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Ratings Policy & Approach

 

A "Universal" Approach to Credit Analysis

 

Because it involves a look into the future, credit rating is by nature subjective. Moreover, because long-term credit judgments involve so many factors unique to particular industries, issuers, and countries, we believe that any attempt to reduce credit rating to a formulaic methodology would be misleading and would lead to serious mistakes.

That is why Moody's uses a multidisciplinary or "universal" approach to risk analysis, which aims to bring an understanding of all relevant risk factors and viewpoints to every rating analysis. We then rely on the judgment of a diverse group of credit risk professionals to weigh those factors in light of a variety of plausible scenarios for the issuer and thus come to a conclusion on what the rating should be. Several analytical principles guide that reasoning process.

 


 

Some Basic Principles

 

Emphasis on the Qualitative: Quantification is integral to Moody's rating analysis, particularly since it provides an objective and factual starting point for each rating committee's analytical discussion. Those who wish further information on the numerical tools we use may consult our written research on industries and specific issuers.

 

However, Moody's ratings are not based on a defined set of financial ratios or rigid computer models. Rather, they are the product of a comprehensive analysis of each individual issue and issuer by experienced, well-informed, impartial credit analysts.

 

Focus on the Long-Term: Since Moody's ratings are intended to measure long-term risk, our analytical focus is on fundamental factors that will drive each issuer's long-term ability to meet debt payments, such as a change in management strategy or regulatory trends. As a rule of thumb, we are looking through the next economic cycle or longer.

 

Because of this, our ratings are not intended to ratchet up and down with business or supply-demand cycles or to reflect last quarter's earnings report. In our view it would be punitive to rate a security conservatively because of poor short-term performance if we believe the issuer will recover and prosper in the long-term.

 

Global Consistency: Our approach incorporates several checks and balances designed to promote the universal comparability of rating opinions. Internationally, ratings are normally limited to the sovereign ceiling rating of the nation in which the issuer is domiciled. Our analytical team approach also supports consistency by including Moody's directors, along with global industry specialists and analysts with regional and other perspectives, in every rating decision.

 

Level and Predictability of Cash Flow: In every sector, the foundation of Moody's rating approach rests on the answer to one question: What is the level of risk associated with receiving full and timely payment of principal and interest on this specific debt obligation and how does that risk compare with that of all other debt obligations?

 

When we speak of "risk to timely payment," we are measuring the ability of an issuer to generate cash in the future. Our analysis focuses, therefore, on an assessment of the level and predictability of an issuer's future cash generation in relation to its commitments to repay debtholders.

 

Our main emphasis throughout the rating analysis is on understanding strategic factors likely to support future cash flow, while identifying critical factors that will inhibit future cash flow. The issuer's capacity to respond favorably to uncertainty is also key. Generally, the greater the predictability of an issuer's cash flow and the larger the cushion supporting anticipated debt payments, the higher the rating will be.

 

Reasonably Adverse Scenarios: In coming to a conclusion, rating committees routinely examine a variety of scenarios. Moody's ratings deliberately do not incorporate a single, internally consistent economic forecast. They aim rather to measure the issuer's ability to meet debt obligations against economic scenarios reasonably adverse to the issuer's specific circumstances.

 

"Seeing Through" Local Accounting Practices: Moody's analysts deal frequently with different accounting systems internationally; we are not bound to any particular one. For the purpose of fixed-income analysis, we regard them as languages with differing strengths and weaknesses.

 

In examining financial data, Moody's focuses on understanding both the economic reality of the underlying transactions and on how differences in accounting conventions may -- or may not -- influence true economic values.

 

For example, in the analysis of assets the concern is with their relative ability to generate cash, not with the value as stated on a balance sheet.

 

Sector-Specific Analysis

 

Specific risk factors likely to be weighed in a given rating will vary considerably by sector. In the following sections, we provide a very rough outline of typical rating considerations for two types of issuers: an industrial enterprise and a structured financing.

 

Moody's publishes more in-depth overviews of our rating approach for each of these sectors and many others -- e.g., sovereign nations, sub-national governments, public utilities, banks, insurance companies, mutual funds, and project financings, along with general obligation bonds and revenue bonds issued by U.S. municipalities. For further information, please contact Moody's directly.

 

© 2014 Moody's Investors Service, Inc., Moody’s Analytics, Inc. and/or their affiliates and licensors. All rights reserved.
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