Conducting Institutional Credit Analysis

---
name: conducting-institutional-credit-analysis
description: Structures credit underwriting with financial ratio analysis, cash flow quality assessment, and downside scenario modeling. Use when underwriting credit, analyzing borrower quality, or writing credit opinions.
tags:
  - process
  - credit-and-institutional-lending
  - credit
metadata:
  author: casemark
  practice_areas:
    - Credit Markets
    - Leveraged Lending
    - Direct Lending
  document_types:
    - Process Documentation
  skill_modes:
    - Process Management
---
# Conducting Institutional Credit Analysis

Structures credit underwriting with financial ratio analysis, cash flow quality assessment, and downside scenario modeling for leveraged lending, direct lending, and broadly syndicated credit facilities.

## When To Use

- Underwriting a new term loan, revolving credit facility, or unitranche facility
- Evaluating borrower creditworthiness for a credit committee memo or credit opinion
- Re-underwriting an existing position after a material event (amendment, waiver, earnings miss)
- Conducting annual or quarterly portfolio credit reviews
- Stress-testing cash flows under downside or recovery scenarios for deal screening

## Inputs To Gather

- **Financial statements**: Minimum 3 years of audited financials plus trailing LTM; interim quarterly statements if available
- **Company-prepared adjustments**: Management EBITDA add-backs, pro forma adjustments, and quality-of-earnings report (if available)
- **Debt schedule**: Full capital structure with maturities, pricing, covenants, and subordination/intercreditor terms
- **Industry data**: Sector benchmarks for leverage, margins, and cyclicality; comparable credit profiles
- **Deal documents**: Credit agreement (or draft term sheet), information memorandum, lender presentation
- **Third-party reports**: Rating agency reports, independent market studies, environmental/legal diligence summaries

## Workflow

1. **Map the capital structure**
   - Lay out all tranches: senior secured, second lien, mezzanine, holdco PIK, equity
   - Calculate total leverage, senior secured leverage, net leverage, and first-lien leverage multiples
   - Identify maturity profile, springing maturities, and refinancing walls
   - Note intercreditor dynamics and structural subordination risks

2. **Assess cash flow quality**
   - Recast EBITDA by evaluating each management add-back for reasonableness and recurrence
   - Distinguish between maintenance capex and growth capex; compute free cash flow (FCF) and unlevered FCF
   - Calculate cash conversion ratio (FCF / EBITDA) and assess working capital volatility
   - Flag revenue concentration (customer, product, geography), contract vs. recurring vs. transactional revenue mix
   - [VERIFY] Treatment of stock-based compensation, restructuring charges, and one-time items against lender-defined Consolidated EBITDA

3. **Build financial ratio profile**
   - Compute key ratios: Total Debt / EBITDA, Senior Secured Debt / EBITDA, Interest Coverage (EBITDA / Cash Interest), Fixed Charge Coverage, Debt / Total Capitalization
   - Benchmark ratios against sector medians and rating category thresholds (e.g., B2/B vs. B3/CCC)
   - Trend ratios over LTM quarters to identify trajectory (improving, stable, deteriorating)
   - [VERIFY] Covenant-defined calculation methodology vs. GAAP-based ratios — use credit agreement definitions where available

4. **Model downside scenarios**
   - **Base case**: Management or consensus projections with independent revenue/margin assumptions
   - **Downside case**: Revenue decline of 10–20% (or sector-appropriate stress); margin compression reflecting operating leverage and cost stickiness
   - **Severe/recovery case**: Recessionary scenario calibrated to the worst historical period for the sector; test whether the borrower can service debt and maintain liquidity
   - In each scenario, track covenant headroom, liquidity runway (months of cash + revolver availability), and whether amortization/mandatory prepayments can be met
   - Estimate recovery value under a distressed scenario using enterprise value waterfall (EV / debt stack)

5. **Evaluate qualitative credit factors**
   - Management track record, sponsor quality (if PE-backed), and governance structure
   - Industry positioning: barriers to entry, competitive moat, regulatory risk, secular tailwinds/headwinds
   - ESG and litigation exposures that could impair cash flow or enterprise value
   - Assess event risk: M&A strategy, dividend recapitalization history, permitted investment baskets

6. **Formulate credit opinion**
   - Assign an internal credit rating or risk score with supporting rationale
   - State the investment thesis in 2–3 sentences: why the credit is acceptable (or not) at the proposed terms
   - Identify the top 3–5 credit risks and corresponding mitigants
   - Recommend approval, conditional approval (with structural enhancements), or decline

## Output

The deliverable is a structured credit analysis containing:

- **Executive summary**: Borrower overview, transaction summary, proposed terms, and recommendation
- **Capital structure table**: All tranches with amounts, rates, maturities, leverage multiples, and key covenant thresholds
- **Adjusted EBITDA bridge**: Walk from reported EBITDA to underwritten EBITDA with line-by-line add-back commentary
- **Financial ratio dashboard**: Key credit metrics with historical trend, projections, and covenant levels
- **Scenario summary table**: Base, downside, and severe case outputs showing leverage, coverage, and liquidity by period
- **Risk matrix**: Top risks ranked by probability and severity with identified mitigants
- **Credit recommendation**: Internal rating, approval conditions (if any), and monitoring triggers

## Quality Checks

- Confirm all add-backs tie to supporting documentation or are flagged with [VERIFY]
- Validate that leverage and coverage ratios use the correct denominator (credit agreement–defined EBITDA vs. GAAP EBITDA)
- Ensure downside scenarios reflect realistic operating leverage — costs should not flex linearly with revenue without justification
- Verify maturity dates, mandatory amortization schedules, and excess cash flow sweep percentages against the credit agreement
- Cross-check recovery analysis assumptions (exit multiple, asset values) against recent comparable transactions
- Confirm the credit opinion addresses all material risks identified during analysis — no orphaned risk without a mitigant or explicit acceptance
- [VERIFY] Regulatory and jurisdictional considerations: leveraged lending guidance thresholds (e.g., 6.0x total leverage), risk retention rules, and applicable banking regulations