Highly Rated

What Does a Rating Really Represent?

At Standard & Poor's, om ratings are meant to be an indication of the LkeW10od that a company will repay its debt on time. Our ratings also give some weight to the issue of ultimate recovery, but the key criterion is timeliness.

The overall credit risk is a combination of the business risk and the financial risk of the firm we are rating. The business risk, which accounts for two-thirds of our evaluation, is a composite of the risk prevalent in, say, the mining industry, and of the firm's position with.in that industry. More about that later.

Once assigned a rating, a company is in effect placed on a global scale that facilitates comparisons across industries and cow1tries. The rating has become an essential tool not only for raising capital but also a key component of cross-industry benchmarking.

Standard & Poor's rating scale goes from AAA - corresponding to "rock-solid credits", no risk at all - clown to D, which means default. We add "+" and "-" to each category so that the scale has 20 notches in all. The last investment-grade category is BBB. The risks of default (a late or non-payment of interest or principal) go up very quickly as one enters the speculative-grade range, from BB to CCC. For example, an investor buying into a portfolio of bonds all rated double by Standard & Poor's should expect, based on historical evidence, to be paid back on time in 80% of cases after 15 years.

In other words, we still expect companies to perform well in a great majority of cases, even in some of the speculative grades.

It is also worth noting what Standard & Poor's ratings do not represent. The most usual warning we give is that our ratings are not a recommendation to buy or sell securities. Likewise, we are not advising a company's management on what strategy they should follow. Ratings are not a guarantee against fraud, are not an audit and are not driven only by financial ratios.

Who Needs a Rating?

Any company that is seeking to raise capital in the forn1 of a capital market bond issue, a syndicated bank loan or an international private placement can make use of a rating. Historically, it is the dominance of the US capital market that made ratings often essential to successfully raise capital. However, in Europe and the rest of the world, ratings are also becoming one of the most efficient ways of raising a group's international profile and managing counter-party relationships. For example, in mining and other project-based financing environment, ratings are often needed to demonstrate a firm's creditworthiness at the bidding stage.

The Rating Process

First, a team of the analyst will visit the company and prepare a rating presentation to the committee that will vote and assign the rating. The issuer is in control throughout the process and can decide to keep the rating confidential, except if making a public issue in the US. Once the rating is public, however, it can go up as well as down, and we will insist on on-going surveillance, including yearly face-to-face meetings, to maintain the rating's accuracy.

The committee will consider both the business risk and the financial profile of the company. The key driver will always be a business risk. Once a business-risk score is agreed upon, the financial characteristics are looked at. In short, this second part of the exercise mainly consists of answering two questions: "Just how much debt is the company going to take on? And how much cash flow doe it generates to service the debt?" In this context, a long track record of tight financial management and adherence to an announced financial policy goes a long way towards convincing Standard & Poor' that a higher rating may be justified.

The Mining Industry

Standard & Poor's considers the mining industry and mining companies as presenting a high degree of risk relative to other areas (such as utilities). The mining industry is characterised by the risks inherent in constructing and starting a new mine, uncertainty regarding the consistency of an ore body and technical operations. In addition to these concerns, the cyclical nature and heavy ongoing capital expenditure requirements of this industry also contribute to increasing its risk profile. Moreover, when a single-mine -site project, as opposed to a mining company, raises debt, it introduces incremental risks such as a lack of geographic and mineral diversity and limited financial flexibility.

However, high ratings can be achieved thanks to potential mitigating factors, such as having a conservative financial structure, a large and mature asset base, reserves with low producing costs, good diversity and a strong track record - for us, these are the keys to success.