Standard & Poor’s (S&P) has updated its criteria for evaluating the stand-alone credit profile (SACP) and issuer credit rating (ICR) for corporate industrial companies and utilities. With this recent guidance, effective immediately, the S&P intends to provide clarity on its approach to assessing a company’s SACP and ICR. Specifically, the updated criteria provides greater detail on the various factors in the S&P’s analysis so the market can better understand how it determines corporate credit risks.
The S&P’s assessment of SACP and ICR for corporate industrial companies and utilities reflects these companies’ business risk profiles, their financial risk profiles and other various factors that may modify the outcome. The business risk profile involves the risk and return potential for a company in its relevant markets, the competitive environment within those markets (also known as its industry risk), the competitive advantages and disadvantages the company has within those markets (also known as its competitive position), and the country risks within those markets. The S&P combines its assessments of industry risk, competitive position and country risk to determine a company’s business risk profile.
The financial risk profile of the company is based off of the results of management’s decisions in the context of its financial risk tolerances and business risk profile. These decisions include management choices regarding the method it uses to secure funding for the company and how it builds its balance sheet. Also reflected is the relationship of the potential cash flows of the company, considering its business risk profile, to the company’s financial obligations. The S&P’s criteria use cash flow/leverage analysis to conclude a company’s financial risk profile assessment.
Once a company’s financial risk and business risk profiles are determined, the S&P combines these two assessments to determine its “anchor.” This anchor may be modified by additional rating factors, including (1) diversification/portfolio effect; (2) management and governance; (3) financial policy; (4) capital structure; and (5) liquidity. The final analytical factor used to determine a company’s SACP is comparable ratings.
The criteria are complimented by industry-specific criteria called Key Credit Factors (KCFs). The KCFs describe the industry risk assessments associated with each sector and could detect sector-specific criteria that supersede certain sections of these criteria.