We are improving the Total Debt calculation used in our Credit Ratings for all companies under coverage. Specifically, we are updating the calculation to use Carrying Value of Debt instead of Fair Value of Debt.
This update allows us to provide more accurate measures of a company’s creditworthiness. Prior to this change, using the fair value of debt in our Total Debt calculation created two related issues:
- Companies under threat of bankruptcy could appear more credit worthy, as the fair value of their debt drops and, in effect, understates the true claims on the company’s future cash flows.
- The fair value of the debt for companies whose debt trades at a premium overstates the claims debtors have on cash flows and makes some of the metrics that drive our credit ratings look worse.
By updating our Total Debt calculation to use carrying value of debt, we more accurately represent the debt a company actually owes, not what the market would pay for that debt.
For instance, if a company borrows $100, and the fair market value of the debt is $50, the company still owes the $100 and pays interest on that $100 value. Conversely, if a company borrows $100, and the fair market value of the debt is $150, the company does not owe more than the $100 plus interest. By making this update, we ensure our Credit Ratings are not impacted by the swings in fair market values for debt.
As a result of this change, Credit Ratings will be:
- worse for companies with a fair value of debt significantly below carrying value, and
- better for companies with a fair value of debt significantly higher than carrying value of debt.
We expect this update to affect our Credit Ratings as follows:
- improved one level for 5 companies.
- worse by one level for 51 companies.
We expect these changes to be live in our Credit Ratings on 8/25/23.
This article was originally published on August 21, 2023.
Disclosure: David Trainer, Kyle Guske II, Hakan Salt, and Italo Mendonça receive no compensation to write about any specific stock, sector, style, or theme.
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