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Rating Methodology

Qualitative Analysis and Quantitative Analysis


Qualitative analysis is adopted to analyze a rated entity’s business risk with respect to the macro-economic and industrial environment, whereas quantitative analysis is adopted to assess a rated entity’s financial risk. These two analytical modules form the basis for CCXAP’s credit rating methodology, qualitative analysis, and quantitative analysis. They are interactive with each other during the rating process; therefore, the support of quantitative data is essential in making a judgment on the rated entity’s business operating risk. For quantitative analysis on a rated entity’s financial conditions, it is necessary to take into account qualitative theories and the business-operating analysis to forecast the rated entity’s future financial condition.


CCXAP’s quantitative analysis focuses on the rated entity’s future cash flow and relevant financial figures. Other financial ratios calculated and analyzed are also directed to the cash flow analysis.


CCXAP’s qualitative analysis focuses on the factors that affect the ability to generate cash flow. Under normal circumstances, a rated entity with adequate operational cash flow has a higher ability to provide better protection to meet its financial obligations on time.


The integral analytical model, comprising qualitative analysis and quantitative analysis, can predict the probability of default from various dimensions and to analyze the major credit determinants, both internal and external, that affects the default probability. Based on CCXAP’s credit rating principles and methodology, an analyst does his or her independent analysis of the credit worthiness of a rating entity, evaluating its internal credit factors and the relevant external environment.

 


Credit Determinants


Primary and Secondary Credit Determinants


CCXAP categorizes credit determinants into primary and secondary. Default probability is the primary credit determinant, followed by the secondary determinants including, but not limited to, issue seniority, expected recovery ability after default, and future credit stability.


Amongst the secondary credit determinants, issue seniority and expected recovery rate are often applied to the analysis of creditworthiness of issues with lower credit ratings, whilst credit stability analysis is applied to issues with higher credit ratings. The weighting of secondary credit determinants is reviewed in accordance with the substantial changes in market conditions and the economic environment.


CCXAP makes credit prediction according to different industry sectors where a rated entity is located. Calculation of the loss rate in a default case is based on historical facts and current empirical data. Such calculation is forward looking. When there are significant changes that may affect the current loss rate or when there are determinants that may affect the calculating parameters, CCXAP will immediately review the situation to ensure consistency and comparability of its rating standards.


Preliminary Rating Adjustment


After completing a preliminary credit rating recommendation, CCXAP will then measure the rated entity’s repayment capacity by using a macroscopic stress test in key areas such as the extent of GDP decline and unemployment rate trend that the credit rating can withstand.


Issuer Credit Rating and Debt Issue Credit Rating


Issuer Credit Rating


In evaluating the creditworthiness of a rated entity, CCXAP emphasizes the analysis of the financial capacity of a rated entity to meet its financial obligations on time. This requires a forward-looking estimate of the rated entity’s future income and the cash flow generated from business operations and investments.


Industry Analysis


Analyzing the developmental trend and regulatory environment of an industry helps deepen the understanding of industry risk and background risk. It is necessary to understand the industry life-cycle where the rated entity is situated, in particular, for those industries whose industry life-cycle is apparent. Therefore, it is necessary to identify the stage of the industry life-cycle when the credit analysis is being carried out. Analyzing the respective industry’s market structure, market concentration, and price trend will indicate a rated entity’s future profitability. For certain industries such as banking and mining, analysis of the respective industry’s regulatory requirements and limitations must not be neglected.


Management Risk Analysis


CCXAP considers a rated entity’s management quality, its experience, and the ways it deals with risks are the core areas in assessing the rated entity’s management competency and objectives. Its senior management must be interviewed since they are the key persons who define the rated entity’s policies and formulate its business strategies. Through interviewing a rated entity’s management, analysts can know the rated entity’s corporate history, vision and mission; its willingness and tendency to undertake and manage risks; its business strategies, internal-control standards and financial control rigorousness.


Business Operating Risk Analysis


On business operating risk analysis, CCXAP stresses a rated entity’s market positioning, relative strength to business competitors, and the impact of globalization. CCXAP looks into the cash flow risk the rated entity may encounter. An in-depth analysis is carried out on the rated entity’s capital commitment, growth prospects, operating income sources, stability of purchasing, and distribution channels and pricing power.


Financial Risk Analysis


Financial risk analysis is the primary work of CCXAP to reach a credit rating result. A rated entity’s cash flow mainly relies on the profitability of its core business. Financial flexibility is an important factor in determining an entity’s solvency position and the ways that a rated entity uses to obtain sufficient funds from different sources to deal with financial challenges arising from unforeseeable circumstances.


CCXAP chooses different methods of cash flow analysis for specific rated entities in different industries. CCXAP broadly classifies industries into four categories; fast developing industries, high cash demand industries, fast recovery industries and stable cash flow industries. Based on the characteristics of an industry, CCXAP analyzes its key financial data, which includes, but is not limited to, debt level, debt components, debt asset ratio, currency risk, interest risk, and short term debt amounts.


Debt Issue Credit Rating


Ranking of Debt Issues


The degree of default risk of a debt issue is also reflected in its seniority ranking. A senior debt’s ranking is higher than that of a subordinated debt issued by the same issuer. Specific repayment restrictions stated in the terms of a debt issue may affect the credit rating result as well.


Credit Enhancement by Guarantee or Collateral


A debt issue’s credit rating can be enhanced by guarantee or collateral, therefore, the credit quality of guarantor or collateral is one of the key factors affecting the credit rating of the debt issue. CCXAP applies the same rating principles and methodology to analyze the credit worthiness of the respective guarantor or collateral as to the rated entity or debt issue.