1.    OVERVIEW AND SCOPE

This document outlines the JCR ER overall rating methodology and criteria for corporate companies other than financial institutions and public services. The criteria refer to process of determining Baseline Risk Profile (BRP), Stand-Alone Risk Profile (SARP), and Issuer Credit Rating (ICR). The criteria may vary depending on the industry in which companies operate and ensure that the analytical process is organized according to a common framework.

JCR ER assessment mainly takes into consideration these companies' business and financial bases and other related figures and factors that may affect and modify the SARP of the companies.

The criteria provide a general guidance about the assessments made by JCR ER for the SARP and ICR of a company and are more detailed in describing the factors used in analysis. The criteria also provide a specific guidance about how we use these factors. These principles are intended by JCR ER to provide the market with a specific structure that clarifies our approach to fundamental corporate credit risk analysis.

The business base includes the risk and return potential of a company by taking into consideration basically these factors; the industry risk in which it participates and entity positioning. Entity positioning covers the competitive conditions of the industry and competitive position of the company in the industry, the scale of the company, the diversification ability and capacity of the company, the efficiency and the profitability of the operations. The business risk profile also affects directly the financial risk profile of the company and provides the basis for the projected economic performance of the company.

The financial base is the result of management's decisions regarding its business base and financial risk tolerances. This requires considerations about how management seeks the company's funding and how it builds its balance sheet. This also shows the relation between the cash flows and its financial commitments. The leverage, coverage, profitability and efficiency variables are mainly used in the financial analysis to determine a corporate issuer's financial risk profile assessment.

JCR ER integrates the results of the business and financial risk profile analyses to obtain BRP. BRP can be modified with additional rating factors. These are known as modulators, and mainly driven by these factors: liquidity, debt structure, financial policy, corporate dynamics, environmental, social, and corporate governance, fine-tuners, and banking system risk records. These factors are assessed in 3 consecutive stages. First stage is liquidity assessment. Second stage is assessment about the debt structure, financial policy, institutional dynamics, environmental, social and corporate governance (ESG) and fine-tuners. Banking system risk records are the last analytical factors under the criteria to determine the final SARP on a company that may potentially modify the anchor conclusion. Especially the negative risk record in the banking system are analyzed in this stage. Following the modulator assessment, group, public and other external support, if any, are addressed in the scope of support assessment to reach the companies' ICR. In case of issuance of bonds/sukuk by the company, the Issue Rating (IR) is reached by taking into consideration the issue-specific evaluation criteria.

2.    GENERAL STRUCTURE OF CORPORATE RATING METHODOLOGY

2.1    Basic Framework

As a basic framework, the corporate analytical methodology organizes the analytical process and divides the task into several sub factors to consider all major issues. JCR ER analyzes the company's business risk profile, makes assessment about its financial risk profile, then combine those to determine a baseline risk profile, then analyzes by considering five modulator factors that may change the baseline profile. Finally, the assessment process is completed by carrying out support analysis consisting of public, group and external support.

A company's business risk assessment combines the analysis of industry risk and entity positioning analysis. Leverage, coverage, profitability and efficiency ratio analysis cover the company's financial risk profile.

The business risk profile consists of two key elements: industry assessment and entity positioning. It is a combination of qualitative and quantitative assessments. Qualitative assessments differentiate risk factors such as diversity level of product and/or service range of a company that is used to assess its diversification position. Quantitative information, on the other hand, deals with criteria regarding the size and efficiency of companies.

Financial risk profile analyses focus on quantitative factors and include leverage, coverage, profitability, and efficiency criteria.

Analysis then combines the business and financial risk profiles to determine BRP of the company.

JCR ER may alter the BRP using additional criteria named modulators. This process consists of 3-steps;

•    In the first step company’s rating may change in a positive way
•    In the second step company’s rating may change in a positive/negative way
•    In the third step company’s rating may change in a negative way

After the BRP has been determined, modulators are used to assign SARP. After determination of SARP, the ICR of the company is obtained as a result of the group, public or external support assessment, if available.

2.2    Business Risk Profile

Quite few factors reflect the ability of a company to resist competitive market pressure, such as its position on key markets, product and brand superiority and price influence. Preserving the high-level operating performance mostly depends on product diversity, the geographical distribution of sales, the diversity of customers and suppliers and competitive cost position. Size and scope may be an important factor if it gives significant advantages in terms of operational efficiency, economies of scale, financial flexibility and competitiveness. However, size of the company may not always result for higher ratings.

Crucial business risk profile factors cover a wide range of qualitative assessment and quantitative information, customized based on the industry specifications for each sector. Industry navigators include commonly observed or expected elements for a number of important corporate industries in order to provide insight on the application of the principles of Corporate Rating Criteria.

The consolidation of industry risk and entity positioning assessments determine a company's business base. Strengths and weaknesses of a company are crucial determining factors for its risk assessment. Strengths and weaknesses are closely related to a company’s capability to generate cash flows in order to cover its obligations on time.

Industry assessment, an integrated component of the business risk assessment, identifies the comparative functional interoperability of the markets in which a company operates.

Entity positioning assessment identifies the situation of a company with regard to the use of key drivers in the industry or to mitigate the associated risks more effectively, gaining a competitive advantage and a better business risk profile than those lacking or are more vulnerable to industry risk.

In order to get the business risk profile assessment output, JCR ER uses the combination of industry and entity positioning assessment results. Because company-specific assessments are deemed to more credibility, the business risk profile assessment depends on the comparative strength of entity positioning

2.3    Financial Risk Profile

The quantitative aspect corporate rating focuses on a company’s financial profile and its ability to meet its obligations from a combination of internal and external funds. In order to determine the strength of a debt servicing ability and funding capability of a company, both the historic, current and the forecasted figures shall be used in financial base assessments.

Financial analysis mainly based on leverage, coverage, profitability and efficiency criteria. Sustainability of cash flows from operations allows a company to increase internal resources while increasing the possibilities of acquiring external financial resources.

The financial metrics are not still used for the assignment of ratings in a particular way, as the same ratio (where applicable) may change among the different industries. Such as, an industry having low earnings volatility may handle higher leverage figures for a given rating than an industry having high earnings volatility.

The number of ratios considered in the financial risk profile assessment may vary based on the industry in which the company operate. The weights of the ratio groups and ratios considered in the analytical assessment may also differentiate depending on the industry.

2.4    Baseline Risk Profile Assessment

The BRP is a combination of business risk and financial risk profile assessments. The BRP is acquired through a matrix. Assessment matrix firstly consider the company's financial base assessment, if the financial base assessment is higher or equal to bbb, the baseline profile output is based on the comparative strength of its business base assessment. If the company’s financial base assessment is below from bbb then the baseline profile output is based on the comparative strength of its financial base assessment.

2.5    Modulator Assessment

After the BRP assessment, SARP of the company is formed by considering the 3-stage modulator assessment results. The first modulator stage is based on liquidity assessment. In stage 2, analyzes of companies' debt structure, financial policy, institutional dynamics, ESG and fine-tuners are performed. In the third and final stage consists of the assessments the company’s banking system risk records. Modulator assessments may have a positive or negative impact on the baseline risk profile assessment result. The modulator assessment may increase or decrease the baseline risk profile rating by one or more notches, or have no effect on the baseline profile in some situations.

Each assessment stage may change the baseline risk profile to a new interval as it progresses. In order to determine the next modulator effect on the baseline risk profile, the rating notch formed after each stage is considered and the same process is performed until the last stage. Also, for the notches below B-, JCR ER neglect the modulators for both positive and negative affect.

2.5.1    1st Stage Modulator Assessment

In the first stage, liquidity assessment is performed to measure the ability of the companies that are below a certain baseline risk profile to cope with stressful situations. Liquidity management focuses on company's liquidity status including current credit lines and controls regarding liquidity requirements during the year. One of the main drivers for liquidity assessment is the cash flows that are the key indicators of a company's liquidity buffer. Liquidity assessment includes qualitative analysis that handles the ability of the company to set against events with high-impact on company’s liquidity position, defensive interval period and available sources from banking system. The output of the liquidity assessment may result as on a scale of: 1; strong positive, 2; positive, 3; neutral.

2.5.2    2nd Stage Modulator Assessment

Second stage assessment includes debt structure, financial policy, corporate dynamics, ESG and fine-tuners elements.

By analyzing debt structure and assessing its risks, JCR ER consider relevant issues that are not typically captured by reviewing leverage and coverage levels. These factors include the risk of debt structure, the maturity and FX risk structure of debt, floating interest rate denomination and investments subfactor.

Financial policy assessment aims to understand and discover standard assumptions beyond the leverage and coverage analysis, debt structure and liquidity assessment analyses. These assumptions may not reflect the long-term financial policy risks of the company or capture them adequately. The financial policy assessment is a measure of the extent to which the financial decisions of management can improve predicted financial risk profile. The assessment includes issues such as dividend coverage ratio, fiscal discipline, fiscal policy framework and the company's risk appetite.

Institutional assessment (corporate dynamics) covers management and governance analysis, management's strategic competence, organizational effectiveness, risk management and how governance practices shape the impact of a company's competitiveness in the market, the strength of its financial risk management and the soundness of its governance. Stronger management on key strategic and financial risks can improve creditworthiness.

The next step involves the company's environmental, social and corporate governance (ESG) assessment analyzes. In the analyzes factors such as environmental legislation and regulations, environmental awareness, approaches to sustainability, the effects of changing social values and habits such as in the pandemic period, employee turnover rate, the flexibility level of labor costs are considered. In addition, the level of independence of the Board of Directors to fulfill its oversight function, the effectiveness of the main partners, risk-conscious professional management staff, the violation of the company's legislation / regulations, tax and other legal issues, and stable relations with regulatory authorities are other prominent criteria. Also, factors such as the company's ability to convey consistent messages to all stakeholders, public and relevant parties on important issues, the effectiveness and adequacy of the company's internal control system and processes, and its competence in providing corporate communication & transparency & rating documentation are discussed with in the analysis.

The final step for the second stage modulator assessment is the fine-tuners. JCR ER covers these issues under the finer-tuners; industry track record, transition period, industry trends, macroeconomic trend, contingencies, comparable analysis and event risks.

The output for the 5 different assessment criteria mentioned above may change between; 1, positive; 2, neutral; 3, negative.

The results obtained from each criterion are weighted to reach a final result for the second stage modulator assessment. The output of the second stage modulator assessment may result as on a scale of; 1, strong positive; 2, positive; 3, neutral; 4, negative; and 5, strong negative.

2.5.3    3rd Stage Modulator Assessment

The last step of the modulator assessment is the records of the companies in the banking system. After this assessment step, the Stand-Alone Risk Profile (SARP) is obtained. In particular, morality criteria have an important role in this step. The dud cheque records, overdue payments, compensated non-cash loans, re-structured loans and the high limit fullness ratio are the main factors considered in this assessment step. These records are mostly used to handle the negative situations faced by the companies. Output of this modulator step may change between; 1; neutral, 2; negative, 3; strong negative.

2.6    Support Assessment

Criteria considered within the context of support assessment outline JCR ER approach to determine impact of guarantees and other forms of supports on the rating(s) of a company and/or its securities. These criteria also outline JCR ER approach to guarantees provided by a government in respect of a government-related entity’s debt obligation. An assessment of the group members affiliated with the company and their main company is also included within the context of the criteria. This involves the group risk profile and the assessment of the company's status relative to other group members. The ownership, control, impact, or support for another entity have a substantial impact on credit quality of the company. The criteria also describe how potential support (or adverse impact) from group members or other external sources is addressed. 

Within the framework of support assessment, group support assessment is conducted firstly, and in the second stage public support assessment is performed. In the last stage, external support factors for speculative-grade companies are analyzed. After all these support assessments, the Issuer Credit Rating is obtained.

2.7    Issue Assessment

While the issuer's credibility, and thus the issuer's rating, is the most important component of the issue rating, several variables unique to the issue may lead the issue rating to diverge from the issuer's rating.

The main situations that may lead to this differentiation are given below.

•    The relative seniority of the issues in the event of default and bankruptcy and/or the existence of an issue-specific positively differentiated recovery process,
•    The credibility level of guarantors providing legal guarantees specific to the liability arising from issue,
•    The additional level of seniority and recourse benefits to be provided through statutory guarantees specific to liability, even in the event of bankruptcy and under other laws impacting the rights of creditors,
•    The credibility level of insurance companies issuing liability-specific policies,
•    Additional seniority and recourse facilities to be provided with liability-specific insurance policies,
•    Level of legally provided loan enrichment (for example, real estate collateral) specific to the liability,
•    Level of additional seniority and recourse benefits to be provided through liability-specific credit enhancement.

Issue ratings may be assigned as long-term or short-term form. If the maturity of the funding instruments issued (will be issued) is longer than 1 year, long-term, if it is 1 year or less than short-term is assigned.

2.8    Basic Criteria Used in Financial Analysis

Various quantitative metrics such as; cash flow, profitability, leverage and coverage ratios are used for the analysis of credit risk. The following sections summarize the key credit metrics used to analyze credit default risk. Earnings before interest, depreciation, and taxes (EBITDA) is the most extensively used metric of cash flow and frequently utilized in analysis, despite its some limitations. EBITDA is also the most commonly used measure in sustainability assessment. For this reason, EBITDA plays an important role in the probability of default analysis.

But considering the limitations of EBITDA, an important measure of cash flow, a number of other criteria are also used to assess ability of debt payment. These include Funds from Operations (FFO), Cash Flow from Operations (CFO), Free Operating Cash Flow (FOCF) and Unlevered Cash Flow (UCF), which are important criteria for measuring the ability to fulfill obligations. 

EBITDA

EBITDA is a widely used and for this reason quite comparable cash flow indicator, even though it has some limitations. Interest payments can be a significant cash outflow for speculative-grade companies and therefore EBITDA can materially overstate cash flow in some cases. It also serves as a useful and common starting point for cash flow analysis and is useful in ranking the financial strengths of different companies.

Funds From Operations (FFO)

FFO is a hybrid cash flow measurement that estimates a company's inherent ability to generate recurring cash flows from its operations regardless of working capital fluctuations. FFO measures the cash flow available to the company before working capital, capital expenditures, and discretionary items such as dividends, acquisitions, etc.

Because the Cash Flow from Operations tends to be more volatile than the Funds from Operations, the Funds from Operations are often used to smooth the period change in working capital. Because companies can more easily manipulate working capital depending on their liquidity or accounting needs, Funds from Operations are seen as a better representative of recurring cash flow generation. In addition to this, when assessment of fluctuations in working capital has an important role on assessment of a company’s creditworthiness and ability to generate cash flow, FFO isn’t the solely cash flow measure. For example, for working capital intensive industries such as retail trade, cash flow from operations can be a better indicator than the Funds from Operations that is company's actual cash generation.

FFO is a good measure of cash flow for well-established companies with high credibility. For such companies, more analytical weight can be given to the FFO and its relationship to the total debt. FFO has a quite important role in the relative ranking of companies.  Well-established companies generally have a wider range of financing opportunities to meet potential short-term liquidity needs and refinance upcoming loan terms.  For companies that has relatively low credibility, Free Operating Cash Flow (FOCF) can become more important. Since this criterion is more directly related to current liability service capacity, free cash flow after deducting various expense items such as working capital investment and capital expenditures can be analyzed.

Cash Flow from Operations (CFO)

The measurement and analysis of the Cash Flow from Operations may be especially important for companies operating in working capital intensive industries or industries where working capital flows can be volatile. CFO differs from Funds from Operations in that it is a cash flow calculated after accounting process of effect of company’s assets and liabilities’ changes on revenues. CFO is cash flow that is available to finance items such as capital expenditures, repay borrowing, and pay for dividends and share buybacks.

During recessions and downturns, in many industries companies shift their priority to cash flow generation. As a result, companies can produce cash by reducing inventories and receivables, despite the fact that they normally generate less cash through conventional business operations due to poor capacity utilization and relatively low fixed cost expenses. As a result, while FFO is expected to be lower during these periods, the impact on CFO can be minimal. In period of high growth, the reverse will be true. Consistently lower CFO compared to FFO despite increase in revenue and profitability can indicate an untenable situation for the companies.

Working capital is an important factor for a company’s cash flow generation. While there is a need to build up working capital and thus consume cash during periods of growth or expansion, changes in working capital can act as a buffer during downturns. Many companies will sell off inventories and invest less in raw materials due to poor business activity during downturns, both of which can reduce the amount of cash and capital tied to working capital.  As a result, working capital changes can occur throughout periods of both revenue growth and contraction, making it critical to assess a company's short-term working capital requirements in order to forecast future cash flow trends.

Capital intensive businesses have lower working capital generally. While capital expenditures are prominent on most equipment and machinery, companies with low fixed assets can have to invest relatively more in stocks and receivables. This also affects profit margins. Because capital intensive businesses tend to have proportionally lower operating expenses (and higher EBITDA margins), working capital-intensive businesses generally have lower EBITDA margins.  This can make the resulting cash flow volatility important. Since most of the investments are made upfront in a capital-intensive company, they have more room to absorb later EBITDA volatility generally because margins are higher. Such as, a capital-intensive company can remain reasonably profitable even if its EBITDA margin drops from 40% to 30%. On the contrary, a working capital-intensive company with a 10% lower EBITDA margin (because of higher operating expenses) can fall into negative EBITDA margins if EBITDA volatility is high.

Free Operating Cash Flow (FOCF)

Free Operating Cash Flow that can be used to quantify the cash flow generated by core operations is obtained by deducting capital expenditures from the CFO. Companies may need to increase their investments owing to strong demand growth or technological changes. Furthermore, regulated companies may be subject to considerable investment needs as a result of the restrictions. A positive FOCF is a powerful indicator for companies, and it can help distinguish between two companies with the identical FFO.

In highly capital-intensive industries (such as when maintenance expenses tend to be high) or where companies have little flexibility to defer capital expenditures, the FOCF/Debt ratio, which will consider also potentially significant capital expenditures, rather than criteria such as FFO/Debt and Debt/EBITDA, can provide a higher analytical foresight.

Due to diminishing fixed and working capital needs, a low-growth company may have a relatively high FOCF. in contrast, due to the investment required to support expansion, growth companies may have a low or even negative FOCF. This high amount of cash flow may not be sustainable for a low-growth company, even if the FOCF appears to be positive. Fast-growing companies, on the other hand, have the opposite problem. Negative FOCF results may not yield meaningful results until current investments start to turn into cash. ​​​​Instead of FOCF/Debt, FFO/Debt will give more accurate results, if the effect of investment in growth is considered temporary and does not cause an increase in the company's debt ratios in the long run in the second case.

Unrestricted Cash Flow (UCF)

Unrestricted Cash Flow/Debt, which more thoroughly represents a company's financial policy, including dividend payouts and share buybacks, can be a crucial predictor of future cash flow adequacy for the investment-grade companies. Furthermore, potential mergers and purchasing might represent a considerable cash outflow and are an important part of cash flow analyze.

The level of dividends depends on a company's financial strategy. Companies with aggressive dividend payout targets may be reluctant to reduce dividend, even under some liquidity pressure. Furthermore, investment-grade companies are generally less likely to reduce their dividend payments, but dividends are at the discretion of company management eventually. In addition to being most accurate indicator of cash flow, UCF, is the most affected criteria by management decisions and for this reason, may not reflect current potential cash flow available.