Credit rating can simply be defined as an organisation being able to pay back its debts which are based on its history of borrowings, such as loans, repayment or other financial resources available to it as well as its assets in relation to its liabilities (Wikipedia:2009). This is usually done by a credit rating agency such as Standard & Poor's (S&P), Moody's or Fitch Ratings. All of these agencies have their different rating system. Moody's for example has its ratings from excellent which is from AAA to poor, C: "AAA, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C" (Wikipedia:2009). Any rating above Baa grade still guarantees safety on investment but below it is a speculative grade.
1.2 REASON FOR THE DOWNGRADE OF SONY CORPORATION
One of the companies recently downgraded by Moody's is Sony Corporation. Sony is a Japanese based company, ranking one of the tops in electronics, video, communication, financial services and games. It was recently downgraded on the 27th of May, 2009 after its last downgrade by Moody's in 2005 from an A2 to A3, though it is still a good investment rating.
For an organisation to be downgraded the credit rating agency must have compared its result in that year with its previous year or years and seen a difference in ratios and the organisation has defaulted in their obligations. For Sony, Moody's cited a slow growth as compared to its previous year end, price declines and a strong yen as the reason for its downgrade.
Fig1.1 (Source: Sony's Financial Report, p37)
Evaluating the five year financial statement of Sony, it is obvious that they have inquired a loss from the Net Income value and ratios in 2009 as compared to 2008. In Howard Stringer's, CEO Sony Corporation, message (2009:9), he explained: "The global economic crisis, combined with the pronounced strength of the yen, significantly the health of our operating results - and those of many other companies - with a speed and ferocity that were unparalleled in recent history". This shows that the global economic crises have led to the loss of the year.
According to CedMagazine News (27th of May 2009), it says that Moody's cited concerns about the declining rate of electronics demand and competition from its other kind in the same market. It also says that the U.S. credit rating agency explained the effect of the global recession is the reason for a significant slowdown in demand of Sony's major electronic products(CedMagazine, 27th, May 2009). Due to this crisis, Sony has cut 4% of its workforce. This might have led to the low productivity of goods and reduction in sales for the year. From the report, cash acquired from operating activities have reduced by 46% compared to the previous year implying that sales have also gone down. Also, since individuals are trying as much as possible to cut down cost, Sony may not be making as much sales as they were before the crises. Also Moody's might have downgraded the organisation because its performance was deteriorating compared to its previous year. Comparing its return on capital employed, though the previous year wasn't fantastic, it reduced from 2.94% to 0.8%.
Sony on the other hand has started an aggressive restructuring on the organisation. One of such restructure is the merger with sharp on the construction of LCD panels. But according to Moody's analyst, Yoshio Takahashi in the Financial Times explains that even after Sony's reforms it might restore the organisation to its past profitability and Sony would be fast with intense completion from other companies of its kind (Financial Times,27th of May 2009).Also, it is obvious from the consolidated report given below that Sony was hit by the strong value of the yen making the total net loss of Y99bn for the year 2009 and anticipates another net loss of Y120bn in the next fiscal year due to the cost of restructuring (Financial Times,27th of May 2009).
Fig 1.2 (Source: Sony's Financial Report, p4)
Total word count (Section 1: 672)
2.1 IMPACT OF LOWERED CREDIT RATING IN THE FINANCING OF A FIRM
There are different sources of finance for organizations ranging from ordinary shares (equity), preference shares, debentures, loans, overdraft etc. Credit ratings are of high importance and relevance in financial markets in terms of business practices and regulatory requirements as it affects the financing of organizations whether positively or negatively. The lower the rating of a firm the difficult it becomes to raise funds or capital. Organisations that are rated by a credit rating agency tell investors about the quality or probability that the initial value and interests will be paid in full and on time. If a firm has been downgraded usually but not all cases, give a bad impression to its investors, thereby making sources of finance through bonds or shares difficult.
When an organisation is downgraded, it is penalized by "rating triggers" i.e. higher interest payments and its present source of financing becomes expensive. According to Scott S. (1986), he explained that the price of an ordinary stock is not affected by a change in credit rating but on preferred stock of the company. He also explained that this would affect smaller business as they provide limited sources of information to their investors. Weinstein (1977) also explains that the returns on corporate bonds are not affected by changes in credit ratings. On the other hand, investors are at a risk of receiving a lower rate or nothing at all on their share value. Although, bond holders are entitled to their initial investment value and an interest, but due to the effect on the downgrade, the company might not be able to pay any of them.
An organization that has been downgraded will find it difficult to receive loans from banks as they also do a thorough check and validation on these companies. The lower the grade of the firm, the higher the risk that interest rate and initial value will not be paid back. They do a check on the firm to know its credit worthiness to know if it will be able to back the high interest rate and in good time. Firms don't just switch completely from non-bank sources of debt financing, instead they engage in more flexible plan such as bank covenants. This allows the bank monitor its affairs.
In 2009, from the financial statement, the gearing ratio has increased in 2009, 41.5% compared to the previous year which was 38.1%. This implies that the company has acquired more debts or higher interest rate which in turn is not good news for ordinary shareholders as they have little left over profit to share. Although, Sony was downgraded because of its slow growth which was due to the recession, it is positive that this would not affect its financial state. It plans to restructure to improve its operating efficiency to level up with its competitive markets and demands.
This is reported by the Deutsche Bank has also lowered its share price to 49% and cuts its recommendation from "buy to hold" blaming them for a high operating cost and this might have an adverse effect on its investors. Sony on the other hand has also been doing some restructuring in its business. This has led to the merger of Sharp and Sony in producing some electronics. This is expected to reduce operating cost of the business. As part of the reconstructing process, it has also decided to cut down the size of its manufacturing suppliers from 2,500 to 1,200 before 2011. This is anticipated to reduce operating cost by $5.3billion. Also, Sony recently announced that it has decided to cut 16,000 jobs and shut about approximately 10% of its 57 manufacturing facilities to reduce cost in this period of recession.
In conclusion, since Sony was downgraded because of its high operating costs and rate of demand for electronics have reduced, it will be best to keep cost at its minimum. Sony has realized that if it doesn't take these measures it might be recording another loss in the next fiscal year and be further downgraded, which is not good news for its shareholders. Mr. Nakagawa of Sony explained that "the following restructuring measures and other cost reductions are expected to reduce costs by more than 300 billion". He also said that the organization would focus on how to use its capital and make sure that general investments generate sufficient returns on capital. Although, some other analysts advised that it shouldn't only consider operating cost but development cost also.
Total word count (Section 2: 754)
Total Word Count (Section 1 & 2:1426)
