Much of the credit research in Europe today looks like equity analysis with a little event risk evaluation tacked on. It has a quantitative basis: a dozen or so standard cash-flow ratios and some balance-sheet analysis are used to analyze a company's ability to service its debt. This process differs little from that employed by the rating agencies, though it will probably be done more frequently. On top of that, analysts put their qualitative analysis of market and sector conditions - the impact on a company's business of a proposed acquisition or new regulations, say - and come up with a forecast of changes in a bond's spread. Credit analysts are happy to admit the similarities with equity analysis. They say it's not rocket science.
But there is rocket science in credit and default risk analysis and the scientist is San Francisco-based KMV Corporation. Its models track credit on a daily basis; they predicted the Asian crisis; they are used as trading indicators by fixed-income investors; they are used to measure portfolio credit risks by banks trying to allocate capital accurately in a Raroc (risk-adjusted return on capital) environment; and they are used to structure CLOs (collateralized loan obligations) and credit-linked notes by some of the world's most sophisticated institutions.