Sponsor covenant (1) Credit assessment techniques (financial metrics…
Sponsor covenant (1)
Credit assessment techniques
assessment of the business outlook in general and of the sponsor's specific sector
cheap to obtain
difficult to quantify
Financial statistics and accounting rations, such as interest cover and gearing/ leverage can be compared both
with similar companies
with previous years to spot any trends, particularly deterioration
PPF use sponsor covenant ratings based on financial metrics to estimate the likelihood of short-term insolvency.
does not give an indication of the absolute level of risk
access to management accounts required (not publicly available)
implied market default risk
where a sponsor has issued investments such as equities or bonds, the market prices of these investments can indicate how the market views the sponsor's credit risks and how these change over time.
excess of the yield over gov bonds
mathematical models used to determine the relationship between a company's equity and debt to derive a cost of default
Treats the value of a traded equity as the excess value of its business less its debt
Models credit quality as a function of the relative amounts of equity and debt and the volatility of the underlying business
market prices also determined by liquidity risk, supply and demand and risk appetite of investors
Risk to a pension scheme will differ from implied market default risk due to a number of factors including differences in priority and/ or security provided
only larger companies tend to have full credit ratings
coverage wider than for implied market default risk method
companies pay specialist agency to provide them with credit rating
Merton-type credit risk models
where a sponsor has traded equities, a model can be used to determine the probability of default based on the behaviour of the equities.
not widely available
quantitatively derived credit risk
model deriving a credit rating or probability of default from standard corporate accounting data, augmented by confidential credit information from credit bureaux and/or commercial banks.
relies on accounting information updated annually in arrears
up-to-date info not easily available
independent business review
report by external credit advisory specialist
typically an accounting form, insolvency practitioner or other specialist
take explicit account of the interdependence of funding and sponsor convenant
help trustees determine how much the sponsor can afford.