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.