Commercial Paper/Debt Instrument Rating Introduction A commercial paper is an unsecured debt instrument issued by an entity to raise short-term funds, with tenure ranging up to twelve months usually for the purpose of working capital. Commercial paper rating is an assessment of t
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Beacon Ratings Financial Instruments
Commercial Paper/Debt Instrument Rating Introduction A commercial paper is an unsecured debt instrument issued by an entity to raise short-term funds, with tenure ranging up to twelve months usually for the purpose of working capital. Commercial paper rating is an assessment of the creditworthiness of an unsecured promissory note in terms of timely payment of interest and repayment of principal with an original maturity of not more than twelve months. Rating Criteria The rating criteria covers l
Commercial Paper/Debt Instrument Rating
Introduction
A commercial paper is an unsecured debt instrument issued by an entity to raise short-term funds, with tenure ranging up to twelve months usually for the purpose of working capital. Commercial paper rating is an assessment of the creditworthiness of an unsecured promissory note in terms of timely payment of interest and repayment of principal with an original maturity of not more than twelve months.
Rating Criteria
The rating criteria covers long-term rating of the issuing entity and its liquidity position in the short-term. The short-term rating reflects the fundamental long-term credit quality of the issuing entity. The long-term assessment covers three key risks – industry risk, business risk, and financial risk, when necessary, parent support. The short-term rating assesses the issuing entity’s industry dynamics, business risk, competitive position, financial risk, liquidity and financial flexibility, adequacy of future cash flows, bank credit lines,strength of promoter and management quality are conducted.
Industry Dynamics
Demand-supply situation
Intensity of competition
Vulnerability to imports
Regulatory risks
Working capital intensity
Prospects for the industry
Competitive Position
The entity’s competitive position within an industry is determined by operating efficiency and market position.
Vintage of technology
Capital cost position
Location advantages
Operating efficiencies
Market share
Distribution network
Financial Risk
Financial risk is to determine the entity’s current financial performance, financial position and adequacy of its future cash flows to service its debt servicing obligations.
Operating profitability: Analysis focuses on determining the trend in operating profitability.
Gearing: Level of debt in relation to own funds and business risks the entity is exposed to.
Debt service coverage: Debt service coverage ratios like Interest coverage.
Working capital intensity: Working capital indicators like receivables, inventory and creditors.
Accounting quality: Accounting policies, notes to accounts, and auditor’s comments are reviewed.
Contingent liabilities: Likelihood of devolvement of exposures and consequent financial implications.
Liquidity and Financial Flexibility
Liquidity risk is to determine adequacy of cash flows to fully cover cash needs over the next 12 months.
Availability of unutilised working capital limit from financial institutions
Quality and nature of entity’s current assets
Sensitivity analysis of key drivers, such as selling prices and input costs
Capacity to raise funds at short notice from financial institutions
Management Quality
Management quality assesses business objectives, plans and strategies, and how management performed.
Experience of management in line with business objectives
Commitment of management to line of business objectives
Attitude of management to risk taking and containment
Plans on new projects, acquisitions, and expansion
Liquidity Back-up Mechanism
Liquidity back-up provides buffer to eventualities that may occur outside financial budget. The quality of liquidity back up mechanism and the covenants/restrictions are assessed. Measures include:
Bank lines for working capital
Revolving credit facilities
Drawing power available against unutilized bank lines
Investments in liquid mutual funds
Cash or encumbrance free fixed deposits in banks
Financial flexibility of the issuer
Mapping Long-Term ratings with Short-Term ratings
The short-term ratings are linked to the long-term ratings as mapped-up below.
Quantum of Short-Term Debt
The quantum of short-term debt as provided in the projections as well as information on liquidity backup for the commercial paper is evaluated. The requirement of working capital has been adequately covered in the long-term loans sanctioned for the project are also evaluated.
Credit Enhancement Mechanism
Credit enhancement mechanisms such as parent entity’s financial support, bank guarantee, backstop facilities etc. are evaluated
Conclusion
In conclusion, a commercial paper rating primarily focuses on assessing the issuing entity’s liquidity and financial flexibility as reflected in the availability of lines of credit, liquidity of investments, availability of parent entity’s support, as well as industry, business and financial fundamentals.