A credit rating serves as an unbiased, independent evaluation of the creditworthiness of a borrower. It is a grading system which provides an objective measure of credit quality, particularly the ability to pay the financial obligations upon maturity. A credit rating considers both the business and the financial risks.
The highest ratings assigned by PhilRatings for short-term and long-term issues are PRS 1 and PRS Aaa, respectively, while the lowest are PRS 6 and PRS C.
Since a credit rating is a third party opinion on creditworthiness, it promotes transparency and greater disclosure in the capital market. It supplements an internal evaluation,particularly those done by the regulators and inventors. A credit rating serves as a focused tool to differentiate credit quality. Aside from the internal rating, it is also allows for continuous monitoring which can serve as an update on company performance and gives a current snapshot on its credit standing.
Having a credit rating is equivalent to the issuer announcing that both the issue and the issuers have been subjected to, and can withstand scrutiny. Generally,having a credit rating lowers the interest rates for the issuer.
GENERAL CREDIT RATING METHODOLOGY
The rating process involves no black box, no formulae, and no standard group of ratios that set minimum requirements for each rating category. The credit analysis includes a wide range of both quantitative and qualitative factors. The weight given to each in the analysis of a particular company varies, depending on the economies, laws and customs of the countries in which it operates, accounting practices, the competitive situation, and the regulatory environment. When analyzing corporate issuers, two major areas are addressed: business risk and financial risk. Both cover a range of broad categories. The following factors provide some flavor as to the issues analyzed and evaluated, but these are by no means exhaustive.
PhilRatings reviews the risks arising from the over-all economy in which the company operates and gauges how the dynamics of the economy affect the operations of the particular company. Accordingly, the economy's strength, diversity, and volatility, as well as the government's ability to manage the economy through boom and recessionary periods, are evaluated. The analysis particularly focuses on the size, structure and growth prospects of the economy, the extent to which it is open to external markets, and potential vulnerabilities.
Industry risk covers many elements, and for any industry, there will be both positive and negative factors. While it is difficult to say which factors will prevail, PhilRatings gauges the dynamics of the industry and the extent to which those dynamics lead to more or less risk from the investor's point of view. Accordingly, the analysis covers the structure of the industry, the dynamics of competition, the regulatory and legislative framework, and the government's philosophy with respect to the industry - i.e., market-oriented or interventionist.
Market position analysis involves an assessment of the benefits or weaknesses stemming from a company's market position (e.g., pricing power, quality of business, etc.). This involves an evaluation of the company's market share in key business lines, and the real advantages stemming from that market position, together with a review of the extent of competition in, and vulnerability of, the market position.
Business diversification addresses the diversity of a company's products, business lines and customer base, and the benefits or weaknesses (such as geographic or business concentrations) that flow from them.
Management and Strategy
Managerial effectiveness and credibility are assessed through an evaluation of the company's past performance and of the appropriateness of management's strategies within a changing environment. Consideration is also given to the organizational structure and the extent to which it enhances managerial efficiency, the quality and depth of both management and the planning process (both financial and strategic). The analysis normally involves a comparison of past performance to budget or plan.
Key considerations are earnings levels, trends, and stability, as well as the fundamental, core, long-term earnings power of the company. The analysis covers operating margins, diversity and sustainability of income sources, cost structure, and the earnings outlook. The company's ability to cover interest and other fixed charges is also considered.
Cash Flow and Liquidity
Cash flow and liquidity analysis involves an evaluation of the company's sources of funds and its adequacy to meet debt service requirements. In assessing cash flow adequacy, the company's future funding needs, such as for expansion of production facilities and acquisition, are also considered.
Key considerations are the debt and equity mix, as well as the maturity profile of existing indebtedness. The types of equity capital utilized are assessed, such as preferred shares that may be redeemable and thus may constitute a future need for refinancing, and appraisal increment in property which may be dissipated if asset values decline. In assessing leverage, off-balance sheet items are also considered, such as operating leases, guarantees to other companies, and contingent liabilities.
Financial flexibility is a summation of all the preceding factors, since it is an evaluation of a company's ability to meet unexpected demands on funds. Factors considered include:
Credit risk across the entire spectrum of the institution's activities is evaluated (including receivables, marketable securities, equity investments, on- and off-balance sheet counterparty exposures, etc.) This involves an analysis of the structure of the balance sheet and the maturity profile of the asset portfolio. Concentrations of credit and investment risk also are considered, along with problem loans and provisioning policy.