Assessing the Effects of Bond Credit Rating Changes Ford Motor Co. reports the f
ID: 2424186 • Letter: A
Question
Assessing the Effects of Bond Credit Rating Changes
Ford Motor Co. reports the following information from the Risk Factors and the Management
Discussion and Analysis sections of its 2010 10-K report...
Credit Ratings: Our short-term and long-term debt is rated by four credit rating agencies
designated as nationally recognized statistical rating organizations (“NRSROs”) by the
Securities and Exchange Commission:
• DominionBondRatingServiceLimited(“DBRS”);
• Fitch,Inc.(“Fitch”);
• Moody’sInvestorsService,Inc.(“Moody’s”);and
• Standard&Poor’sRatingServices,adivisionofTheMcGraw-HillCompanies(“S&P”).
Lower credit ratings generally result in higher borrowing costs and reduced access to capital
markets. In 2005 and 2006, the credit ratings assigned to Ford Credit were lowered to below
investment grade, which increased its unsecured borrowing costs and restricted its access to the
unsecured debt markets. In response, Ford Credit increased its use of securitization transactions
(including other structured nancings) and other sources of funding. In 2010, although Ford Credit
experienced several credit rating upgrades and its credit spreads narrowed considerably, its credit
ratings are still below investment grade. Ford Credit’s higher credit ratings have provided it more
economical access to the unsecured debt markets, but it is still utilizing asset-backed securitization
transactions for a substantial amount of its funding . . . Over time, and particularly in the event of
any credit rating downgrades, market volatility, market disruption, or other factors, Ford Credit may
reduce the amount of receivables it purchases or originates because of funding constraints . . .
A signicant reduction in the amount of receivables Ford Credit purchases or originates would
signicantly reduce its ongoing prots and could adversely affect its ability to support the sale of
Ford vehicles. The following ratings actions have been taken by these NRSROs since the ling of
our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010:
Ford
- On January 28, 2011, Moody's affirmed Ford Motor Company's ratings and changed the rating outlook to positive from stable.
- On Januaary 28, 2011, Fitch upgraded Ford's corporate rating to BB from BB-, the senior secured ration to BBB- from BB+ and the senior unsecured
ration from BB- from B. Fitch also changed the outlook to positive from stable.
- On February 1, 2011, S&P upgraded Ford's corporate rating to BB- from B+, the senio secured debt rating
to BB+ from BB and the senior unsecured debt rating to B+ from B. The outlook remains positive.
Ford Credit
- On January 28, 2011, Moody's affirmed Ford Credit's ratings and changed the rating outlook to positive from stable.
- On January 28, 2011, Fitch upgraded Ford Credit's corporate rating to BB from BB-. Fitch also affirmed the senior unsecured rating at BB- and the short-term rating at B. Fitch
changed the outlook to positive from stable.
- On February 1, 2011, S&P upgraded Ford Credit's corporate rating to BB- from B+ and its senior unsecured debt rating to BB- from B+. The outlook
remains positive.
Questions:
a. What nancial ratios do credit rating companies such as the four NRSROs listed above, use to evaluate the relative riskiness of borrowers?
b. Why might an increase in credit ratings result in lower interest costs and increase Ford’s access to credit markets?
c. What type of actions can Ford take to improve its credit ratings?
Explanation / Answer
A credit agency uses various financial ratio related to a company to assess the risk associated with various financial areas of the. some of the key ratios which a company generally follows is related to capital structure of the company, solvency of the company, long term and short term, turnover ratio of the company, varios price earning ratio and various market price related ratio.
various ratios related to capital structure is of utmost importance for rating agencies for evaluating the long term
solvency of the company. a gearning ratio informs investors about the probability of timely servicing of the rated debt obligation.Therefore, financial risk in the form of high gearing adversely affects a firm’s credit rating. The rating alsodepends on the mix of business and financial risks borneby the firm
Gearing = Total debt /Tangible net worth
Total Indebtedness Ratio = Total Outside Liability/ Tangible Net Worth
Interest coverage ratio = Profit before depreciation, interest, and tax (PBDIT 1)/ Interest and
Net worth related to concerned companies and ratios which are frequently used for assessing the net worth of the comapny are as follows:
PAT margin = Profit after tax / Operating income
RoCE = Profit before interest and tax (PBIT) /[Total debt + Tangible net worth + Deferred tax liability
NCATD =[PAT-Dividend + Depreciation]/ Total debt (short and long term, including off-balance-sheet debt)
liquidity ratios are used to find out the short term solvency related to concerned company. some of related ratios are as follows
Current ratio: Current ratio = Current assets (including marketable securities)/Current liabilities (including current portion of long-term debti.e. CPLTD)
Gross Current Assets Days = Total current assets related to operations/ operating income
these are some of the ratios which are frequently used by rating agencies.
2- an increase in credit rating shows a better financial position sound financial records and good will generate a faith and confidence in public and in investors so an ncreasing credit rating would decrease the risk associated with the company and when risk associated with company will decrease more and more investors will prefer to invest in company and will demand less risk premium and easily many institutions and lenders would readyto offer funds to company.
3- ford can improve its credit rating by improving its various financial ratios related to solvency, profitability, liquidity turnover etc and by reducing the risk attached with the company. more transperency in accounting process and disclosures can increase the financial performance and can help in improving credit rating.
better use of financial and other resources of the company can change in the credit rating of the company,