casemark/drafting-credit-memos

Drafting Credit Memos

When To Use

• Recommending a new bond purchase, loan participation, or credit facility for a portfolio or credit committee
• Documenting the rationale for increasing, reducing, or maintaining an existing credit exposure
• Presenting a credit opinion on a new issuer or counterparty for internal approval
• Refreshing an annual or semi-annual credit review on a held position
• Supporting a rating change recommendation (upgrade, downgrade, or watch placement)

Inputs To Gather

• Issuer/borrower identity: Legal name, ticker, CUSIP/ISIN, sector classification (GICS or internal taxonomy)
• Financial statements: Minimum three years of audited financials plus latest interim period; confirm GAAP vs. IFRS basis
• Capital structure detail: Debt schedule with maturities, coupon rates, seniority, covenants, and guarantor structure
• Market data: Current spread levels (OAS, Z-spread, or CDS), comparable issuer spreads, recent price action
• Rating agency views: Moody's/S&P/Fitch ratings, outlooks, and most recent rating action commentary
• Industry context: Sector fundamentals, competitive positioning, key risk drivers (commodity exposure, regulatory, cyclicality)
• Transaction specifics (if new issue): Proposed terms, use of proceeds, pricing guidance, syndicate structure
• Portfolio context: Current exposure, concentration limits, mandate guidelines, and any investment policy constraints [VERIFY]

Workflow

1. Confirm scope and recommendation direction

   • Clarify whether memo is for new investment, annual review, or event-driven reassessment
   • Identify the target audience (credit committee, portfolio manager, trading desk)
   • Determine recommendation type: Buy / Hold / Sell / Avoid, with size and tenor guidance

2. Build the issuer profile

   • Summarize business description: revenue mix, geographic footprint, market position
   • Identify the 3-5 key credit drivers (e.g., leverage trajectory, margin stability, asset quality, liquidity, management track record)
   • Note ownership structure and any parent/subsidiary support or structural subordination

3. Conduct financial analysis

   • Compute and trend core credit metrics: Debt/EBITDA, Interest Coverage (EBITDA/Interest), FFO/Debt, FCF generation
   • Adjust for off-balance-sheet obligations, operating leases (if pre-IFRS 16 comparisons needed), and non-recurring items — flag each adjustment explicitly
   • Stress-test metrics under a downside scenario (revenue decline of X%, margin compression of Y bps) and identify the break-even deterioration level
   • Compare metrics against rating agency medians for the assigned rating category [VERIFY agency-specific methodology]

4. Assess capital structure and recovery

   • Map the priority-of-claims waterfall: secured → senior unsecured → subordinated → equity
   • Estimate recovery prospects by tranche using enterprise value or asset-based approach
   • Flag covenant protections or weaknesses (incurrence vs. maintenance tests, restricted payments baskets, change-of-control provisions)

5. Evaluate relative value

   • Compare spread to sector peers at similar rating, maturity, and seniority
   • Assess whether current spread compensates for identified risks vs. comparables
   • Note any technical factors: index eligibility, supply/demand dynamics, event catalysts

6. Formulate recommendation

   • State recommendation clearly: action (Buy/Hold/Sell), notional size, target spread or price, and investment horizon
   • Summarize supporting thesis in 2-3 sentences
   • List key risks to the recommendation and monitoring triggers (e.g., leverage exceeding 4.5x, downgrade to below-IG)

7. Draft the memo

   • Use the output structure below
   • Write in direct, declarative style — lead each section with the conclusion, then support with data
   • Mark any unverified data points with [VERIFY]

Output

Structure the credit memo with these sections:

1. Executive Summary — Recommendation, issuer name, rating, key metric snapshot, and 2-3 sentence thesis
2. Issuer Overview — Business description, revenue breakdown, competitive position, ownership
3. Industry & Macro Context — Sector trends, regulatory environment, cyclical positioning
4. Financial Analysis — Historical and projected metrics table, adjustment notes, stress scenario results
5. Capital Structure & Recovery — Debt maturity profile, priority waterfall, covenant summary
6. Relative Value — Spread comparison table vs. peers, technical factors
7. Risk Factors — Ranked list of 3-5 material risks with severity assessment
8. Recommendation & Monitoring — Actionable conclusion, position sizing rationale, triggers for review
9. Appendix — Detailed financial tables, source list, rating history

Quality Checks

• All credit metrics tie back to sourced financials; no computed ratio is left without its inputs shown
• Recommendation is internally consistent — risk factors do not contradict the thesis without explicit acknowledgment
• Covenant analysis references actual indenture or credit agreement language, not summaries [VERIFY document availability]
• Peer comparison uses issuers of genuinely comparable credit profile (same sector, similar rating band, comparable maturity)
• Stress scenario assumptions are stated and plausible, not arbitrary round-number shocks
• Spread and pricing data carry timestamps — stale data is flagged
• Portfolio limit compliance is confirmed against current mandate or IPS guidelines [VERIFY specific fund constraints]
• No rating agency content is reproduced verbatim beyond fair-use thresholds; paraphrase and cite