Bond Ratings (2)

by Maestri

8. Regulation: Is the issuer regulated, and could an adverse regulatory climate cause the company’s economic position to decline? Regulation is especially important for utilities and telephone ompanies.
9. Antitrust: Are any antitrust actions pending against the firm that could erode its position?
10. Overseas operations: What percentage of the firm’s sales, assets, and profits are from overseas operations, and what is the political climate in the host countries?
11. Environmental factors: Is the firm likely to face heavy expenditures for pollution control equipment?
12. Product liability: Are the firm’s products safe? The tobacco companies today are under pressure, and so are their bond ratings.
13. Pension liabilities: Does the firm have unfunded pension liabilities that could pose a future problem?
14. Labor unrest: Are there potential labor problems on the horizon that could weaken the firm’s position? As this is written, a number of airlines face this problem, and it has caused their ratings to be lowered.
15. Accounting policies: If a firm uses relatively conservative accounting policies, its reported earnings will be of “higher quality” than if it uses less conservative procedures. Thus, conservative accounting policies are a plus factor in bond ratings.

Representatives of the rating agencies have consistently stated that no precise formula is used to set a firm’s rating; all the factors listed, plus others, are taken into account, but not in a mathematically precise manner. Nevertheless, as we see in Table 4-2, there is a strong correlation between bond ratings and many of the ratios described in Chapter 10. Not surprisingly, companies with lower debt ratios, higher cash flow to debt, higher returns on capital, higher EBITDA interest coverage ratios, and EBIT interest coverage ratios typically have higher bond ratings.

Taken From : Five-Minute MBA – Corporate Finance