1.   GENERAL OVERVIEW AND SCOPE

This section summarizes the JCR-ER general rating methodology and criteria for corporate companies outside the financial and public service sectors. The criteria organize the analytical process within a common framework, may vary according to the industry in which the firms operate, and represent the steps for developing the Baseline Risk Profile (BRP), the Stand-Alone Risk Profile (SARP), and the Issuer Credit Rating (ICR) for an entity.

The assessment primarily considers the business risk profile and the financial risk profile of companies, as well as other relevant factors that might influence or alter the firm’s SARP.

While the criteria provide a general overview of the assessments made for a firm's SARP and ICR, the explanations of the factors used in the analysis are more detailed. The criteria also serve as a guide on how these factors are applied. They are intended to provide a specific structure that clarifies our approach to basic corporate credit risk analysis.

The assessment of the business risk profile primarily consider the sector risk associated with the industry in which the company operates and the factors relating to the firm’s positioning. Company positioning includes considerations such as the competitive conditions in the industry, the company’s competitive stance, its scale, diversification capacity and capability, as well as the efficiency and profitability of its operations. The business risk profile also affects the company’s financial risk profile and forms the basis for its projected economic performance.

The financial risk profile, on the other hand, emerges as a result of the decisions taken by the company’s management within the context of the business risk profile and its appetite for financial risk. This assessment encompasses assessments of how the management finances the company and structures its balance sheet. It also reflects the relationship between cash flows and financial obligations. In determining the financial risk profile of a corporate firm, the primary variables considered in the financial analysis are leverage, coverage, profitability, and efficiency ratios.

After the assessments of business and financial risk profiles, these assessments are combined to determine the Baseline Risk Profile (BRP). The BRP can be modified by additional rating factors, referred as modulators, which primarily consider factors such as liquidity, debt structure, financial policy, corporate dynamics, environmental, social, and corporate governance (ESG), other adjustments (Fine-tuners) and negative records in the banking system, other negative events experienced, and interim financials. These assessments are carried out in three stages. In the first stage, a liquidity assessment is performed; in the second stage, a combined assessment of debt structure, financial policy, corporate dynamics, ESG, and other adjustments is made; and in the third and final stage, negative records in the banking system, significant negative events related to its operations (such as difficulties in coupon/principal payments on debt instruments, concordat, bankruptcy, tender bans, tax and social security debt information), adverse developments within group companies, and changes in interim financials are considered. After the modulators are evaluated, the next step is to consider the support assessments. Group support, public support, and any other external support elements are then used to obtain the firm’s Issuer Credit Rating (ICR). In cases where the firm has issued securities, specific assessment elements for the issuance are considered to determine the Issue Rating (IR).
 

2. GENERAL STRUCTURE OF CORPORATE RATING METHODOLOGY

2.1    Basic Framework

The corporate analytical methodology, as the basic framework, organizes the analytical process by breaking it down into several sub-factors to ensure that all significant issues are considered. The company’s business and financial risk profiles are analyzed, then combined to determine the Baseline Risk Profile, after which relevant criteria are considered by considering modulators that may alter the baseline profile, ultimately leading to the Stand-Alone Risk Profile. Finally, by conducting a support assessment comprising public support, group support, and external support, the assessment process is completed.

The business risk assessment combines industry risk analysis and company positioning analysis. Analyses of leverage, coverage, profitability, and efficiency ratios shape the company’s financial risk profile.

The business risk profile is a mix of qualitative assessments and quantitative data and essentially consists of two main components: industry assessment and company positioning. Qualitative assessments differentiate a series of risk factors—such as scale and scope, competitive strength, diversification, efficiency, and key performance indicators—used to evaluate the company’s position. Quantitative data, on the other hand, address criteria related to the size and efficiency of the firms.

Financial risk profile assessments focus entirely on quantitative factors, incorporating metrics such as leverage, coverage, profitability, and efficiency. The analysis then combines the business and financial risk profiles to determine the company’s Baseline Risk Profile (BRP).

After determining the BRP, additional factors, called modulators, are used to establish the Stand-Alone Risk Profile (SARP). The modulators are evaluated in three stages:

• In the first stage, the firm’s rating may improve;
• In the second stage, the firm’s rating may either improve or deteriorate;
• In the third stage, the firm’s rating may either improve or deteriorate.

Once the SARP is determined, group or public support (if exist) and the external support impact is evaluated to arrive firm’s Issuer Credit Rating (ICR).

Figure: Corporate Methodology Framework

2.2    Business Risk Profile

There are few factors that truly reflect a company’s position in key markets, product and brand superiority, or its ability to withstand competitive market pressures such as price competition. The preservation of top-level business performance largely depends on factors including product diversification, geographic distribution of sales, diversity of customers and suppliers, and competitive cost positioning. Size and scope can be significant factors if they provide considerable advantages in terms of operational efficiency, economies of scale, financial flexibility, and competitive strength; however, a company’s size does not always guarantee higher ratings.

Key factors in the business risk profile encompass a wide range of qualitative assessments and quantitative data tailored to industry specifications. Industry assessments include a set of significant elements that are commonly observed or expected in each industry to provide insights into the application of corporate rating criteria principles.

The consolidation of industry risk assessments and company positioning assessments determines a company’s business risk profile. The strengths and weaknesses of a company are critical determinants in the risk assessment process. These strengths and weaknesses are closely related to the company’s ability to generate cash flow in a timely manner to meet its obligations.
An integrated component of the business risk assessment is the industry assessment, which involves a comparative analysis of the company’s sector against other sectors.

The company positioning assessment describes the firm’s situation in terms of its ability to capitalize on key industry factors or mitigate related risks more effectively, to gain competitive advantages, and to achieve a more favorable business risk profile compared to those more vulnerable or deficient in handling industry risks.

The final business risk profile is determined by combining the results of the industry and company positioning assessments. Given that company-specific assessments are considered more prominent for credibility purposes, the business risk profile relies on the relative strength of the company positioning.

2.3    Financial Risk Profile

The quantitative side of corporate rating essentially focuses on a company’s financial profile and its ability to meet obligations in time through a combination of internal and external resources. Historical, current, and forward-looking estimates may be used in evaluating the strength of a company’s debt-servicing capacity.

Financial analysis mainly considers leverage, coverage, profitability, and efficiency criteria. The sustainability of cash flows from operations not only enhances a company’s access to external financing sources but also enables the augmentation of internal resources.

Since the assessment of financial ratios may differ across industries, both the financial criteria and the assessment ranges can vary on an industry basis. For example, an industry with low profit margins may tolerate higher leverage figures for a given rating compared to an industry with high profit margins.

The number of ratios considered in financial risk profile assessments may vary according to the sectors in which the companies operate. Additionally, the weights assigned to ratio groups and the individual ratios in the analytical assessment may also differ by industry.

2.4    Baseline Risk Profile Assessment

The Baseline Risk Profile (BRP) is formed by combining the business risk and financial risk profile assessments. The BRP is determined through a matrix that primarily considers the company’s financial risk profile assessment.

2.5    Modulator Assessment

After the Baseline Risk Profile is evaluated, the company’s Stand-Alone Risk Profile (SARP) is determined by considering the results of a three-stage modulator assessment. The first modulator stage is based on evaluating the firm’s liquidity. In the second stage, the firm’s debt structure, financial policy, corporate dynamics, environmental, social, and corporate governance (ESG) and other adjustment factors are considered. In the third and final stage, negative records experienced by the firm in the banking system are considered. In addition to these records, qualitative information—difficulties in coupon/principal payments on debt instruments, including the firm’s declaration of concordat or bankruptcy, tender bans, significant improvements or deteriorations in interim financials, and adverse events in group companies—is collectively evaluated to determine the firm’s Stand-Alone Risk Profile (SARP). Modulator evaluations may have either a positive or negative effect on the Baseline Risk Profile (BRP); thus the modulator evaluation may raise or lower the baseline risk profile by one or more notches, or in some cases, it may have no effect at all.

Each evaluation stage can adjust the Baseline Risk Profile into a new rating scale. To determine the impact of the next modulator on the baseline risk profile, the rating obtained after each stage is considered, and the same process is repeated until the evaluation is complete. Moreover, for ratings below B-, the effects of the Stage 1 and Stage 2 modulators, whether positive or negative, are not considered.

2.5.1    1st Stage Modulator Assessment
In the first stage, a liquidity assessment is conducted to measure the ability of firms that fall within a certain BRP range to withstand stressful conditions. This assessment focuses on the company’s liquidity position, including assessments of liquidity management, current credit limits, and intra-year liquidity requirements. One of the main drivers in the liquidity assessment is the cash flows, which serve as the basic indicators of the company’s liquidity buffer. The assessment comprises a qualitative analysis of the firm’s liquidity position, the Defensive Interval Period, and its ability to counter adverse events significantly affecting the firm using resources available from the banking system. The output of the Stage 1 modulator is categorized as: 1 – Strongly Positive, 2 – Positive, 3 – Neutral.

2.5.2    2nd Stage Modulator Assessment

The Stage 2 modulator assessment includes the analysis of debt structure, financial policy, corporate dynamics, ESG, and other adjustment factors.

JCR ER analyzes the debt structure, assesses its risks, and reviews leverage and coverage levels while considering relevant issues that are typically not addressed. These factors encompass risks associated with debt maturity, currency risk, and variable interest rate risk.

The financial policy assessment goes beyond the analyses of leverage, coverage, debt structure, and liquidity to understand and explore the standard assumptions, which may not fully reflect or explain the company’s long-term financial policy risks. This assessment measures the extent to which management’s financial decisions can improve the anticipated financial risk profile, addressing issues such as dividend coverage ratio, financial discipline, the framework of financial policy, and the firm’s risk appetite.

The corporate assessment includes an analysis of management and governance, considering the strategic competence of management, organizational effectiveness, the impact of risk management and governance practices on the firm’s competitive strength in the market, as well as the robustness of financial risk management and overall governance. Effective management of key strategic and financial risks can enhance credit reputation.

The next step involves evaluating the firm’s environmental, social, and corporate governance (ESG) aspects. This includes considerations of environmental legislation and regulations, environmental sensitivity, approaches to sustainability, employee turnover rates, and the flexibility of labor costs. Additionally, factors such as the independence of management in performing the Board’s oversight functions, the effectiveness of the controlling shareholders, the presence of risk-aware professional management teams, compliance with legislative/regulatory, tax, and other legal matters, and stable relationships with regulatory authorities are key criteria. Other factors include the company’s ability to consistently deliver and communicate coherent messages to all stakeholders, the effectiveness and adequacy of its internal control systems and processes, and the sufficiency of its corporate communications, transparency, and rating documentation.

The final assessment factor in the Stage 2 modulator process is the “other adjustment factors.” These primarily include the company’s industry experience, transition periods that may significantly alter strategies (such as mergers or acquisitions), shifts in industry trends, changes in macroeconomic trends, and event risks.

The five different assessments mentioned above for each group are categorized as: 1 – Strongly Positive, 2 – Positive, 3 – Neutral, 4 – Negative, and 5 – Strongly Negative. The results from each criterion are weighted to reach a final outcome for Stage 2. The output of the Stage 2 modulator is categorized as: 1 – Strongly Positive, 2 – Positive, 3 – Neutral, 4 – Negative, and 5 – Strongly Negative.

2.5.3    3rd Stage Modulator Assessment

The final stage of the modulator assessment is based on a comprehensive assessment of qualitative data, negative banking system records, occurrences of concordat, bankruptcy, tender bans, tax and social security debt information, significant improvements or deteriorations in interim financials, and adverse events experienced by group companies. Following the assessments in this stage, the Stand-Alone Risk Profile (SARP) is determined. Notably, morality criteria hold significant importance in this assessment. This stage considers factors such follow-up loans, delinquency, non-cash credits that have been compensated, restructured loans, high utilization rates of credit limits, cheque records, bankruptcy, concordat, and tender bans. This stage is primarily employed to address adverse situations experienced by firms. However, the qualitative assessment regarding interim financials may positively influence the firm’s rating. All criteria are assessed together to calculate the final effect for Stage 3. The output of the Stage 3 modulator assessment is categorized as: 1 – Positive, 2 – Neutral, 3 – Negative, and 4 – Strongly Negative.

2.6    Support Assessment

The criteria addressed under support assessments comprise the methodological approach to determine the impact of given guarantees and other forms of support on a company’s rating. These criteria also include the guarantees provided by the state to companies that are associated with the public sector in the context of their debt obligations. Assessments are also made regarding the group members related to the evaluated firm and their main company. This includes an assessment of the group risk profile and the status of the evaluated firm relative to other group members. For such companies, it is considered that their ownership, control, influence, or support from another institution can have a significant impact on credit quality. The criteria also explain how the potential for support (or negative impact) from group members or other external sources such as the public is handled.

Within the scope of support assessments, group support is evaluated first, followed by public support assessments. In the final stage, for firms with speculative-level ratings, the presence of any external support elements is evaluated. With all these assessments, the firm’s Issuer Credit Rating (ICR) is determined.

2.7    Issue Assessment

The fundamental component of issue rating is the creditworthiness of the issuing firm, and thus the issuer rating, although certain issuance-specific conditions may result in the issue rating diverging from the firm’s rating. This assessment covers issuances conducted without securitization. For issuances resulting from securitization processes, Structured Finance Methodologies are applied.
The main situations that may lead to such divergence include:

• The relative seniority of the instruments issued in default or bankruptcy situations and/or the presence of a positively differentiated rescue process specific to the instrument;
• The credit quality of the legally binding guarantors that provide security for the obligation arising from the issuance;
• Even in the event of bankruptcy, under other laws affecting the rights of creditors, the level of additional seniority and recourse ease provided through legally given guarantees specific to the obligation;
• The credit quality of the insurance companies issuing obligation-specific policies;
• The additional level of seniority and recourse ease provided by the obligation-specific insurance policies;
• The degree of credit enhancement provided by legal means specific to the obligation (e.g., real estate collateral);
• The level of additional seniority and recourse ease provided through obligation-specific credit enhancements.

Issue ratings may be long-term or short-term. If the maturity of the issued (or to-be-issued) debt instruments exceeds one year, a long-term issue rating is assigned; if it is one year or less, a short-term issue rating is assigned.

2.8    Basic Criteria Used in Financial Analysis

The analysis of credit risk employs various quantitative measures of cash flow, profitability, leverage, and coverage ratios. The following sections summarize the key credit metrics used in analyzing credit default risk. Despite its limitations, Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is the most commonly used measure of cash flow and is therefore frequently used in analyses. EBITDA is also the most widely used measure in going concern valuations. Consequently, EBITDA plays a significant role in analyzing the probability of default.

However, given the limitations of EBITDA as an important measure of cash flow, a series of other criteria are also used to assess debt-servicing capacity. These include Funds From Operations (FFO), Cash Flow from Operations (CFO), Free Operating Cash Flow (FOCF), and Unlevered Free Cash Flow (UCF), which are key measures of a company’s ability to meet its debt obligations.

EBITDA

Despite certain limitations, EBITDA is widely used and is thus a highly comparable measure of cash flow. Interest payments can be a significant cash outflow for companies at speculative levels, and therefore EBITDA may, in some cases, substantially overstate cash flow. Nevertheless, it serves as a useful and common starting point for cash flow analysis and is beneficial for ranking the financial strength of different companies.

Funds From Operations (FFO)

FFO is a mixed cash flow measure that estimates a company’s inherent ability to generate recurring cash flows from its operations independently of working capital fluctuations. It measures the cash flow available to the company before discretionary items such as working capital changes, capital expenditures, dividends, acquisitions, etc.

Since CFO tends to be more volatile than FFO, FFO is frequently used to smooth inter-period changes in working capital. Companies can more easily manipulate working capital due to liquidity or accounting needs; thus, FFO is seen as a better representation of recurring cash flow generation. However, in cases where assessing changes in working capital is critical for evaluating a company’s cash flow generation capability and overall creditworthiness, analysts do not rely solely on FFO. For instance, in working-capital intensive industries such as retail, CFO might be a better indicator of the firm’s actual cash production than FFO.

FFO is a good measure of cash flow for well-established companies with high credit ratings. In such firms, greater analytical weight may be given to FFO and its relationship with total debt. FFO occupies an important place in ranking companies. Older and healthier companies generally have broader financing options to meet potential short-term liquidity needs and to refinance upcoming credit maturities. For firms with relatively lower creditworthiness, Free Operating Cash Flow (FOCF) may become more important, as this criterion is more directly related to current debt service capacity after accounting for various expense items such as working capital investments and capital expenditures.

Cash Flow from Operations (CFO)

The measurement and analysis of CFO can be particularly significant for companies operating in working-capital intensive industries or sectors where working capital flows can be volatile. Unlike FFO, CFO is calculated after the accounting for the effects of changes in operating assets and liabilities on income. CFO represents the cash flow available to finance items such as capital expenditures, debt repayments, dividend payments, and share repurchases.
In many industries, companies shift their focus to generating cash flow during economic downturns and recessions. As a result, even though they might typically produce less cash from ordinary business operations due to low capacity utilization and relatively low fixed costs, they may still generate cash by reducing inventories and receivables. Therefore, while FFO might be lower during such periods, the impact on CFO may not be as pronounced. Conversely, during periods of strong growth, a consistently lower CFO compared to FFO, absent a corresponding improvement in revenues and profitability, could indicate a problematic situation for the company.

Working capital is a crucial element of a company’s cash flow generation. Although companies may need to build working capital (and thereby consume cash) during periods of growth or expansion, changes in working capital during downturns can serve as a buffer. In many cases, companies will sell off inventories and invest less in raw materials during downturns, both of which can reduce the cash and capital tied up in working capital. Therefore, fluctuations in working capital can occur during both expansion and contraction phases, making the analysis of a company’s short-term working capital requirements important for predicting future cash flow developments.

In capital-intensive industries, working capital is generally lower. While capital expenditures predominantly focus on equipment and machinery, companies with lower fixed assets might be required to invest relatively more in inventories and receivables. This can also affect profit margins, as capital-intensive companies tend to have proportionately lower operating expenses (and hence higher EBITDA margins), whereas working-capital intensive companies usually exhibit lower EBITDA margins. This may result in significant cash flow volatility. In a capital-intensive company, where most investments have been made earlier, there is typically more capacity to absorb subsequent EBITDA volatility because the margins are higher. For example, even if a capital-intensive company’s EBITDA margin declines from 40% to 30%, it can remain reasonably profitable. In contrast, a working-capital intensive company with a 10%-lower EBITDA margin (due to higher operating expenses) may fall into negative EBITDA margins if EBITDA volatility is high.

Free Operating Cash Flow (FOCF)

By subtracting capital expenditures from CFO, FOCF is derived as a measure of the cash flow a company generates from its core operations. Firms may need to increase investments due to strong demand growth or technological changes. Additionally, companies regulated by legal frameworks may face significant investment requirements under regulatory mandates. A positive FOCF is a strong indicator for companies and can help differentiate between two companies with similar FFO levels.

In high capital-intensive industries (where maintenance expenses tend to be high) or in situations where companies have little flexibility to postpone capital expenditures, the FOCF/Debt ratio—considering potentially significant capital expenditures—can provide a more insightful analytical perspective than ratios such as FFO/Debt or Debt/EBITDA.

A company exhibiting relatively strong FOCF may do so due to declining fixed and working capital needs, even if its growth rate is low. Conversely, growing companies may exhibit weak or even negative FOCF due to the investments required to support growth. For a company with a low growth rate, even if FOCF appears positive, such high levels of cash flow may not be sustainable. For rapidly growing companies, however, if ongoing investments have not yet begun to yield cash returns, negative FOCF might not be indicative of long-term issues. In the latter case, if the impact of the growth-related investment is deemed temporary and does not result in an increase in the company’s leverage in the long run, the FFO/Debt ratio might provide a more accurate assessment than the FOCF/Debt ratio.

Unrestricted Cash Flow (UCF)

For companies that are primarily rated at an investable level, the UCF/Debt ratio can serve as an important indicator of future cash flow adequacy, as it more comprehensively reflects the company’s financial policy, including decisions regarding dividend payments and share repurchases. Furthermore, potential mergers and acquisitions may represent a significant level of cash utilization and thus constitute an important component of the cash flow analysis.
to reduce their dividends even under some liquidity pressure.

The amount and ratio of dividends to be distributed depend on a company's financial strategy. Companies with aggressive dividend payout targets may be reluctant to reduce dividends even under some liquidity pressure. Additionally, companies at an investment-grade level tend to have a lower tendency to reduce dividend payments, but ultimately, dividends are at the discretion of the company's management. UCF, while the most accurate indicator of cash flow, is also the most affected by management decisions and, therefore, may not reflect the current potential cash flow.