Financial Modeling for Modern Credit Analysis

L

Luchano

New member
Joined
Jun 18, 2026
Messages
0
Reaction score
0
What sort of financial modeling do modern credit analysts employ and how does it conceptually differ from equity research analysts' models? I mean DDM, FCFF, RI, EVA that are covered in Level 2. Does credit financial modeling simply mean that we adjust cash flows and determine sustainable trends, like FCFF model does?

Please read how I conduct credit analysis and tell me what I can improve:

I usually begin with profitability (Dupont), solvency, coverage, capitalization, then other Cs like covenants, collateral, character.

Then I run credit score models (post hoc), summarize agencies reports (initially, I read ratings methodologies for particular sectors and their ratio&quality criteria for certain rating), sell side credit reports; listen to market signals like CDS spreads volatility, equity prices.

Finally, I try to predit corporate actions/event risks, e.g., if a company is inclined to borrow to pay dividends or a company may become an LBO target - very credit negative. I read company's major news in Bloomberg over the last two years to find any corporate risks that may appear in the future.

If the company is a high yield name I pay closer attention to its short term borrowing facilities and look for additional structural support from parents/subsidiaries.

Now I am going to have an interview for the credit analyst position where "financial modelling" is required. I wonder how it may differ from what I do?
 
I'm guessing its for structured finance products, ABS, CDOs and the like. Maybe refresh yourself on montecarlo simulations and the binomial models. Unless you know its for corporates, then I'd say you're barking up the right tree.
 
I think you're on the right track for sure. Credit models usually aren't as detailed as equity models, becuase forecasting EPS down to the penny is much less important. Also valuation models like a DCF aren't really used (i.e. no real need to discount the cash flows because you aren't valuing the company per se), but genearlly for corporates or industrials free cash flows are projected to get a feel for where the credit metrics will go under different scenarios, and to develop an idea of what the credit / rating trends are for the company going forward.

This credit view is then taken in conjunction with current spreads for the credit and its peers to make a relative value call. I'm talking about credit analysis for the management of bond portfolios, so if the position is counterpaty credit risk or structured finance then it might be different.

In your interview I would spend a good chunk of time talking about event risk. This is constantly on the minds of all credit analysts in this market. I'd mention looking at LBO activity in the sector, equity returns, pressure on management, activist shareholders, and also any potential mitigants to event risk such as regulatory hurdles, market cap (although with club deals and massive PE AUM this is only really true for mega caps and even then maybe not), concentrated ownership, etc.
 
You're missing stress tests, forecasts, and liquidity analysis (esp. for high yield).

I run a forecast based on my estimate of sustainable OCF, future capex needs. I'm adjusting for the usual non-recurring items: artificially low or high cash taxes (NOLs, etc.), capitalized interest, cash from disc. ops., etc.. etc. I may use a management base case or my own forecast as a start. Then I'll stress the numbers accordingly, running a few different scenarios and see what this does to debt and coverage levels, and credit metrics. Does the company have sufficient liquidity available to weather such a storm. Also, because some companies have volatile working capital needs, I'll often like at FFO based metrics as well. Be careful of EBITDA; while it's still widely used, depending on the underlying accounting, it can diverge widely from actual cash generation (like if the firm has significant unrealized earnings from MTM).

The subjective analysis is hugely important, mostly to determine the quality of the cash flows.

Overall, I'd say you're on the right track. The modeling is definitely less complicated than equities.
 
"Be careful of EBITDA; while it's still widely used, depending on the underlying accounting, it can diverge widely from actual cash generation (like if the firm has significant unrealized earnings from MTM)."

Very good advice. This is overlooked way too often.
 
Thanx for input! This is a fundamental credit research position, TMT sector, buy side.

My analysis is mostly retrospective. I will definitely need some ad hoc modeling beef up. As I understand I can make some assumptions about growth rates for particular items and then check final ratios.

The question is how to make growth assumptions? Should I regress the previous 5 year trend for an item and them use the regression slope as a multiplier? Or should it be just a general assumption for all items at the same time?

As for EBITDA, I am preparing for the Level 2, and that measure is critisized in the curriculum as well - not a good proxy for sust. CF. I think the main idea is to determine sustainable cash flows from CFO, adjust the total debt (leases, pensions etc) and then relate it to the determined cashflows. The adjusted CFO will be also related to adjusted interest expense to determine the main coverage ratio.

The other question is about the interview: Is there any sense to show my writing samples or it is better to wait till I get a case from them? This is a dilemma since the interviewers have 20 years of credit experience and they may become more preoccupied with the writing samples than actually talking to me, and any mistakes/confusions may become too exaggarating in their view, e.g., when I had an interview for the same position at Merill Lynch, I showed a tech spreadsheet - bankruptcy prediction based on post hoc data, but they though I am too technical for the role.

That is, I am not directly asked to bring anything for the interview. I did not see any writing samples from that company since it is a buy side. Therefore I can have only a vague understanding regarding their standards. At the same time, this is the first round and if I do not impress them now they may not invite me for the second round (in fact they are going to interview many people). Should I take risk to show what I have or it is better to play a conservative game?
 
I would not bring anything to the interview and I would not offer a writing sample/model/anything unless they ask. I would practice, practice, practice for the interview. I always spent time working on my story: where I'd been, where I was headed, and how this job fit perfectly into that picture.
 
agree, only give what they ask for.

For the growth assumptions, I probably wouldn't do a regression but I don't do a ton of forecasting since I cover financials. I would make a conservative estimate based on recent results and your opinion of business conditions and the company's prospects going forward. For credit analysis you usually want to err on the conservative side. And also use scenario analysis to stress test these assumptions. That's what I did in my interview for buy side credit research anyway. Whatever you do be able to defend it intelligently, and stick by it if challenged.
 
My advice is keep it simple. I'd look at long-term average growth rates and then be a little conservative as your base case, and then run some stresses.
 
Here is one more tip / talking point that just came to me regarding liquidity analysis. If you are looking at their uses and sources of funds, be sure to back outstanding CP out of their current availability under their revolvers and other credit facilities. CP facilities have to by fully backstopped by committed credit facilities, so when you look at total available funds you need to recognize that in the event of a liquidiy crisis the company won't be able to access short-term debt markets and the committed facilities will have to be used to retire outstanding CP.

Sort of a random point but one that credit anlaysts will like to see you familiar with.
 
You must log in or register to reply here.
Back
Top