Corporate Workshop - Presentation

8/6/2019 Corporate Workshop - Presentation

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How does Moody's Assign CorporateRatings?

DAVID STAPLES, MANAGING DIRECTOR, EMEA CORPORATESSOUMMO MUKHERJEE, VP SENIOR ANALYST EMEA CORPORATES


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2South African Corporate Ratings

Overview of Corporate FinanceAnalysis1


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Key rating drivers

Business Risk Profile Product diversification

Geographic diversification

Customer base and supplier exposure

Control on costs and revenues drivers

Exposure to volatile markets

Industry analysis Key trend in the industry

Macroeconomic scenarios

Competitive position and market share trend

Political and regulatory environment

Cyclical vs. stable demand

Strategy and Management

Growth prospective and assumptions

Financial policy and targets

Shareholders returns

Management team experience

Corporate governance

Financial Risk and Liquidity

Historic and forecasted ratios analysis

Peer group comparison

Liquidity profile and debt maturities

Structural consideration

Off-balance sheet liabilities and adjustments

Rating


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Meaning of rating

Rating

Issuer rating

For Investment Grade

Normally in line with debtinstruments ratings

Baseline CreditAssessment (BCA)

Used for GovernmentRelated issuers

One of the 4 core inputsalong with Support,Dependence and rating ofsupporting entity

Corporate Family Rating(CFR)

For Sub-IG

Normally in line withProbability of Default

Ratings (PDR) Used as a base for

notching of differentclasses of debt

Expected loss


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Aiding tools

Industry rating methodology

Overall assessment

Industry analysis

Analyst expertise

Industry outlook

Financials

Adjusted Financial ratios (MFM)

Liquidity Risk Assessment Peer group

Notching of debt instruments

Loss Given Default

Assessment of Management quality

Track record and ability to execute

Corporate Governance assessment

Government Related Issuer Methodology

Mix of qualitative and quantitative skills to judge soft and

hard data


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Global Scale National Scale- Long Term Rating National Scale- Short Term Rating

Aaa Aaa.za P-1.za

Aa2 Aaa.za P-1.za

Aa3 Aa1.za P-1.za

A1 Aa1.za/Aa2.za P-1.za

A3 Aa2.za/Aa3.za P-1.za

Baa1 Aa3.za/A1.za P-1.za/P-2.za

Baa2 A1.za/A2.za P-1.za/P-2.za

Baa3 A2.za/A3.za P-1.za/P-2.za

Ba1 A3.za/Baa1.za P-1.za/P-2.za

Ba2 Baa1.za/Baa2.za P-2.za/P-3.za

Ba3 Baa2.za/Baa3.za P-2.za/P-3.za

B1 Ba1.za/Ba2.za NP.za

B2 Ba2.za/Ba3.za NP.za

B3 Ba3.za/B1.za NP.za

Caa1 B2.za/B3.za/Caa1.za NP.za

Caa2 Caa1.za/Caa2.za NP.za

Caa3 Caa3.za NP.za

Ca Ca.za NP.za

Moodys South Africa national scale mapping

Independent opinion

National comparability

Issuer and Issuance ratings

Not globally comparable


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Financial Ratios and KeyAdjustments2


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Reasons for adjusting accounts

Improve comparability

US GAAP accounts IFRS accounts Convergence programme still has some way to go

Also, different treatments are permitted under IFRS for the same transactions in certainareas

Accountants couldnt agree on a single method

Better reflect underlying economic reality

We need a full and accurate picture of financial performance and position

Implies accounts are deficient in certain respects

Three biggest problem areas: Lease accounting

Pensions accounting

No global standard for the same transactions in certain areas (i.e. Treatment of R&Dcosts)


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Summary of adjustments typically made by Moodys

Off balance sheet leases are capitalised

Pension deficit is added to the debt

Product development costs are written off

Securitization proceeds are treated as financing when risk not fully transferred

Hybrid securities are reclassified according to a basket to reflect Moodys view of

their debt-like vs equity-like characteristics

Interest capitalised is reversed

One-off items are stripped out


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What is Debt?

Not as simple as it may seem, so we make Adjustments!

On Balance Sheet Debt, i.e. Borrowings We tend to focus on gross debt (i.e. excluding cash) but give some credit for

cash balances in excess of working cash

BUT ALSO

Leases

Pension obligations

Different rules for different GAAPs

Some other off-balance sheet obligations

Environmental

Legal

Put Options

Guarantees


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Which ratios do we focus on and why?

Operating Performance and Profitability Business model sustainability

Margins earnings divided by sales

Returns earnings divided by something

Leverage Financial structure sustainability

Debt to EBITDA (largely used but with some limitations)

Cash flow divided by debt

Interest Coverage Capability to sustain ongoing payments

Cash flow or earnings divided by Interest

Capitalisation

Debt divided by Capital (Debt plus Equity)

Debt divided by Equity

All ratios are adjusted according to our methodology


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Leverage - Which Ratios do we Look at?

Debt to EBITDA

EBITDA is not a good proxy for Cash

Largely used in financial documentation

Cash Flows to Debt Cash Flow from Operations (CFO) = Funds From operation +/- Working

Capital Changes

Retained Cash Flow (RCF) = FFO (before working capital) Dividends

Free Cash Flow (FCF) = CFO Dividends Capex


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How We Assess a CompanysLiquidity Profile3


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Liquidity A critical factor in recent crisis

Liquidity is crucial in todays environment

Difference between life and death

Liquidity crisis can emerge very quickly

Market liquidity

2001/2003 and 2007/2008 crisis

Re-pricing of risk may be costly even fatal for most leveraged issuers

Consequences on mostly cyclical issuers

Default increases lead to lack of confidence in the markets

Issuers performance

Covenant breach

Issuer specific rather than sector

Moodys uses LRA as a gauge for liquidity strength


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What is important to survive a liquidity crisis

Degree of preparation by management

Robust Contingency Plan

Degree of nimbleness in crisis management

Conviction by lenders that entity is viable

Proven business model

Soundness of operations

Capacity to control cash-burn

Manageable level of leverage

And ability to raise cash

Committed bank facilities that can be drawn

Cushion under covenants

Valuable assets that can be pledged/sold


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The LRA - Liquidity Risk Assessment

Internal External Assets / Back Door

Liquid assets

Cash, marketable

securities, accounts

receivable

Repatriation

Tax implications

Convertibility

Cash From Operations

Committed bank

facilities

Availability

Quality (facility

attributes: MAC,

covenants, maturity

date, triggers)

Quantity

Trade credit

Unencumbered assets

Divestitures

Product lines

Divisions

Sources

Uses

Operations, Working capital, Capital expenditures, Debt payments (P&I), Dividends,

Share repurchases, Contingencies


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Example of a Methodology: GlobalPackaged Goods Industry4


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Global Packaged Goods Industry Methodology Grid


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1. Scale and Diversification

Size matters as a driver of scale, lower fixed costs,marketing strength, diversification


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2. Franchise Strength and Growth Potential


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3. Distribution Environment and Pricing Flexibility

- For packaged goods companies exposure to private

labels is a negative in particular on some European

markets where private labels represent significant

market shares


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4. Cost Efficiency and Profitability

Operating margin is an indicator of efficiency,

profitability, competitive position


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4. Financial Strategy and Credit Metrics


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4. Financial Strategy and Credit Metrics (Contd)

Credit metrics measure the capacity of operations to generatesufficient cash to repay debt.

Our packaged goods methodology suggests a 40% weighting

for Credit metrics in the rating (45% including assessment of

financial policy)

Weak factors are often overweighted in the methodologies or

by rating committees

Ratings based on prospective credit metrics more thanhistorical ones


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Grid-Indicated Ratings as of July 2009


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Grid-Indicated Ratings as of July 2009 (contd)


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Grid summarizes main factors but is not the rating

Grid outcome is the weighted average of the various qualitative and quantitative

factors determined by the methodology

Rating committees may determine that some measures are mitigated by qualitative

factors

Other factors are not captured by the grid: liquidity, management quality, corporate

strategy, corporate governance, legal environment

in particular ratings may be shaded due to local operating conditions: ratings in

emerging markets are generally lower than calculated weighted average of the grid

The grid is published as a reflection of historical performance but ratings are primarily

forward-looking

Ratings aims at stability through the cycle


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Notching Framework:

How do we arrive at our guidelinesfor notching?

Notching Framework:

How do we arrive at our guidelinesfor notching?

5


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What is Notching?

Notching refers to the relative ratings assigned to different obligations of an economic unit.

Relative seniority and security of corporate obligations

We refer to two Moodys Special Comments:

Notching for Differences in Priority of Claims and Integration of the PreferredStock Rating Scale, November 2000

Summary Guidance for Notching Secured Bonds, Subordinated Bonds, andPreferred Stocks of Corporate Issuers, September 2001


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Notching Guidelines

Senior Secureddebt should be rated one-notch higher than unsecured debt.

Secured bank loansmay merit a rating two or more notches above senior unsecured debt.

Subordinated debtshould be rated one-notch lower than senior unsecured debt.

No distinction between Senior and Junior Sub Debt.

Wider notching differentials for issuers that carry corporate family rating (CFR) or seniorunsecured ratings of Ba3 or lower.


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CFG Notching Framework:

LGD Ratings

6


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Goal of LGD Framework & Model

Studies show that Family LGD rates are extremely difficult to forecast (Carey &

Gordy 2004)

Standard fundamental analysis provides little guidance for separating PD from

E[LGD]

A leverage ratio might offer information about both

However, some factors may help explain Family LGD

Industry, credit cycle/macroeconomic conditions, covenant considerations, and capital structure

LGD Framework is designed to provide robust estimates of family-wide and

obligation-specific recovery rates

LGD Model blends the expected liability structure at default with a model of

uncertainty to produce LGD estimates


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Using the Model: Estimate Liabilities at Default Resolution

Make adjustments to reported liabilities

Assume bank loans will be fully drawn

Evaluate adequacy of expected collateral coverage

Incorporate expected issuance and retirement of debt

Analyze non-debt obligations (trade credit, tort claims, pension obligations, etc.)

Establish priority of claim

Senior obligations will be paid in full before junior obligations receive anything

(absolute priority)


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Introduce Uncertainty An Example

Suppose a firm has $50 million in secured debt, $50 million in unsecured debt,

and $50 million in anticipated enterprise value at resolution

The expected family recovery rate (as well as the Family LGD Rate) is 50%

Without uncertainty, the recovery rate on secured debt would be 100% (LGD = 0%)and that for unsecured debt would be 0% (LGD = 100%)

With uncertainty (using a distribution with a mean of 50% and a standard deviation

of 20%), the expected recovery for secured debt will be 86% (LGD = 14%) and forunsecured debt, 14% (LGD = 86%)


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0%

2%

4%

6%

8%10%

12%

14%

5%

15%

25%

35%

45%

55%

65%

75%

85%

95%

Family Recovery Rate

Probability

Behind the Scenes (1)

A Family Recovery Rate of 15% implies:

The secured debt recovers 30% ($15 mill./$50 mill.)

The unsecured debt recovers 0% ($0/$50 mill.)

This state will occur with a probability of 2.93%

2.93%


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0%

2%

4%

6%

8%10%

12%

14%

5%

15%

25%

35%

45%

55%

65%

75%

85%

95%


Probability




The unsecured debt recovers 0% ($0/$50 mill.)


9.57%


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0%

2%

4%

6%

8%10%

12%

14%

5%

15%

25%

35%

45%

55%

65%

75%

85%

95%


Probability




The unsecured debt recovers 50% ($25 mill./$50 mill.)


5.45%


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We multiply the payout for every debt class (using absolute priority) under eachstate (family recovery = 0%, 1%, 2%, etc.) by the probability that the state willoccur

We then sum across all possible states

The result is an Expected Recovery Rate and therefore Expected LGD foreach debt class


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Assigning LGD Ratings

Obligation-level LGD estimates will be used to assign LGD ratings using 6

buckets

LGD1 0% -


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Assigning Obligation Ratings

Obligation-level Expected LGDs are combined with the Corporate Family Rating(CFR) to determine obligation ratings

A Rating Committee decides the CFR, which implies a Family EL using idealizedloss tables

The Family EL, combined with the expected Family LGD, determines the FamilyPD

The obligation EL (= PD*E[LGD]) will be derived from the Family PD and obligationE[LGD], and will imply an obligation bond rating using an idealized loss table


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Rating Timetable

New ratings have been delivered in as little as a few days or weeks following appointment;however the norm for investment grade issuers is around 6-10 weeks from appointment,assuming high quality information flow

Issuer and advisers often prepare rating information packs with background and importantinformation

Moodys analysts meet management following receipt of background pack for formalpresentation

Moodys reviews information and interacts with issuer/adviser to request further informationor clarify points

Moodys holds rating committee meeting

Rating disclosed to management on confidential basis

Rating outcome can be appealed if new information is available

If rating is accepted for publication, rating is publicly disseminated though press releaseand accompanying research, always with issuers ability to review


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Dissemination of the Rating Decision

Issuer is informed immediately following the rating committee. This information is

confidential and privileged until Moodys makes a public statement Public statement can be in the form of a press release, new issue or new issuer reportor other broad-based electronic media transmission

Public statement is sent to the issuer in advance of public dissemination to ensureaccuracy and that no confidential information has inadvertently been included

Following publication of the rating, the analyst is available to investors and other usersof the rating to comment on Moodys rating decision

Issuer always has right not to accept a new rating and in such cases it is not madepublic by Moodys, but it is not able to be used by the issuer


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Monitoring Moodys Ratings: Meeting Schedule andRating Review, Outlook and Action

After the initial rating decision, ratings are monitored continuously

Issuers determine whether, and how often, they want to meet with the analyst, butmeeting schedules do not determine the timing of rating reviews. Normally, issuermeetings are conducted on an annual basis.

Events in the market place may put positive or negative pressure on an issuers rating,ultimately resulting in a rating action for:

Upgrade

Downgrade

Confirmation

Rating Review and/or a Rating Outlook may precede a Rating Action


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Sign & return to Moodys

a Rating Application Form

Initial discussion withMoodys

Schedule date for RatingMeeting

Submission of backgroundinformation

Moodys forwards Agenda

for Rating Meeting

Rating Meeting

Subsequent analysis andquestions

Rating Committee &assignment of Rating

Weeks

M T W T F S S

1

2 3 4 5 6 7 8

9 10 11 12 13 14 15

16 17 18 19 20 21 22

23 24 25 26 27 28 29

30

Month 1 2010

M T W T F S S

1 2 3 4 5 6

7 8 9 10 11 12 13

14 15 16 17 18 19 20

21 22 23 24 25 26 27

28 29 30 31

Month 2 2010

M T W T F S S

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 27 28 29 30

Month 3 2010

2

10th

1

3rd

3

17th

4

24th

5

1st

6

8th

7

15th

8

22nd

9

29th

10

5thDate

Typical timescale for a rating assignment


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Soummo MukherjeeVice-President Senior AnalystEMEA Corporates+27 11 217 [email protected]

David StaplesManaging Director

EMEA Corporates+971 (4) [email protected]


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CREDIT RATINGS ARE MOODY'S INVESTORS SERVICE, INC.'S (MIS) CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDITCOMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MIS DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIALOBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK,INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS ARE NOT STATEMENTS OF CURRENT ORHISTORICAL FACT. CREDIT RATINGS DO NOT CONSTITUTE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS ARE NOT RECOMMENDATIONS TOPURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. CREDIT RATINGS DO NOT COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULARINVESTOR. MIS ISSUES ITS CREDIT RATINGS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATIONOF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE.

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Corporate Workshop - Presentation