In this presentation, the speakers outline a credit‑rating methodology built around five financial metrics that together capture a company’s balance‑sheet strength, operating profitability, and cash‑flow health. The metrics are debt‑to‑capital and cash‑to‑debt (balance‑sheet focused), EBITDA‑to‑debt and interest‑coverage (income‑statement focused), and free‑cash‑flow‑to‑debt (cash‑flow‑statement focused). For each metric two versions are calculated: a "traditional" version that uses only the primary financial statements, and an "adjusted" version that incorporates additional information extracted from footnotes and other disclosures, a process the presenters claim is validated by Harvard and MIT research. Threshold bands derived from the traditional values define rating categories (very unattractive to very attractive). The adjusted values are then compared against these thresholds, producing a component rating scored 1‑5. All five component scores receive equal weight; the simple average (rounded to the nearest integer) yields the final credit rating. The talk walks through examples from Apple and General Motors to illustrate the rating calculation, and notes that the credit‑rating framework mirrors the firm’s equity‑rating system for consistency and ease of use.
Chapters
When we were thinking about what particular metrics we wanted to focus on for the credit rating, we wanted to have metrics that really captured the entire business. So we wanted to look at the balance sheet, we wanted to look at the cash flow statement, we wanted to look at the income statement. We came up with these 5 particular metrics that we think accomplishes that. So if you think about something like debt-to-capital, we're looking at the total leverage of the company. How much debt do they have relative to the value of the equity? And then when you think about something like liquidity, we're looking at EBITDA, earnings before interest, taxes, depreciation, and amortization to debt, as well as free cash flow to debt. And then lastly, coverage. We're looking at cash-to-debt and interest coverage ratio. So when you look at these, debt-to-capital and cash-to-debt are really more balance sheet heavy type analysis, whereas EBITDA-to-debt and interest coverage ratio look at the income statement. They're concerned with operating profits and how they relate to the total debt as well as to the interest payments. And then free cash flow to debt is the cash flow type analysis. And all of these are relevant to the overall credit rating in their own individual way. We believe that they synchronize to give you the best picture of the total, the creditworthiness of the company as a whole, which was really what we were trying to capture. And that's why we chose these 3 categories and these 5 metrics. So there's 2 versions of each of those metrics that I just showed you. The first is the traditional version that is just using the balance sheet, income statement, and cash flow statement. So very basic. This is what we would compare to the data that you would get from traditional data providers. And what we presume is the data that most of the traditional legacy credit rating companies are using. And that goes back to what David was saying about how they weren't even encompassing off-balance sheet debt for a long time. So we're pretty confident that they are putting as much focus on getting additional information from the notes. The traditional version of each of those metrics is really the basic version. The adjusted takes the traditional and it adds all of our new constructs value add. So everything that we get from the notes, converting it to more of the core operations of the business. And really the adjusted is the data that was proven to be better. By Harvard and MIT. So the adjusted is what we use to dictate the actual rating. And I'll go into more detail about that on the next slide here. So this is an actual example from the website. I believe it's Apple. That's why everything's extremely attractive. But when you look at the credit rating on the website, you'll see that there's the 5 different metrics. And then you'll see bands for each of the underlying ratings. So looking at debt-to-capital, if they have a debt-to-capital that's greater than 0.75, they're going to receive a very unattractive individual component rating. And so on and so forth. Those bands are what we call thresholds, and those thresholds are determined using the traditional metrics. And I'll go into more detail about that in the next slide, but the actual values that you see at the very bottom there, those are adjusted metrics. So those have all the new constructs adjustments that make them improved upon versions of the traditional values. But the adjusted actual values are compared to those thresholds, and that's how you get the individual ratings for each one of these 5 metrics. But what I mentioned before there, so each one of those individual ratings gets a number, numerical number between 1 through 5, and that's related to the rating scale that you see on the left there. So it starts with very unattractive. Those get a value of 5, and then it goes, scales all the way up to very attractive, and those get a value of 1. That ultimately gets summed up and we do a simple average, and that simple average gets rounded to the nearest integer, and that is the value of the final rating that you see. So the example there on the right highlights that where if you had all of those individual components, they would sum up to the neutral rating. So what's a little bit easier is if you look at this slide, this is an actual example as of a few days ago. So hopefully GM, this correlates to what you would see today. But if you look at each one of their component ratings, so debt-to-capital is unattractive. The numerical rank would be 4. EBITDA to debt is neutral, so it'd get a 3. Free cash flow to debt is unattractive, so it'd get a 4, and so on and so forth. Cash to debt, 2. Interest coverage ratio, 2. If you add all of those up and you divide it by 5, you'd get an overall neutral rating of 3. That's just an idea of how to read this on the website and how we get the overall credit rating. One thing to note there is that each one gets equal weight in the total rating. We don't value one of these 5 metrics greater than the other. They all play an equal role in terms of what the actual final credit rating for the company is.
I think it's also important to point out for just a second here how, how this rating is set up to be very similar to our equity rating. That's on purpose. We're not trying to throw another design and product at you to make our products harder to use. We want to make it simple. Because the stock rating system is great and the credit rating system is equally excellent. And it's set up to be simple like that.
