to-worst and assess likelihood of early redemption
Form credit opinion and recommendation
- Summarize the bull case, bear case, and base case with probability weightings
- State a clear directional view: overweight / market-weight / underweight, or buy / hold / sell
- Identify key monitoring triggers that would change the recommendation (e.g., leverage above Xх, loss of a key customer, downgrade watch)
Output
The analysis report should include:
- Executive summary: One-paragraph credit opinion with recommendation and target spread/price
- Capital structure table: All tranches with seniority, size, coupon, maturity, current price, YTW, and OAS
- Credit metrics dashboard: Leverage, coverage, and liquidity ratios with trend (improving/stable/deteriorating)
- Recovery analysis: Waterfall table showing estimated recovery per tranche under base and stress scenarios
- Relative value snapshot: Spread comparison vs. 3-5 closest comps with brief rationale for any premium or discount
- Risk factors: Ranked list of material risks with estimated probability and impact
- Monitoring triggers: Specific thresholds or events that warrant immediate re-evaluation
Quality Checks
- All leverage and coverage ratios tie back to sourced financials — no orphan numbers
- Recovery waterfall sums correctly and respects strict priority (no value leakage past senior claims unless surplus exists)
- Covenant analysis references actual indenture terms, not generic descriptions
- Spread and yield data are date-stamped; stale pricing (>2 business days) is flagged
- Downside stress scenario is plausible and internally consistent (e.g., EBITDA decline flows through to FCF and coverage ratios)
- Any assumed EBITDA multiples, haircut rates, or default probabilities are labeled with source or marked [VERIFY]
- Recommendation is consistent with the analysis — no disconnect between bearish fundamentals and a buy recommendation without explicit justification