Credit Rating Institutions - Essay Example

Student’s Name: Instructor’s Name: Course Code & Name: Date of Submission: Introduction Credit rating institutions have been in existence since the mid nineteenth century. As defined in UNITED STATES (2003), their duty was to handle the degree that was considered the correct measure of information asymmetry in the money and capital markets. The call for credit agencies that were independent became necessary when businesses started to borrow from savers directly rather than trough banks and other lending institutions. The process of mobilizing funds became complex since borrowers wanted to avoid the credit risks assumed by most banks and there was need for a close assessment of the records of borrowers. CANTOR, (1996) suggests that there have been different opinions concerning industrial ratings by different rating agencies. These differences bring out the quality of rating by different agencies to have different standards. The mechanism of systematic credit rating had been in operation since old days of growth and adaptation. The first credit rating was conducted by John Moody in the year 1909 on a company known as the United States Railroad as bonds were rated. The credit rating agencies started by rating simple debt products and later progressed to more complex derivatives in the national economies. They had to restructure their business to incorporate a wider variety of products and services. The well known credit rating agencies are only three. They comprise of; Standard and Poor’s, Moody’s investor services, and Fitch. The three agencies have a lot of things in common but their ratings for different corporations differ depending on the basis of rating (DARBELLAY 2013). A good credit report enables a firm or an individual to gain access to loans and mortgages at a fair rate, to be approved for jobs as well as gain access to rental property. The credit report should give a good reflection on the financial stability of the firm or the business. Preparation of a credit rating report involves obtaining relevant data concerning the financial position of the firm and its credit worthiness. Key areas to be analyzed involve the historical records of the firm’s loans and repayment schedules, its operations, profitability and balance of creditors. This report seeks to analyze the personal information of Csl group, the summarized information on the credit history of the business, detailed financial statements and other accounting information, as well as the profitability of the firm. In response to this information, the analysis will also include a feedback on the true and accurate position. Any negative information will also be supported with relevant calculations as well as any signs of bankruptcy (UNITED STATES 2012). The purpose of this report is to do an analysis into the information that the Csl group avails to the public and evaluate them for credit rating. The report also seeks to develop a credit rating analysis schedule by using the various credit rating models. The study will employ these models in calculating relevant figures and ratios for determining credit worthiness of the Australian company. The report begins by giving a brief description of the Csl group limited and how it operates. A brief history of the company credit report is then given and the conclusions thereby given. About Csl Group: Csl group is a company in the construction industry. The company has two major functions, the corporate and operational functions. In the operational function, it deals with the development and manufacturing of vaccines and plasma protein biotherapies. The company offers products that are derived from plasma and recombinants (DATAMONITOR 2000). The company also offers vaccines and pharmaceuticals. In the corporate function, the company invests much in research and development. This it does not only in Australia but as a worldwide business. The latest report shows that the company has had revenues of up to $7.3 billion. This revenue was generated through its various units of operation such as the CSL Behring unit, and the bioCSL. The company is also faced with a high degree of competition from companies in the same industry. The major competitors are; Pfizer Australia, CSIRO, and Sigma pharmaceuticals. Apart from just doing business, the company also takes part in corporate social responsibility. Australia being a widely affected area by climate change, the company carried out an enterprise wide climate change risk assessment. This is due to the fact that manufacturing institutions are associated with pollution of the environment. The assessment was conducted in all major production sites and other key areas of operation. In relation to credit rating reports, the company completed its sixth credit rating report in the twelfth month of the year 2014. Such reports are important for the public since they give details of performances in all major aspects of sustainability. These aspects are so valued by both stakeholders and the business itself. Credit History of Csl Group Being a company listed in the Australia securities exchange, Csl group issues securities and therefore has financial obligations. The historical data includes reports of earlier years, as far as the 1900s up to the recent years of 2015 (COMMONWEALTH 1900). Credit rating agencies helps investors in sifting information available in the public domain concerning Csl group in order to distinguish that which is valuable from that which is invaluable. The credit rating agencies also help investors in knowing the credit risks they are to charge by getting involved in a lending business to the company. The reports provided by credit rating agencies also enable investors to judge and analytically criticize the information about the business and the financial risks foreseen. The credit history of Csl group is seen to be moving in a positive direction. In the 2014-2015 annual report, it is indicated that the company had a strong balance sheet as there were more cash on hand as compared to borrowings. This is a clear indicator that the company is far from facing cash problems that would however require excessive borrowings. To avoid too much of cash at hand, the company also did a share buyback which helped in boosting the earnings per share for the company shares. Analysis of the publicly available data Publicly available data on the Csl group is given in terms of financial statements, trade documents, informative journals and articles. An analysis into the income statements for the past five years indicates that the firm has had a yearly increase in the net profits. This has been distributed to payment of dividends, capital reserve funds and retained earnings. The statements also indicate that the company has settled accounts of tax payment as there are no deferred tax accounts. Similarly, the operating profits are also increasing from one year to the next, therefore, the products of the Csl group limited can be said to be fast moving. This ensures a great stock turnover ratio. The Australia stock exchange also provides a share buyers guide which is useful for all traders to make decisions on the company shares to trade in. Most investors invest their time in reading this manual since it provides clear information on the most tried and well tested analysis of companies that can be said to be public in Australia (ROTH 2014). It also defines the objectives of each company and the overall outlook of the company in terms of market performance. From the statements of financial position, it also evidenced that the company has had a revaluation on its property, plant and equipment, purchase of more assets and a revaluation of intangible assets. Ratings report based on the analysis of the public information The company is rated as a highly credit worthy company. It has enough of noncurrent assets that can be used to secure loans, it has invested some cash in capital assets, and it has maintained clear records of debtors and creditors as well. The company has also increase3d the amount of dividends paid to its shareholders from the 2013-2014 financial years, from $0.53 to $0.58 per share held. The company is highly rated since the shareholders are interested in buying more of its shares and the general net profits have been increasing on a yearly basis, The value of the firm is also seen to increase as more people are likely to do business with it. Similarly, good financial reports and proper documentation of its activities reveals that the firm is entitled to positive credit and a rank above other companies in the same industry. The company also invests in long term assets and long term liabilities. Therefore, the general view point is that Csl group limited is a highly credited firm. Credit analysis models Different models can be used in analyzing the credibility of a firm or a business entity. Some of these models are applicable to all the existing urgencies available while others are most applicable to individual rating urgencies (MATTAROCCI 2014). In this report, the analysis models to focus on will be capacity analysis, character analysis, median credit rating model, and the Altman Z-score model. In each of these models, the methods of analysis will differ since some require calculation while others only require reasoning in theoretical terms. The overall results will be an average of the results from the four models. Each model will be analyzed separately to obtain either a positive or negative credit rating, after which the average rating will be obtained by outweighing between negatives and positives to ascertain which values outweigh the other. i. Capacity analysis (historical and forecast) This is the process of evaluating a company, its process or line of production and the tools of production in order to determine the maximum output it can generate. The results are given in terms of the rate of output. The Csl group limited is a large scale manufacturing company with various production systems and numerous work stations that uses multiple tools to make different product types. The production takes a series of steps to ensure high quality products that will ensure good health restoration techniques. The analysis focuses on the production quantity of the major products, materials requirement for each production centre, and the quantity of tools and raw materials that are necessary to maximize output. The analysis also reviews the throughput requirements, number of cycles and investment in the products. In this line, the company has over time delivered all its products on promise. This is an indication that the firm produces to a maximum capacity. Its ability to produce timely and quality products has led it to being the leading producer of biotherapeutic products around the world in more than thirty different countries. The company has a labor intensive unit as all of its employees are driven by the deep passion that the company has for patients (CSL 1993). As indicated in the annual reports for the year 2015, the company has developed a high class research and development unit that ensures quality research work and sure results for all kinds of problems. The high degree of innovations and creativity also ensures that the solutions are patient centered and well managed. ii. Character analysis, This is a model of analysis that puts into consideration the characteristics of a potential borrower. It is a theoretical model that assesses the five Cs of credit worthiness. The borrower in this case is assessed for character, capacity, capital, collateral, and conditions. The assessment results are then used to decide whether to lend to the potential borrower based on the conclusion as to whether the borrower can default payment or not. It is an evaluation method that puts into consideration both the quantitative and qualitative aspects and measures. In determining the credibility of the business, character is used to refer to the reputation of a borrower. Capacity is the measure of the ability of a borrower to repay the loan. This is determined by the length between debts and their repayment date as well as the outstanding amounts. The lender also puts into consideration the amount of investment capital the borrower puts into the potential investment. Similarly, the lender considers collateral which is the property or any large asset that the borrower gives as security to the loan. In addition, the loan terms which are the conditions will determine whether the lender will be willing to finance the borrower. Such conditions as the interest rate and the amount of principal required. From the year in reviews of Csl group in the fiscal year ended June 2015, the company had a net profit of united state $ 1379 million. The company also pays both interim and final dividends to its ordinary shareholders. In addition, the company also carried out 100% on-market share buyback. These activities have led to an increase in the investment return ratios (www.csl.com.au, 2015). The company was also listed in the Australia stock exchange in the 1994, this shows that it has a wide trading base and therefore can source funds from a wide pool of lenders. The company has had an increase in its debtor accounts thus more debtors than in earlier periods. Generally, the company has had a strong business performance for the last five years of operation across their plasma products portfolio. This can be sourced from www.annual reports.csl.com.au/. The company has full capacity to repay loans since it has enough operating cash. The company also invested US$347.5 during the year 2015 in capital investment. The above analysis, indicates that Csl group limited is worthy of being credited. In terms of character, the company is of good character and therefore has a positive credit profile. iii. Median Rating model (forecast) This is a model that was suggested by one of the rating agencies known as Moody. In his model, Moody’s suggests that the purpose of nay rating system should be to give insight to investors such that there is a simple system by which they can use to grade companies for credit worthiness of their securities. The agency assigns specific ratings for different areas of organizational performances. The ratings ranging from Aa to Caa have been appended numerical modifiers of 1, 2 and 3. In his view, the least number deserves the highest rating and vice versa. The ratings in this case are not restricted for investment decisions only. Similarly, they are not close determinants of the market price, but rather, mere determinants of the market position of a single entity and the credit risks involved thereto. It is a weighted average rating with certain adjustments (Voloshyn, n.d.). It puts into consideration the fact that ratings are relative and have a fairly stable distribution in every subsequent year (BALTAEV et al 2014). The calculations involve mapping a given range of normalized values in a set of data for a fiscal year which may be unique to each other, and then the yearly metrics are then averaged to find the final rating. The formula assumes a monotonic relationship is all we need to estimate the cutoff points and nodes. All sequences of nodes must be aligned to their corresponding sequence of implied ratings. The model is based on the determination of the various coverage ratios using the knowledge on ratios from the financial point of view (BRAGG 2007). In this case, simple coverage ratios like the interest coverage ratio, debt-service coverage ratio and the asset coverage ratio will be calculated. This is a combination of debt and profitability ratios that determines the ease with which a company can pay interests on any outstanding debts. It takes into account the company earnings before payment of interest and taxes as well as the amount interests that the company has to pay on debts (MAYES et al 2015). The formula is; Interest coverage ratio =Earnings before interest and tax (EBIT)/total interest charges 1774.2/59.6 = 29.77 times This shows that the company can repay interest on debts 29 times more than the actual interest. This is the margin of safety for Csl group in paying interests during a given period. The interpretation is that the company can borrow more funds and invest in capital assets or even maintain an emergency reserve. The other implication is that the company is not at a risk of default since it has enough cash to settle its present obligations. Apart from interest coverage ratio, the debt/Service coverage ratio can also be used to account for the down payments required of a business in every quarter. The potential investor compares the net income to the total borrowing expense which is a sum of the principal repayments and the interest costs. The normally used formula is; Debt-service coverage ratio = Net income / (Principal repayments + Interest expense) 870.6 / (704+59.6) =1.14 If the debt-service coverage ratio is below 1, then the business is said to be having a negative cash flow. In this case, the company is paying more in borrowing expenses than the amount it earns as revenue. For investors, it is advisable that they lend to companies with debt-service coverage ratio of at least one so that they are sure of enough cash flow to settle future liabilities. Therefore, Csl group limited has a positive cash flow and therefore has a stable base for payment of future obligations. These obligations comprise of interests and principals payable on a quarterly basis. Finally, we look at the asset coverage ratio. Unlike the other coverage ratios which compare the debt of a business to its earnings, this ratio focuses on the company statement of financial position. It compares the company assets to its total borrowings. The more the assets owned by the company, the more likely it is for the company to make payments for its borrowings. It deals with the division of the tangible assets of a company (after accounting for short term liabilities) by the number of debts outstanding at the end of the period. The formula in this case is given as; Asset coverage ratio = [(Total assets – Intangible assets) – (Current liabilities – Short-term debt obligations)] / Total debt outstanding For Csl group limited, the asset coverage ratio is computed as; Asset coverage ratio = [(6401-926.9)-(936.1-3.2)] / (2277.7+3.2) = 1.991 The results will determine the future of an investor only if the investor accepts the industrial structure. Different industries have different requirements for the asset coverage ratio. For instance, the utility industry requires a minimum of 1.5 as the asset coverage ratio whereas most companies have a minimum of 2.0. From the above calculations, we can conclude that the coverage ratio is slightly below the requirements of 2.0. Therefore, investors should be more careful when lending to Csl group limited. iv. Altman Z score model (forecast) This is a model that was introduced by Professor Edward Altman used for the analysis of companies on matters of corporate distress, bankruptcy, and default risk. The model was named after its founder and is basically used to determine the scores of a company in different financial aspects in order to ascertain that the company is not at a verge of corporate closure. It uses different kinds of financial ratios to detect whether the company is bankrupt or not. The model brings together five key ratios of performance in order to ascertain the health status of the firm. The results of this calculation should indicate whether a company is at a position of continuing as a going concern or at the verge of collapse. The formula states that; Z-score = 1.2x + 1.4x2 + 3.3x3 +0.6x4 + 1.0x5 Where; X = working capital/total assets X2 = retained earnings/total assets X3 = earnings before interest & tax (EBIT)/total assets X4 = market value of equity/total liabilities X5 = sales/total assets The results are then interpreted to find out the true position of the company. If the Z-score is lower than 1.8 then the company is said to be going bankrupt. A score between 1.8 and 3.0 shows that the company is in a gray position and therefore it is difficult to determine its true position. A score that is higher than 3.0 indicates that the company is at a good position and is not even close to going bankrupt. From the financial statements of Csl group limited, the financial statements of each fiscal year can be used to determine whether the firm is financially distressed or is already in a bankrupt position. For instance, using the latest financial statements provided in the Annual report 2014-2015, we can calculate the relevant ratios for determination of a Z-score for the financial year 2014/2015 as shown below; Ratio Formula Workings Answer X Working capital/total assets 5464.9/6401 0.8538 X2 Retained earnings/total assets 6000.8/6401 0.9375 X3 EBIT/total assets 1714.6/6401 0.2679 X4 Market value of equity/total liabilities 2746.9/3654.1001 0.7517 X5 Sales/total assets 5458.6/6401 0.8528 Z score 1.2X+1.4X2+3.3X3+0.6X4+1.0X5 1.2*0.8538+1.4*0.9375+3.3*0.2679+0.6*0.7517+1.0*0.8528 4.52495 In this case, the Z score is 4.52495 which is a figure higher than 3.0. This shows that the Csl group limited is not bankrupt and is at an excellent position to carry out business (ALTMAN 2001). Findings of the credit analysis models From the credit analysis models, it can be concluded that Csl group limited has a good and positive credit report. It satisfies most of the requirements of a credit worthy company. The character analysis reveals that the business has adequate facilities and capacity to repay its liabilities in due time. The firm also has enough fixed assets to be used as collateral for the purpose of securing loans. Similarly, the conditions for loaning out and the interest and principal payment terms are favorable to investors and therefore the firm is qualified as a credit worthy business. Capacity analysis report reveals that the firm has adequate and qualified labor to service all its customers. The company also has divisions and production centers in every country that they operate. All these production centers have adequate tools for purposes of producing quality products. The company also conducts high quality research and this is farther developed through creativity and innovativeness of its staff. Due to its high productivity, the company has achieved advancements in its recombinant coagulation products, licensing by the FDA, product differentiation, operational effectiveness, expansion in terms of production facilities, product leadership as it seeks to acquire the Novartis influenza vaccines business in order to combine it with the bioCSL product, as well as the creation and development of an attractive culture of talent development and retention. The median rating model has utilized Moody’s analogy to compute coverage ratios based on interest, debt and assets of the firm. The results are widely reliable since they are obtained using one of the highly credited agencies. This rating agency gives a higher rating of triple A (AAA) to indicate the highest possible rating and a C for the least possible rating. This has resulted in different results with some having a negative portrait of the credit worthiness of the company. On average, the credit rating of the firm using the model is positive and therefore, lenders can consider doing business with the Csl group limited. Finally, the Altman Z-score model accurately reveals that the company is highly credited. The results are a true reflection of the financial position, income statement and cash flows of Csl group limited. The ratios involved are the most common ratios used in financial analysis. This indicates that the results are accurate and the interpretation is the true position for the company. Conclusion: Credit rating reports are always prepared in order to assess both financial and non-financial performance of a firm. For a firm in large scale operations, the credit worthiness should be assessed from a wide range of data, both in the public and those meant for management use only. Credit rating reports are based on various credit rating models. These models range from those provided by credit rating agencies to those that are formulated by individuals. The ratings can be used for multiple purposes, some of them being; credit worth assessment, financial performance determination, and the position of a firm with regard to its competitors. For Csl group limited, the credit rating report was last prepared in December 2014. The performance of the firm in most sectors has improved from the previous data. This is a clear indicator that the firm has a competitive advantage over its competitors. Similarly, the value of the firm has risen and thus shareholders have greater interests in the shares of the company. Using different rating models, Csl group limited has shown a consistent positive result in both financial and non-financial aspects. Some of the financial issues addressed are related to the financial statements. On the other hand, the non-financial issues addressed are related to corporate social responsibility, character of the company and the productivity of the different divisions and production centers within the company. In comparison with other companies in the manufacturing industry, specifically those that manufacture and development of vaccines and plasma protein biotherapies, as well as plasma and recombinants, Csl group limited can be said to be a product leader. References: ALTMAN, E. I. (2001). Bankruptcy, credit risk, and high yield junk bonds. Malden, MA, Blackwell Publishers. BALTAEV, ALEXANDER, & CHAVDAROV, IVAYLO. (2014). Predicting Corporate Defaults: Evaluating Moody's Credit Rating Institute. Lunds universitet/Nationalekonomiska institutionen. http://lup.lub.lu.se/student-papers/record/4499681. BRAGG, S. M. (2007). Business ratios and formulas: a comprehensive guide. Hoboken, N.J., Wiley. CANTOR, R., & PACKER, F. (1996). 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