The bases of a credit rating
Important factors that will cause a credit rating agency to give a high rating to a company or country.
By: Ximena Peinado
As we already know, each of the international credit rating agencies has a specific method for issuing the results of each country, organization and company that they are studying. It is common for a rating agency to have some additional or missing criteria to, for example, its competitor Moodys. However, there are certain criteria that for all agencies are of vital importance to show the credit quality of a moral person.
The final judgment is based on the information obtained from the issuer, including its audited financial statements, strategic objectives and investor presentations. Other information reviewed includes peer group data, industry and regulatory analysis, and forward-looking assumptions about the issuer or its industry.
Already with the necessary information, the agencies carry out the exhaustive analysis of the key rating factors, financial reports, information from the private and public sector and the performance of the company over long periods.
11 key classification factors
1. Risk profile of the sector
The agencies determine the classification depending on the context of the industry to which the studied organization belongs. Industries that are declining, highly competitive, or cyclical are inevitably riskier than stable industries with few competitors, little domination at the national level, and predictable levels of demand.
2. Country risk
The country risk associated with an issuer’s operations has two different impacts on the credit profile: its operating environment and its transfer and convertibility risk (also known as “T&C Risk” or “Country Ceiling”).
3. Corporate governance
Agencies generally focus on the following characteristics of government: governance structure, group structure, and financial transparency. The purpose of evaluating the governance and structure of the group is to assess whether the way in which power is distributed within the company prevents problems. The elements to consider are, in particular, the presence of effective controls to ensure sound policies, an effective and independent board of directors, management compensation, transactions with related parties, integrity of the accounting and auditing process, concentration of ownership. and key man risk.
4. Transfer and convertibility risk
They are related to the probability that a sovereign issuer will default on its debt and are not an indicator of the general financial health of the economy, much less of an industrial sector within a given country.
5. Management strategy
It is considered in terms of its ability to create a healthy business mix, where the efficiency of the operation is maintained and the company’s position in the market is strengthened. Financial behavior over time is a useful piece of the puzzle to know if there is a real ability to execute operational and strategic strategies.
6. Business profile
Several factors indicate an issuer’s ability to withstand competitive pressures, which may include, for example, its position in key markets, its level of product dominance, and its ability to influence price. Maintaining a high level of operational performance often depends on product diversity, geographic distribution of sales, diversification of major customers and suppliers, and comparative cost position.
7. Financial profile
The quantitative aspect of corporate ratings focuses on the financial profile of an issuer and its ability to meet its obligations from a combination of internal and external resources. The sustainability of these credit protection measures is evaluated over a period of time, using both actual historical numbers and forecasts to determine an issuer’s debt service and financing capacity.
8. Crisis and stress management
The rating agencies assess the risks of the rated entities and structures under a variety of scenarios to ensure stability in their ratings. The scenarios are developed based on the potential risks that an issuer may encounter through ratings and stress cases.
9. Cash flow and profitability
Earnings and cash flow are key elements in the financial health of an issuer, as they affect the maintenance of operating facilities, internal growth and expansion, access to capital and the ability to withstand recessions in the environment. business. While earnings form the basis of cash flow, adjustments must be made for items such as non-cash provisions and contingency reserves, asset amortizations with no cash effect, and one-time charges. The agencies’ analysis focuses on the stability of earnings and ongoing cash flows of the issuer’s major business lines.
10. Financial structure
The financial structure of the issuer is analyzed to determine its level of independence from external financing. Several factors are considered in assessing the credit implications of an issuer’s financial leverage, including the nature of its business environment and major cash flows from operations, as industries differ significantly in their need for capital and their ability to support high levels of debt, financial leverage in an issuer’s capital structure is considered relative to industry standards.
11. Financial flexibility
Financial flexibility allows an issuer to meet its debt service obligations and manage periods of volatility without eroding credit quality. The more conservatively capitalized an issuer, the greater its financial flexibility. In general, a commitment to keeping debt within a certain range enables an issuer to better cope with unexpected events. Other factors that contribute to financial flexibility are the ability to review capital spending plans, strong banking relationships, the degree of access to a variety of debt and equity markets (domestic or foreign), and committed and long-term bank lines. term.
There are other additional factors that are not mentioned, however these 12 are the basis to be able to give an adequate rating to whoever requests it. Once with the necessary information, the rating committee or the Council will proceed and determine the final rating.
Keep learning with PR1ME Capital
Previously we discovered the origin, evaluation procedures and competitive differences of the Risk Rating Agencies and we understood that for companies, having a good rating is vital in order to find new investors who want to give a part of their capital to the development of the organization.
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