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A "Universal" Approach to Credit Analysis |
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Because it involves a look into the future, credit rating is by nature subjective. Moreover, because long-term credit judgments involve so many factors unique to particular industries, issuers, and countries, we believe that any attempt to reduce credit rating to a formulaic methodology would be misleading and would lead to serious mistakes. |
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That is why Moody's uses a multidisciplinary or "universal" approach to risk analysis, which aims to bring an understanding of all relevant risk factors and viewpoints to every rating analysis. We then rely on the judgment of a diverse group of credit risk professionals to weigh those factors in light of a variety of plausible scenarios or the issuer and thus come to a conclusion on what the rating should be. Several analytical principles guide that reasoning process. |
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Some Basic Principles |
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Emphasis on the Qualitative: Quantification is integral to Moody's
rating analysis, particularly since it provides an objective and
factual starting point for each rating committee's analytical
discussion. Those who wish further information on the numerical
tools we use may consult our written research on industries and
specific issuers. |
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However, Moody's ratings are not based on a defined set of financial
ratios or rigid computer models. Rather, they are the products of a
comprehensive analysis of each individual issue and issuer by
experienced, well-informed, impartial credit analysts. |
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Focus on the Long-Term: Since Moody's ratings are intended to
measure long-term risk, our analytical focus is on fundamental
factors that will drive each issuer's long-term ability to meet debt
payments, such as a change in management strategy or regulatory
trends. As a rule of thumb, we are looking through the next economic
cycle or longer. |
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Because of this, our ratings are not intended to ratchet up and down
with business or supply-demand cycles or to reflect last quarter's
earnings report. In our view it would be punitive to rate a security
conservatively because of poor short-term performance if we believe
the issuer will recover and prosper in the long-term. |
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Global Consistency: Our approach incorporates several checks and
balances designed to promote the universal comparability of rating
opinions. Internationally, ratings are normally limited to the
sovereign ceiling rating of the nation in which the issuer is
domiciled. Our analytical team approach also supports consistency by
including Moody's directors, along with global industry specialists
and analysts, with regional and other perspectives, in every rating
decision. |
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Level and Predictability of Cash Flow: In every sector, the
foundation of
Moody's rating approach rests on the answer to one
question: What is the level of risk associated with receiving full
and timely payment of principal and interest on this specific debt
obligation and how does that risk compare with that of all other
debt obligations. |
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When we speak of "risk to timely payment," we are measuring the
ability of an issuer to generate cash in the future. Our analysis
focuses, therefore, on an assessment of the level and predictability
of an issuer's future cash generation in relation to its commitments
to repay debt holder. |
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Our main emphasis throughout the rating analysis is on understanding
strategic factors likely to support future cash flow, while
identifying critical factors that will inhibit future cash flow. The
issuer's capacity to respond favorably to uncertainty is also key.
Generally, the greater the predictability of an issuer's cash flow
and the larger the cushion supporting anticipated debt payments, the
higher the rating will be. |
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Reasonably Adverse Scenarios: In coming to a conclusion, rating
committees routinely examine a variety of scenarios. Moody's ratings
deliberately do not incorporate a single, internally consistent
economic forecast. They aim rather to measure the issuer's ability
to meet debt obligations against economic scenarios reasonably
adverse to the issuer's specific circumstances. |
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"Seeing Through" Local Accounting Practices: Moody's analysts deal
frequently with different accounting systems internationally; we are
not bound to any particular one. For the purpose of fixed-income
analysis, we regard them as languages with differing strengths and
weaknesses. |
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In examining financial data, Moody's focuses on understanding both
the economic reality of the underlying transactions and on how
differences in accounting conventions may - or may not – influence
true economic values. |
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