Annex A : Assessment Factors in Assigning Ratings
A1 Borrower Ratings
A1.1 The following are the relevant factors that banks should consider in assigning borrower ratings. However, these factors are not intended to be exhaustive or prescriptive, and certain factors may be of greater relevance for certain borrowers than for others:
• the historical and projected capacity to generate cash to repay a borrower’s debt and support its other cash requirements (e.g. capital expenditures required to keep the borrower a going concern and to sustain its cash flow);
• The capital structure and the likelihood that unforeseen circumstances could exhaust the borrower’s capital cushion and result in insolvency;
• The quality of earnings (i.e. the degree to which the borrower’s revenue and cash flow emanate from core business operations as opposed to unique and nonrecurring sources);
• The quality and timeliness of information about the borrower, including the availability of audited financial statements and their conformity with applicable accounting standards;
• The degree of operating leverage and the resulting impact that deteriorating business and economic conditions might have on the borrower’s profitability and cash flow;
• The borrower’s ability to gain additional funding through access to debt and equity markets;
• The depth and skill of management to effectively respond to changing conditions and deploy resources, and the degree of prudence reflected from business strategies employed;
• The borrower’s position within the industry and its future prospects; and
• The risk characteristics of the country the borrower is operating in, and the extent to which the borrower will be subject to transfer risk or currency risk if it is located in another country.
A2 Facility Ratings
A2.1 Banks should look at the following transaction specific factors, where applicable, when assigning facility ratings:
• The presence of third-party support (e.g. owner/guarantor). Considerable care and caution should be exercised if ratings are to be improved because of the presence of any third-party support. In all cases, banks should be convinced that the third party is committed to ongoing support of the borrower. Banks should establish specific rules for third-party support;
• The maturity of the transaction. It is recognized that higher risk is associated with longer-term facilities while shorter-term facilities tend to have lower risk. A standard approach is to consider further adjustment to the facility rating (after adjusting for third-party support), taking into account the remaining term to maturity;
• The structure and lending purposes of the transaction, which influence positively or negatively the strength and quality of the credit. These may refer to the status of borrower, priority of security, any covenants attached to a facility, etc. Take, for example, a facility that has a lower rating due to the term of a loan. If its facility structure contains very strong covenants which mitigate the effects of its term of maturity (say, by means of default clauses), it may be appropriate to adjust its facility rating to offset (often partially) the effect of the maturity term.
• The presence of recognized collateral. This factor can have a major impact on the final facility rating because of its significant effect on the LGD of a facility. Banks should review carefully the quality of collateral (e.g. documentation and valuation) to determine its likely contribution in reducing any loss. While collateral value is often a function of movements in market rates, it should be assessed in a conservative manner (e.g. based on net realizable value or forced-sale value where necessary).