Credit Rating Benefits
Credit Rating Benefits
This article provides an overview of the use, importance, purpose and credit rating benefits for businesses.
Sorting out the “Lemons”
There is a well known law in economics, sometimes informally called the “lemon law”, usually applied to cars. Explained briefly, it means that the really bad companies often drive out the market for the good ones. For e.g. if there are many bad cars on the market, and no credible way to be able to distinguish the good from the bad, what happens? Poor products can sell at a lower rate, while premium products cannot. Customers cannot tell the good from the bad, so the market for the good is driven out, as customers go unsatisfied and begin to be suspicious of all cars on the market. Likewise, in the case of bank loans, the problem of prospective default is a headache to bankers, and all possible steps must in their view be taken to avoid it. Defaults can create potential huge losses, and usually if there is no way to be certain, banks would charge huge premiums on all loans to cover up for the PD (probability of default), and LGD (Loss given default) calculated through a complicated financial modelling process, and regulated by Basel II and III. But to address precisely this problem, we have certifications in the market, such as the credit rating provided by established agencies like CRISIL, etc which help to differentiate the good and the bad.
A key usefulness of a good credit rating from a reputed agency is the immense scope for differentiation it affords the company. Banks have to deal with a large volume of loan applicants and as a matter of fact often frankly lack the requisite patience to go through business plans, executive summaries and detailed project reports. Besides, they will not be able to diagnose all market conditions and other factors with the same skill as a credit rating analyst.
For a new business in particular to go for a bank loan unaided can very often prove to be a capital mistake, and can lead if not to rejection at least to a lengthy delay. But a mere BBB+ or even for that matter something like a BBB- from an established agency can practically ensure a swift and certain approval and loan sanction as being now a mere formality. Thus, the importance of a good credit rating can never be overstated. Another mistake companies sometimes make – companies who perform their own business quite well, but lack the required knowledge of leverage, liquidity and other financial and operational ratios that our professionals can provide – is to go to credit rating agencies without a financial intermediary such as VERVE or IndiaFilings.
This lack of knowledge is often exploited by the rating agencies, and results in a poorer rating than deserved, which goes unchallenged and is passively accepted by the company, since there is now no alternative. If you come to us, on the other hand, we will review the rationale for the rating given and all the financial jargon and carefully examine the entire process so as to assure you the rating you deserve. Just like you need a good lawyer – trained, knowledgeable and skilled in his profession – when you make your case in court, you need India Filings on all credit-related issues if you want to ensure a good rating for your company. We will perform and take care of all the financial matters relating to rating, which is what we do best, and you can concentrate on running your business successfully, as you do best. Do not be among the companies who have made this mistake! Verve will also be happy to use its expertise in writing a successful B-Plan or a DPR for your company.
In the case of established companies either seeking a loan or desirous of considering such a prospect in the not-too-distant future, credit ratings maintain their usefulness. For although an established business is adjudged on a generally different basis than a startup is, yet the financials involved tell a clear story of the business’ prospects to established professionals. A financial intermediary who is able to forestall a poor rating will be able to advise you a priori in what area in particular your business’ financials or bottom line needs to be shored up, advising you perhaps to apply again for a rating in a little while, in a season when business has picked up. Knowing the ins and outs of the process, and having gone through hundreds of similar cases with experience of the results, we will be able to advise you on the parameters that need additional work, and help you present a winning proposal when the time comes.
The competitive advantage a rating such as A+ provides is worth its weight in gold. Such a rating provides instant respect and is universally recognized as a good indicator of a truly creditworthy candidate. This is true not only with respect to the banks but also with investors of all sorts, including private equity, venture capitalists, and Angel investors. Finally, such a rating immensely helps businesses overall as well, including from the point of view of customers, both in attracting new ones, and in retaining current ones.
Interest Rate Penalties and Saving
Needless to say, and as briefly touched upon above, if a company’s creditworthiness is unknowable and indeterminate, the banks will not simply sanction all loans indifferently. Rather, they will charge a significant interest premium, which often cumulatively turns out as a hefty penalty to be paid. In some jurisdictions, a credit rating is mandatory for this reason. Some banks by the law or by their own charter are expressly forbidden from loaning to companies in the “speculative grade”, called alternatively high-yield or “junk” bonds by investors. On the contrary, companies in “investment grade”, i.e. in the top range of ratings, can frequently avail loans on interest much below the market rate for corporations, and sometimes at levels close to the industry risk-free rate. Clearly, then, for all these reasons and more, a credit rating is very useful, and the difference between a good rating and a bad one can make or break a company’s prospects for availing timely and needed credit at desirable rates.
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