What is a Credit Rating
Content
W H AT I S A C R E D I T R ATI N G ?
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.
T H E R ATI N G P R O C E S S
B E N E F I T S AN D I M P O R TAN C E O F A C R E D I T R ATI N G
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.
P H I L R ATI N G S ' M E T H O D O L O G Y
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.
BUSINESS RISK
Economic risk
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
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
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
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.
FINANCIAL RISK
Earnings Generation
Key considerations are earnings levels, trends, and stability, as well as the fundamental, core, longterm 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.
Capital Structure/Leverage
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
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:
the company's ability to access various funding markets and raise capital from the public or
private sources, generally, and in a difficult environment
the extent of internal reserves available to cover unexpected losses
the franchise value of specific businesses
assets where the market value is significantly greater then the book value
ability to sell; and
the likelihood of support from private stockholders or the government
Asset Quality
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.
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.
T H E R ATI N G P R O C E S S
B E N E F I T S AN D I M P O R TAN C E O F A C R E D I T R ATI N G
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.
P H I L R ATI N G S ' M E T H O D O L O G Y
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.
BUSINESS RISK
Economic risk
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
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
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
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.
FINANCIAL RISK
Earnings Generation
Key considerations are earnings levels, trends, and stability, as well as the fundamental, core, longterm 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.
Capital Structure/Leverage
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
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:
the company's ability to access various funding markets and raise capital from the public or
private sources, generally, and in a difficult environment
the extent of internal reserves available to cover unexpected losses
the franchise value of specific businesses
assets where the market value is significantly greater then the book value
ability to sell; and
the likelihood of support from private stockholders or the government
Asset Quality
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.
