Tag Archives: Risk Rating Agencies evaluation

The bases of a credit rating

Los sustentos de una calificacion crediticia The bases of a credit rating PR1ME Capital 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. 

What will we talk about next week? Don’t miss our next content from  PR1ME Capital.


The Risk Rating Agencies: their origin, their evaluation procedures and their competitive differences

Calificadoras de Riesgo origen evaluacion diferencias competitivas The Risk Rating Agencies origin evaluation procedures competitive differences PR1ME Capital The Risk Rating Agencies: their origin, their evaluation procedures and their competitive differences

By:  Ximena Peinado Fabregat 

Just as a grade is given to an exam or to a student’s academic performance, countries, financial institutions and companies are also assigned a classification depending on their ability and willingness to pay the debt issuer.

These companies allow their users to be fully up-to-date in making investment decisions, thus generally saving time and money. For companies, having a good rating is vital to be able to find new investors who want to give a part of their capital to the development of the organization.

Their origin

The classification of securities had its origin at the end of the 19th century in the United States when a credit information system was created and used by investors and financial institutions in the country. At the beginning of the 20th century, with the development of the railway industry and the bonds that financed it, rating companies were created to study the quality of these instruments.

Outside the United States, Canada was the first foreign country to create ‘Canadian Bond Rating Services’ in Montreal in 1972. Then Japan with ‘Nikoi Kensai Shimbum’ in 1979; and in Europe it was consolidated with ‘Renta 4 S.A’.  in Spain. In Latin America, the first securities rating agency was authorized in Chile in 1988 and it was the Humphrey’s Risk Rating Agency Ltda.

However, the United States Securities and Exchange Commission (the government agency dedicated to protecting investors) only recognizes 9 rating agencies in the world: A.M. Best Rating Services Inc, DBRS Inc, Egan-Jones Ratings Company, Fitch Ratings Inc, HR Ratings de México S.A. de C.V., Japan Credit Rating Agency Ltd, Kroll Bond Rating Agency Inc, Moody’s Investors Service Inc and Standard & Poor’s Global Ratings.

Of these nine, the best known are Fitch Ratings, Moody’s and S&P.

We will mention Standard & Poor ‘s first for being the oldest. It was founded in 1860 by Henry Poor, who made a record of all the financing of the railroads and canals in the United States as a kind of guide for interested investors. The “Standard” part was added to the name when Poor joined the Bureau of Standard Statistics (which examined the finances of companies that were not related to the railroad industry) in the 1940s.

Moodys was established in 1909 by John Moody, who published an analysis of railway finance, rating the value of its stocks and bonds.

Third, Fitch Ratings was founded by John Fitch in 1913. Each of these rating agencies has its own procedures and ratings.

Rating System, which factors are relevant to it?

The Risk Rating Agencies their origin, their evaluation procedures and their competitive differences

Fortunately, global credit agencies have recently started to publish their rating criteria to justify rating changes that countries or companies have.

The analysis of each company or country is decided by a committee of between five and eight people, according to S&P. The rating agencies base their evaluation on a variety of financial and commercial attributes that could influence repayment, some of which may depend on the issuer of the bond (that is, who gives the loan).

The reasons for rating adjustments vary and can be broadly related to general changes in the economy or business environment, or more narrowly focused on circumstances that affect a specific industry, entity or individual debt issue.

The process of obtaining a credit rating on a particular issue generally begins with a request from the company that has expressed interest in obtaining a rating prior to the issuance of a bond; then a series of meetings are scheduled between the company and the rating agency to acquire the necessary information to be able to give it a fair rating.

In general, a company’s growth potential, its capital requirements, the degree of competition in its market and industrial environment, its productive diversification, and ownership structure are included as business risks. Subjective judgments often play an important role in this part of the rating process. The ability of a company to meet its debt can be clearly seen by rating agencies from its income statements, balance sheets and indicative financial performance indices.

The second most important financial indicator is whether a company has spread too much: this can be measured through the measure of its debt leverage.

The third most important financial indicator measures the profitability and efficiency of the company.

Finally, other financial risks are also considered, such as whether the company can withstand economic cycles and financial flexibility in a stress scenario. However, these stress tests are not based on actual forecasts of the future performance of the company. Rather, they are generally based on the company’s past performance as revealed by its 3-5 year financial statements.

Something that can also influence the rating is the country where they are located and whether areas that belong to the OECD are located, since country risks (represented by sovereign risks) are closely related to company-level risks. It is understood that, to some extent, such a close relationship between company ratings and sovereign ratings is justifiable.

Despite having a strict procedure, rating agencies have been the subject of much criticism over the years. Well-known independent media such as “The Conversation” have expressed the opinion that many share: rating agencies can be more damaging than contributors to the economic system. Like any argument, it has its reason behind it.

But you can only know that reason if you follow our networks and continue reading the new series of Rating agencies that Pr1me Capital has for you.

Source: Academia, BBC, Moody’s analytics, ‘How do Global Credit Rating Agencies Rate Firms from Developing Countries?’ by Li-Gang Liu and Giovanni Ferri