Credit & Fixed Income
Credit is governed by defined terms, not GAAP. A credit-agreement leverage ratio, a covenant EBITDA, a yield to worst, a subordination waterfall, each is a contractual or structural construct that a model trained on general financial text tends to replace with its nearest GAAP or textbook cousin. The substitution is plausible, fluent, and wrong in exactly the place that determines compliance.
Covenant interpretation
MechanismCredit-agreement leverage uses a defined-term numerator — often net of cash up to a cap, inclusive of certain guarantees — that is not GAAP total debt.
ConsequenceThe headroom calculation is wrong: a compliant borrower can read as in breach, and the reverse.
MechanismCovenant EBITDA permits defined add-backs — synergies, one-time items — frequently subject to caps and look-forward limits; it is a contractual construct, not GAAP.
ConsequenceMisstates every leverage and coverage ratio in the agreement.
Bond pricing & yield
MechanismFor a callable bond trading above the call price, yield to worst — often yield to call — is the governing measure.
ConsequenceOverstates yield and misranks relative value.
MechanismBonds quote on clean price but settle on dirty price, which adds accrued interest.
ConsequenceMisstates cash proceeds by the accrued amount.
Leveraged loans
MechanismLeveraged loans are typically callable at par after a short soft-call period and refinance well inside maturity.
ConsequenceOverstates spread duration and carry.
MechanismOriginal-issue discount is amortized into yield over expected life, not received as a cash coupon.
ConsequenceMisstates running yield and total return.
Leverage & coverage metrics
MechanismOnly cash available to service debt should net against debt; restricted or trapped cash should not.
ConsequenceOverstates deleveraging capacity.
MechanismPost-IFRS-16, whether lease liabilities count as debt depends on the agreement's defined terms.
ConsequenceMisstates leverage by the capitalized lease.
Structured & securitized
MechanismStructured credit absorbs losses bottom-up; senior tranches are protected until junior support is exhausted.
ConsequenceMisprices every tranche and the implied attachment points.
MechanismCash-flow waterfalls switch between sequential and pro-rata based on performance triggers.
ConsequenceMisstates the weighted-average life of each tranche.
The full bank contains additional items not published here. The taxonomy is a living artifact, derived from practice — versioned, dated, and never claimed to be exhaustive.