Question

Could you please help me solve problem E7-33. Assessing the Effects of Bond Credit Rating Changes
Ford Motor Co. reports the following information from the Risk Factors and the Management Discussion
and Analysis sections of its 2015 10-K report.

Credit Ratings Our short-term and long-term debt is rated by four credit rating agencies designated
as nationally recognized statistical rating organizations (“NRSROs”) by the?U.S. Securities
and Exchange Commission:
• DBRS Limited (“DBRS”);
• Fitch, Inc. (“Fitch”);
• Moody’s Investors Service, Inc. (“Moody’s”); and
• Standard & Poor’s Ratings Services, a division of McGraw-Hill Companies (“S&P”).
In several markets, locally-recognized rating agencies also rate us. A credit rating reflects an assessment
by the rating agency of the credit risk associated with a corporate entity or particular securities
issued by that entity. Rating agencies’ ratings of us are based on information provided by us and other
sources. Credit ratings are not recommendations to buy, sell, or hold securities, and are subject to
revision or withdrawal at any time by the assigning rating agency. Each rating agency may have different
criteria for evaluating company risk and, therefore, ratings should be evaluated independently
for each rating agency.
The following rating actions were taken by these NRSROs since the filing of our Quarterly Report on
Form 10-Q for the quarter ended September 30, 2015:
• On November 23, 2015, S&P affirmed its ratings for Ford and Ford Credit, and revised the
outlook to positive from stable.
The following chart summarizes certain of the credit ratings and outlook presently assigned by
these four NRSROs:

Ford Ford Credit NRSROs
Issuer
Default/
Corporate/
Issuer Rating
Long-Term
Senior
Unsecured
Outlook/
Trend
Long-Term
Senior
Unsecured
Short-Term
Unsecured
Outlook/
Trend
Minimum
Long-Term
Investment
Grade Rating
DBRS . . . . . . BBB (low) BBB (low) Positive BBB (low) R-3 Positive BBB (low)
Fitch . . . . . . . BBB2BBB2 Positive BBB2 F3 Positive BBB2
Moody’s . . . . N/A Baa3 Stable Baa3 P- 3Stable Baa3
S&P * . . . . . . BBB2BBB2 Positive BBB2 A-3Positive BBB2

*S&P assigns FCE a long-term senior unsecured credit rating of BBB, a one-notch higher rating than Ford and Ford
Credit, with a stable outlook.

a. What financial ratios do credit rating companies such as the four NRSROs listed above, use to evaluate
the relative riskiness of borrowers?
b. What economic consequences might there have been for Ford when S&P revised its outlook on the
company in November 2015?
c. What type of actions can Ford take to improve its credit ratings?

Module 7 Current and Long-Term Liabilities 7-38 E7-33. Assessing the Effects of Bond Credit Rating Changes Ford Motor Co. reports the following information from the Risk Factors and the Management Discus sion and Analysis sections of its 2015 10-K report. LO5 Ford Motor Co. (F) Our short-term and long-term debt is rated by four credit rating agencies desig- nated as nationally recognized statistical rating organizations ("NRSROs") by the U.S. Securities! and Exchange Commission: · DBRS Limited ("DBRS"); . Fitch, Inc. ("Fitch"); - Moody's Investors Service, Inc. ("Moody's"); and Standard & Poor's Ratings Services, a division of McGraw-Hill Companies ("S&P"). In several markets, locally-recognized rating agencies also rate us. A credit rating reflects an assess- ment by the rating agency of the credit risk associated with a corporate entity or particular securities issued by that entity. Rating agencies' ratings of us are based on information provided by us and other sources. Credit ratings are not recommendations to buy, sell, or hold securities, and are subject to revision or withdrawal at any time by the assigning rating agency. Each rating agency may have dif- ferent criteria for evaluating company risk and, therefore, ratings should be evaluated independently for each rating agency. The following rating actions were taken by these NRSROs since the filing of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2015: . On November 23, 2015, S&P affirmed its ratings for Ford and Ford Credit, and revised the outlook to positive from stable. The following chart summarizes certain of the credit ratings and outlook presently assigned by these four NRSROS: Ford Ford Credit NASROS

Answer 1

a) Credit rating companies use several parameters to evaluate the relative riskness of borrowers.Through credit rating these rating companies are assessing the credit worthiness of a particular company/institution on its ability to repay the debt amount on the maturity date or the date mentioned on the contract.Credit rating agencies like the four NRSROs use various financial ratios to assess the credit rating of companies such as:

• Liquidity Ratios:This ratio determines the ability of a firm on how quickly they can convert their assets to cash.Its used to determine the ability of the issuer to pay the short term debt.The commonly used ratios are current ratio and quick ratio.
• Profitability Ratios:This helps to determine how profitable the business is.If the issuer is profitable, it can pay the interest to the bond holders.Gross profit Margin and Net Profit Margin can be used
• Leverage Ratios:While liquidity ratio looks at short term obligations Leverage ratios takes into account Long term obligation risk.Debt/EBITA is the most common ratio used by credit rating agencies in this category.The higher the ratio the more the credit risk.Debt/Asset ratio is another ratio used which indicates the ratio of the total debt of a company to its assets.It helps to understand how leveraged the business is.
• Coverage ratios:Last but not the least is coverage ratios which helps in determining the ability of the issuer to pay off the interests to the bond holders on a timely manner as per the contract.The most commonly used ratio is Interest coverage ratio which is EBIT/Interest Expense which explains the ability of the company to cover the interest expense.

b)As mentioned,S&P provides Ford a rating higher than Ford and Ford credit ,BBB+ which is within the investment grade which is considered to be still safe to invest than the speculative range which is BB and below.An improvement in the credit rating will help the company in different ways.It will result in increase in the share price of the company.

c) Event hough BBB+ is considered to be investment safe, its still the lowest in investment grade section by the investors. When a company's credit rating goes down,Its an indicator of increasing credit risk to the borrowers.This will result in investors not willing buy a bond and will invest their their money in more safe haven instruments.They should look at improving their financial strength and the ratios mentioned above.The borrowers also should be paying off the interests to the investors on a timely manner.The business strategies and decisions taken by them also will have a direct impact on the financial performances of the company which will impact the credit worthiness of the issuer.And finally the economic cycle or the overall market will have an indirect impact on it.