A common line of questioning that FHRX members have on our reporting is regarding the allocation of debt.
Our policy is to take debt as it is shown on the financial statements according to US GAAP accounting standards. If the line item in question is a form of borrowed capital that is shown in current or long term liabilities, we take it as debt. This includes related company loans, shareholder loans, convertible debt, and any otherwise unspecified liabilities that are due on demand. Our conservative rating methodology takes into account all debt that will have to be eventually repaid. Our methodology does not account for differences in repayment terms, convertibility, covenants or any other qualitative factors affecting the debt.
Although we do not account for qualitative factors in our conservative rating assessment, we strongly recommend that in conversations with customers who use RapidRatings' reporting, FHRX members should bring up any material qualitative factors regarding their debt burden. That information may provide important context to your company’s financial health.
Below are some specific debt items and our policies on their treatment:
1. Lease Liabilities:
Lease liabilities are treated as debt if they are not broken out into operating leases and capital leases on the balance sheet. If this line item is not broken out between operating and capital leases, then the FHRX member must provided a separate breakout showing the total, exact amounts of operating leases and capital leases for each period being rated.
2. Convertible loans:
Convertible loans are treated as debt, unless they have already been converted to equity. Convertible loans that may be converted to equity at some point in the future are still taken as debt. Prematurely treating convertible debt as equity would be giving a biased assessment of the company’s leverage situation.
3. Subordinated debt/shareholder loans/non-interest-bearing debt:
These types of debt are still treated as debt even though they often have more favorable repayment terms. We treat all debt the same way in our analysis, so there are no tranches of different debt types on our reports - we do not exclude these types of debt from our analysis.