101 Concepts for the Level I Exam

Concept 86: Four Cs (Capacity, Collateral, Covenants, and Character) of Traditional Credit Analysis

The components of traditional credit analysis are known as the 4 Cs:

  • Capacity: The ability of the borrower to make interest and principal payments on time. Capacity to repay is assessed by examining: Industry structure à industry fundamentals àcompany fundamentals àcompetitive position.
  • Collateral: The quality and value of the assets pledged as collateral against the debt.
  • Covenants: Provisions in a bond indenture that protect the lenders by requiring the borrower to perform some actions (affirmative covenants) or avoid some actions (negative covenants). Covenant analysis is especially important for high-yield bonds.
  • Character: Refers to the quality of the management, strategy, quality of earnings and past treatment of bondholders.