Equity analysis asks what a business could become. Credit analysis asks a narrower, harder question: will this borrower pay, and if not, what is left?
The narrower question has a narrower set of answers, which makes credit work more tractable — and less forgiving. An equity can recover from a bad decision. A default is final for the bondholder.
The first question: capacity to pay
The starting point is whether the cash flows cover the obligations. Three measures carry most of the weight:
- Interest coverage — operating earnings relative to interest expense. How many times over can the company service its debt from current operations?
- Leverage — total debt relative to earnings or to capital. How much is owed relative to what the business generates?
- Free cash flow — cash remaining after running and maintaining the business. A company can report profit and still not generate cash to service debt.
Each is a ratio, and each can be flattered. The relevant question is always whether the number is stable, cyclical, or deteriorating.
The second: willingness and structure
Capacity is not sufficient. A borrower with the means to pay can still choose not to, or be prevented from doing so by the terms of other obligations.
- What is the debt's rank? A secured bond has a claim on specific assets; a subordinated bond stands behind more senior claims. In a restructuring, this difference is most of the outcome.
- Who else is owed? Bank facilities and trade creditors often sit ahead of bondholders. A company that looks moderately levered on its bond debt alone may be heavily encumbered once all claims are counted.
- What do the covenants do? Covenants are the lender's protection: limits on further borrowing, requirements to maintain ratios, restrictions on asset sales or payments to shareholders. Loose covenants mean the position can deteriorate before the holder has any right to act.
- Can assets be moved out of reach? The answer depends on jurisdiction and structure, and it has decided many recoveries.
The third: what is left if it goes wrong
Recovery is where bond analysis is genuinely different from equity analysis — the question is not whether the value grows but what the claims are worth.
Working through it requires estimates of:
- The enterprise value in distress, which is usually well below the going-concern value.
- The claims ahead of the position, in order of seniority.
- The costs of the process, which are significant and senior.
- The time to resolution, which can be years, during which the capital is unproductive.
A high yield with low expected recovery may be worse than a lower yield with strong seniority. The comparison that matters is yield against expected loss, not yield alone.
What actually causes defaults
The proximate cause is rarely a single bad year. More often it is:
- Refinancing risk — debt maturing at a moment when the market will not lend. A solvent company with a maturity wall and no access to funding defaults.
- Liquidity running out — an inability to meet payments as they fall due, which is a different condition from insolvency.
- A covenant breach triggering acceleration, which converts a manageable problem into an immediate one.
- Contagion through a group structure, where a weak subsidiary and cross-default provisions pull stronger entities down.
Notice how many of these are about timing rather than creditworthiness in the abstract. A borrower who cannot roll their debt is in difficulty regardless of how good the business is.
The consequences for a portfolio
- Diversify by issuer. Concentration in credit is a position that a default decides.
- Watch the maturity profile across the portfolio, not only per issuer. A cluster of maturities in an unfavourable year is a portfolio-level risk.
- Price the illiquidity. Corporate bonds trade far less than equities, and the quoted price is not always one at which size could transact — particularly in stress.
- Consider the correlation between credit risk and equity risk. In a downturn, the same underlying weakness hits both the bonds and the shares. It is not automatically diversification.
Eonvera's fixed-income research forms part of the same cross-asset framework as equities, commodities and digital assets, with independent risk oversight of concentration, liquidity and counterparty exposure.