Page 46 - FINAL CFA SLIDES DECEMBER 2018 DAY 15

Session Unit 16:
55. Fundamentals of Credit Analysis

Corporate structure. Many high-yield companies use a holding company structure. A parent

company receives dividends from the earnings of subsidiaries as its primary source of operating
income. Because of structural subordination, subsidiaries’ dividends paid upstream to a parent
company are subordinate to interest payments. These dividends can be insufficient to pay the debt

obligations of the parent, thus reducing the recovery rate for debt holders of the parent company.

Despite structural subordination, a parent company’s credit rating may be superior to subsidiaries’
ratings because the parent can benefit from having access to multiple cash flows from diverse
subsidiaries. tanties

Some complex corporate structures have intermediate holding companies that carry their own debt

and do not own 100% of their subsidiaries’ stock. These companies are typically a result of mergers,
acquisitions, or leveraged buyouts.

Default of one subsidiary may not necessarily result in cross default. Analysts need to scrutinize
bonds’ indentures and other legal documents to fully understand the impact of complex corporate

structures. To analyze these companies, analysts should calculate leverage ratios at each level of
debt issuance and on a consolidated basis.