Chp Methodology

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Credit Health Panel

The Methodology for Determining A Relative Credit Health Score NOVEMBER 2013

S&P Capital IQ Global Markets Intelligence Introduction The Credit Health Panel [CHP] is a workflow tool designed to aid the evaluation the credit worthiness of a chosen company [Focus Company] relative to a unique group of industry peers1. The key analytical element of the CHP tool is the relative credit health score [CHP Score]. The CHP Score is a relative quartile ranking [Top, Above Average, Below Average and Bottom] that expresses the credit worthiness of the Focus Company relative to its unique peer group. The CHP scores are delivered at three levels for each Focus Company:

Overall Score for the company Financial panels scores [Operational, Solvency, Liquidity panels] Fundamental metrics scores2 Utilizing standardized fundamental data from publicly available financial statements3, CHP applies a proprietary peer group calculation and scoring methodology to determine the CHP Scores for a Focus Company relative to its unique peer group. This paper explains the data and the methodology for determining CHP Scores.

Data CHP uses standardized fundamental data sourced from Capital IQ, a Standard & Poors business. This data set includes companies that are rated by Standard & Poors Ratings Services as well as those that are not.

Standardized Data From Capital IQ Financial statements are standardized from reported financial statements via the Capital IQ proprietary methodology to align them in a format that can be compared across industry groups, accounting standards and national boundaries. For example, standardization allows users to compare revenue reported by an aerospace and defense company with revenue from an auto manufacturer.

1 The Credit Health Panel is independent of the Standard & Poors credit ratings organization and the relative credit health score (CHP Score] is not a credit rating. The Credit Health panel is provided by S&P Global Markets Intelligence which is analytically and editorially independent from any other analytical group at Standard & Poors, including Standard & Poor's Ratings Services. 2 The approach used at the fundamental metric-level, is based on a relative ranking system that uses the mean and standard deviation rather than the quartile approach. 3 As sourced from Capital IQ.

The Methodology for Determining A Relative Credit Health Score | November 2013


Selecting The Core Universe For CHP We screen the Capital IQ data for non-financial companies that have filed public financials within the past two years, and utilize only companies that meet that criterion.

We normalize the last twelve month [LTM] financials of the Focus Companys peer group to the Focus Companys reporting currency by using the spot exchange rate.

In addition, we exclude companies that do not meet certain data quality and availability thresholds.

Currency To enhance comparability for purposes of CHP, we convert the financial statements of the Focus Companys GICS peer group universe to the Focus Companys reporting currency by using the spot exchange rate.

Coverage The Credit Health Panel data set of more than 210,000 companies includes companies that are rated by Standard & Poors as well as those that are not. The coverage is depicted on a regional basis in the following table:

Global Credit Health Panel Coverage by Region as of November 6, 2013

Americas APAC EMEA Total Rated Entities 2,340 1,023 759 4,122

Non-Rated Entities 6,837 19,476 179,580 205,893

Total 9,177 20,499 180,339 210,015



Methodology Components The CHP Score methodology consists of three components:

1. Creating a unique peer group for the Focus Company 2. Performing comparisons of fundamental metrics within the peer group 3. Applying an iterative scoring methodology at the fundamental metric-, panel- and company-levels

Component 1: Creating A Unique Peer Group For The Focus Company The Focus Company can be compared to a GICS based peer group or a custom peer group as defined by the user.

S&P GICS Based Peer Group We determine the set of CHP Scores for the Focus Company by comparing it to a group of close peers. Starting from a basis of the Focus Companys industry peers, we isolate a group of similarly-sized peers by determining where the Focus Company sits within the industry universe based on a financial ranking criterion.

The Industry Peer Group Universe The initial universe is based on the Focus Companys eight-digit Global Industry Classification Standard [GICS] code. [The GICS code classification corresponds to a business or industrial activity such as Oil & Gas Drilling or Wireless Telecommunication Services.]

The Financial Ranking Criterion We rank the GICS universe based on the average of last 12-month [LTM] revenue and EBITDA4 to determine where the Focus Company ranks within its industry. This criterion is useful because its data components are widely available, readily comparable and easy to interpret. For private companies [we are not changing the logic for Public companies]: If the company has Revenue but not EBITDA we use [Operating Income + D&A] from the Income Statement for EBITDA and use the existing methodology.

Constructing The Focus Companys Unique Peer Group We then select a unique peer group from the companies that are closest to the Focus Companys position in the ranked universe. A Focus Companys peer group comprises the next 20 higher-ranked companies, if available, and the next 20 lower-ranked companies, if available, as follows:

If the Focus Company is ranked at the top of its GICS code universe, then its unique peer group comprises the Focus Company and the next 20 lower-ranked companies for a total of 20 peers.

If the Focus Company is ranked second from the top of its GICS code universe, then its unique peer group comprises the Focus Company, the one higher-ranked company and the next 20 lower-ranked companies for a total of 21 peers.

If the Focus Company is ranked somewhere in the middle of its GICS code universe, then its unique peer group comprises the Focus Company, the next 20 higher-ranked companies and the next 20 lower-ranked companies for a maximum of 40 peers.

If the Focus Company is ranked at the bottom of its GICS code universe, then its unique peer group comprises the Focus Company and the next 20 higher-ranked companies for a total of 20 peers.

4 EBITDA = Earnings Before Interest, Tax, Depreciation and Amortization.



Therefore, a Focus Companys unique peer group could consist of a minimum of 5 companies and a maximum 41 companies [including the Focus Company itself]5.

Creating a Custom Peer Group A custom peer group can be constructed by using the Credit Health Panel advanced search function to screen and select companies for a group that will be most relevant for your analytical needs. The advanced search provides multiple criteria such as geography, industry, ratings and functional metrics used by the Credit Health Panel.

Component 2: Performing Financial Comparisons We utilize a set of fundamental metrics to analyze a companys relative credit health. These metrics form the basis for consistent financial comparison among the constituents of a unique peer group.

We measure a Focus Companys credit health from three main perspectives: ability to generate income, ability to manage its balance sheet, and ability to repay its debt obligations on time. We selected a total of 24 fundamental metrics to use to perform financial comparisons. These fundamental metrics are grouped into three equally weighted panels:

Operational-related metrics The fundamental metrics we selected are useful in analyzing a Companys ability to generate sustained profits from primary business operations and its resilience against impact on earnings or cash flow measures. Please refer to the Operational-Related Fundamental Metrics table in Appendix for the list of operational related financial metrics.

Solvency-related metrics The fundamental metrics we selected are useful in analyzing ability of a Companys cash flow and operating profits to meet periodic interest payments and pay total financial leverage. These fundamental metrics also analyze the Companys capital structure to measure degree of reliance on external financial capital. Please refer to the Solvency-Related Fundamental Metrics table in Appendix for the list of solvency related financial metrics.

Liquidity-related metrics The fundamental metrics we selected are useful in analyzing a Companys ability to repay its debt obligations on time and to mitigate unforeseen contingencies. Please refer to the Liquidity-Related Fundamental Metrics table in Appendix for the list of liquidity related financial metrics.

5 Should a GICS code consist of 41 companies or fewer, the peer group will include all companies within the GICS code. For more information, please visit: http://www.standardandpoors.com/indices/gics/en/us



Component 3: Applying An Iterative Scoring Methodology The Overall CHP Score is the result of an aggregation process. We first score metrics within each panel. We then aggregate those scores at each panel level [operational, solvency, liquidity]. And, lastly, we roll up the three panel-level scores at the company-level in order to generate the Focus Companys CHP Score, as illustrated in the following diagram:

Producing A Relative Ranking Score at the fundamental metric-level Scoring at the fundamental metric-level is performed by comparing the subject value with the mean value of the unique peer group. We express the distance of the subject value from the mean in terms of standard deviation. The resulting standard deviation is mapped to a score expressed as Top, Above Average, Below Average and Bottom and assigned a corresponding numeric value ranging from +2 to -2 as shown in the following diagram.

These numeric values are then used to perform aggregation at the panel- and company-levels.



Generating Scores At The Panel Level The numeric values of the metric-level are first aggregated at the panel-level, and then divided by the number of each panel constituents, to create an average at the panel-level.6

Panel Liquidity

Line Item [FFO + Cash] to Short Term Debt FFO to Gross

Profit Basic Defense

Interval Current Ratio Quick Ratio

Score Top Top Above Average Below Average Bottom

Numeric +2 +2 +1 -1 -2

We perform the above-mentioned process for each company in the unique peer group, for each panel separately [operational, solvency and liquidity]. This exercise produces 3 sets of numeric panel-level values across the group. We then rank these sets within the unique peer group, and apply a quartile-based scoring logic to the resulting values:

The resulting rank is transformed into a score expressed as Top, Above Average, Below Average and Bottom depending on the corresponding quartile of the rank distribution, and assigned a corresponding numeric value ranging from +2 to -2 as shown in the following diagram.

Tie-breaker Rules At The Panel Level CHP maintains an equal number of companies in each quartile, in order to avoid unwanted skewing of the distribution of the companies across the quartiles. To this purpose, when the normal ranking process would concentrate more companies in a specific quartile [and too few in another], CHP looks at specific tie-breaker ratios, that will resolve the ties, and redistribute companies across different quartiles more evenly.

6 Note: The numeric values shown in the table are not displayed on the CHP. The numeric values are used solely to aggregate the scores.



The tie-breaker ratios considered for each panel are the following:

Panel Tie-breaker line item Priority Impact on Score

Operational

Gross Profit/Revenue 1 Positive

EBITDA/Revenue 2 Positive

Return on Capital 3 Positive

Net Working Capital/Total Assets 4 Positive

Total Revenue 5 Positive

Solvency

Total Debt/Capital 1 Negative

FFO to Total Debt 2 Positive

Net Debt to EBITDA 3 Negative

Total Debt/Total Revenue 4 Negative


Liquidity

(FFO+Cash)/Short Term Debt 1 Positive

Quick Ratio 2 Positive

Current Ratio 3 Positive

Basic Defense Interval 4 Positive


Overall

Total Debt/Capital 1 Negative

EBITDA/Revenue 2 Positive

Quick Ratio 3 Positive

Net Working Capital/Total Assets 4 Positive


The methodology starts from the top quartile, ensuring that there are exactly [floor [n / 4]] companies; if there are less than [floor [n / 4]] companies, it will look at the relevant tie-breaker ratio for the companies in the rank immediately below, and will move the top ranked companies to the top quartile, until the top quartile contains exactly [floor [n / 4]] companies; the converse will happen when there are too many companies in the top quartile. The process is repeated then for the next quartiles, ensuring there are always [floor [n / 4]] companies; the remainder out of the [floor [n / 4]] companies is evenly redistributed in the lowest quartiles. So, for example, if there are a total of 14 companies including the focus company, then [floor [n / 4]] = 3 and the quartiles will contain [from top to bottom quartile] 3, 3, 4, 4 companies.



Generating Scores At The Company Level To generate a score at the company level, we start from the 3 individual panel-level values and average them to determine an overall numeric value for each company. We then rank these values for all companies within the unique peer group, and apply the quartile-based scoring logic to the resulting values.

Tie-breaker Rules At The Company Level In analogy to what is done at the panel level, CHP maintains an equal number of companies in each quartile, also for producing the final score at the company level, avoiding unwanted concentration of companies in specific quartiles. The methodology followed is similar to what described in the paragraph Tie-breaker Rules At The Panel Level, and it is applied to the following tie-breaker ratio.

Total Debt / Capital [x]

The Focus Companys CHP Score The result of the final ranking exercise determines the Focus Companys relative or overall Credit Health Score [CHP Score] and the panel level scores are expressed as a quartile based ranking: Top, Above Average, Below Average and Bottom.

Furthermore, within each panel [Operational, Solvency, and Liquidity] the Focus Companys fundamental metric values are provided along with the corresponding peer group average. Moreover, the weight of each fundamental metric contributing to the overall score is reported.

Conclusion The CHP seeks to provide a consistent, quick snapshot of a companys relative financial performance vs. a unique group of peers or companies. Therefore, we calculate fundamental metric-, panel-level and company-level CHP scores programmatically using Capital IQ financials adjusted using a proprietary methodology. This programmatic approach is designed to keep the score calculation free of opinion. For example, CHP scoring intentionally excludes the type of adjustments that Standard & Poors credit analysts make to financial statements when doing credit analysis.



Appendix

Ratio Definition Description Impact on Score

Operational-Related Fundamental Metrics

Size: Resilience against impact on earning or cash flow measures

Total Revenue Total Revenues or Turnover [The gross amount of funds generated from sales]

Indicative of company size. Larger companies are often able to better withstand adverse impacts to revenue.

Positive

Total Equity Total Equity Indicative of company size and capital cushion before debt holders are affected. Also points to capacity to add leverage.

Positive

Profitability: Ability to generate earnings that could translate to better cash flow generation

Return on Capital [%]

EBIT / [Total Equity + Total Debt + Deferred Tax Liability Non Current + Deferred Tax Liability Current]

A measure of the company's ability to generate operating profit from capital

Positive

Recurring Earnings/ Total Assets [%]

EBIT / Total Assets A company's operating profit relative to its total asset base

Positive

Net Working Capital/ Revenue [x]

Net Working Capital / Total Revenues

Receivables and inventory on hand to cover payables, scaled by revenue to account for size of company

Positive

Operating Efficiency: Indicates likelihood of generating sustained profits from primary business operations

Asset Turnover [x] Total Revenues / Total Assets A measure of how efficient a company is at using its assets to generate revenue/sales

Positive

Intangible Assets/ Revenue [x]

Total Intangibles / Total Revenues

A measure of a company's assets that cannot be easily converted to cash scaled by revenue to account for size of company

Negative

Net Working Capital/Total Assets [x]

Net Working Capital / Total Assets

A measure of operating efficiency in turning raw materials into finished goods and generating sales

Positive

Payables/ Receivables [x]

Accounts Payable, Total / Accounts Receivable, Total

A measure of a company's ability to delay payments to suppliers relative to its ability to collect payments from customers

Positive

Management Rate Of Return [%]

EBIT / [Net Property, Plant and Equipment + Net Working Capital]

A measure of how well a company is utilizing its fixed assets [net of depreciation and amortization] plus net working capital to generate operating profits

Positive

Gross Margin [%] Gross Profit / Total Revenues Gross marginthe profit margin from sales generated in primary business after cost of goods sold

Positive

EBITDA Margin [%] EBITDA/ Total Revenues EBITDA marginthe profit margin from sales generated in primary business after cost of goods sold and selling, general and administrative expenses

Positive




Solvency-Related Fundamental Metrics

Cashflow ProtectionInterest: Ability of cash flow and operating profits to meet periodic interest payments

FFO Interest Coverage[x]

[Cash From Operations - Net Cash From Discontinued Operations] / [Interest Expense, Total]

A measure of a company's available cash on hand that can be used to pay its current debt obligations [interest expense]. Typically industry-specific levels and/or company-specific indentures, loan documentation, etc. will determine thresholds for debt acceleration and/or default. A value less than 1 indicates inability of the company to pay financial interest with closest measure to cash on hand.

Positive

EBITDA/Interest Exp [x]

EBITDA / [Interest Expense, Total]

A measure of a company's available indirect cash from operations that can be used to pay its current debt obligations [interest expense]. Typically industry-specific levels and/or company-specific indentures, loan documentation, etc. will determine thresholds for debt acceleration and/or default. A value less than 1 indicates inability of the company to pay financial interest with closest measure to indirect cash from operations.

Positive

Cashflow ProtectionLeverage: Cash flow measures of ability to pay total financial leverage

FFO to Total Debt [x] [Cash From Operations - Net Cash From Discontinued Operations] / Total Debt

A measure of a company's available cash on hand that can be used to pay its debt obligations [a proxy for debt amortization]. Typically industry-specific levels and/or company-specific indentures, loan documentation, etc. will determine thresholds for debt acceleration and/or default.

Positive

Net Debt/EBITDA [x] [Total Debt - Total Cash and Short Term Investments]/ EBITDA

A measure of net debt obligations [a proxy for debt due less cash on balance sheet] relative to a company's available indirect cash from operations. Typically industry-specific levels and/or company-specific indentures, loan documentation, etc. will determine thresholds for debt acceleration and/or default.

Negative

Capital Structure/Indebtedness: Degree of reliance on external financial capital

Total Debt to Capital [%]

Total Debt / [Total Equity + Total Debt + Deferred Tax Liability Non Current + Deferred Tax Liability Current]

An indicator of the company's financing structure. This ratio indicates leverage - the proportion of the company's capital that is financed by debt.

Negative

Total Debt/ Total Liabilities [%]

Total Debt / Total Liabilities A measure of the proportion of debt relative to other liabilities. A lower number would indicate periodic cash flows would get diverted toward paying liabilities other than debt. A higher ratio is therefore desirable for bond holders.

Positive

Total Debt/ Revenue [x]

Total Debt / Total Revenues An measure of the company's debt relative to its total revenue

Negative




Liquidity-Related Fundamental Metrics

Liquidity: Flexibility available to pay short term obligations and/or mitigate unforeseen contingencies

[FFO + Cash] to Short Term Debt [x]

[[Cash From Operations - Net Cash From Discontinued Operations] + [Total Cash and Short Term Investments]] / [Short-Term Borrowings + Current Portion of Long-Term Debt + Finance Division Debt Current]

A measure of a company's most liquid cash assets [cash on hand and period-generated cash flows] to meet short term financial obligations

Positive

FFO to Gross Profit [x] [Cash From Operations - Net Cash From Discontinued Operations] / Gross Profit

Cash generated through primary business operations relative to revenues less cost of goods sold

Positive

Basic Defense Interval [days]

[[[Total Cash and Short Term Investments + Total Receivables + Finance Division Accounts Receivable + Finance Division Cash and Cash Equivalents + Finance Division Short Term Investments] / [Other Operating Expenses, Total + Interest Expense +Income Taxes ]]] * 365

The number of days a company can cover its obligations with available cash, cash equivalents and receivables.

Positive

Current Ratio [x] Total Current Assets / Total Current Liabilities

Measure of the current assets available to cover current liabilities

Positive

Quick Ratio [x] [Total Cash and Short Term Investments + Total Accounts Receivable] / Total Current Liabilities

Measure of the liquid current assets available to cover current liabilities

Positive



Important Disclosures When CHP Scores are refreshed The CHP scores are regenerated daily.

CHP Scores are not comparable to Standard & Poors credit ratings Please note that CHP scores and rankings are not credit ratings and the results should not be compared to Standard & Poors credit ratings. Any correlation or contradiction between the two is coincidental. The Credit Health Panel is provided by S&P Global Markets Intelligence which is analytically and editorially independent from any other analytical group at Standard & Poors, including Standard & Poor's Ratings Services.

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