Case 082Credit analysis and ratingsWarm up
Three borrowers ask for similar loans: a steady dairy at 2.5x, a fast-growing cold chain at 3.5x with one big contract, and a seasonal resort at 3.0x. What do you look for, and which do you lend to first?
1The situation
A private credit fund is offered three five-year senior loans, each to a company with EBITDA of about Rs 100 crore, all priced near 9%.
Pushkala Dairy wants Rs 250 crore, 2.5x EBITDA. Its margins have stayed between 9% and 11% for a decade, it sells to thousands of retailers and no customer is more than 8% of sales, and it grows about 6% a year. Trivikram Cold Chain wants Rs 350 crore, 3.5x. It grows 30% a year and earns margins of 18% to 24%, but one food delivery company provides 45% of its revenue under a contract that renews in two years. Sanvika Resorts wants Rs 300 crore, 3.0x. It earns most of its profit in two holiday seasons and its margin has ranged from 12% to 26%.
2Your task
What does a lender look for in a company, how do the three compare on it, and which loan would you make first?
Quick check
Which loan would a senior lender usually make first?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Lend to Pushkala Dairy first: its leverage is lowest and, more to the point, barely moves in a bad year. A lender looks for cash flow that is stable, diversified and able to carry the debt in the downside, because its return is capped at the coupon. Pushkala's worst year takes leverage to 2.8x. Losing its one contract takes Trivikram to 7.0x, and a bad season takes Sanvika to 4.6x.
Step 1What does a lender look for in a company?
Start from how a lender gets paid. The best a senior lender can do is get its money back with interest, so it looks for the business most likely to keep paying in a bad year, not the one most likely to boom in a good one. In practice that means four things: cash flow that is stable across years, customers spread thin enough that no single loss is fatal, leverage low enough to survive a downturn, and a business that turns profit into cash. A landlord choosing between tenants prefers a government office on a long lease to a fast-growing start-up paying the same rent.
| Borrower | Debt / EBITDA | EBITDA / interest | Margin range | Largest customer | Growth |
|---|---|---|---|---|---|
| Pushkala Dairy | 2.5x | 4.4x | 9% to 11% | 8% | 6% |
| Trivikram Cold Chain | 3.5x | 3.2x | 18% to 24% | 45% | 30% |
| Sanvika Resorts | 3.0x | 3.7x | 12% to 26% | none | 10% |
Step 2How do the three look in their own bad year?
Give each borrower the stress that fits its business, not one uniform haircut. Pushkala's worst year in the decade cut EBITDA about 10%. Trivikram's real risk is the contract: losing it would take out about half its EBITDA, because the trucks and warehouses stay. Sanvika's is a weak season, about 35% off. On those stresses leverage goes to 2.78x for Pushkala, 7.0x for Trivikram and 4.62x for Sanvika, and interest cover to 4.0x, 1.6x and 2.4x. The ranking on today's numbers and on stressed numbers is the same here, but the gaps are far wider once stressed.
Step 3Would you lend to the other two at all?
Possibly, on different terms. Trivikram is a contract-renewal bet more than a business risk, so lend less, around 2.5x, or wait until the contract is renewed, and tie the loan to it with a covenant. Sanvika can work with a structure that fits the seasons: a cash reserve built in the good quarters, covenants tested on a rolling twelve months, and repayments timed after the peak. Close by naming the limitation: all three stresses are judgements from each company's history, and a lender's real work is checking those histories hold.
Where candidates lose it
Candidates pick Trivikram because 30% growth sounds like quality. Growth is the shareholder's reward; the lender is paid the same 9% whether Trivikram doubles or not, and bears the loss if the contract goes.
The second miss is comparing only today's leverage. The spread between 2.5x and 3.5x understates the difference; the stressed figures of under 3x against 7x are what separate the credits.
What the interviewer asks next
- What covenant would you put on Trivikram's loan to protect against the contract risk?
- How would you set Sanvika's repayment dates around its seasons?
- Would a subordinated lender with equity warrants choose differently, and why?
Asked at HPS Investment Partners, Credit, New York, 2021 (Wall Street Oasis): very focused on the questions "where would you invest in the capital structure?" and "what do you think we look for in companies?"
Company names and figures are illustrative.