Why the credit profile in relation to funding conditions matters

The previous article focused on the planning and control cycle in relation to financing. In conclusion, Orchard argued: integrating funding into the planning and control cycle has a number of advantages: i) It is a litmus test for strategy and makes directors and organisation more aware of the importance and limits of financing. ii) It makes the principles of financing explicit and forces timely action. This results in more direction towards the financing market with more time and space for a competitive selection and negotiation process. 

In this article, we discuss the importance of the credit profile in relation to financing terms. It is important to realize when insight into this adds value for directors and what the impact can be on the process of negotiating a financing. 

Problem definition

It is common for directors to face increased costs (funding and mark-ups) when refinancing. This is often driven by the commercial process and timing of funding. When a process of financing is only started when there is a real need, the short-term liquidity required is often more important than good conditions. Can this be done differently?

Financiers request annual figures and perform an ‘overhaul’ – a kind of ‘annual roadworthiness check’ of the financier’s position in relation to any default risks. If the financing arrangement is committed, then a revision is more like a spot check. If conditions are uncommitted or of a similar nature, the outcome of a revision may result in an adjustment of the conditions. 

Greater insight through ratings: Probability of Default (PD)

During the review, a rating is made on the basis of financial statements. A rating is a risk score of the probability that the company cannot meet its obligations within one year: a so-called Probability of Default (PD). This PD is a very important indicator of the conditions to be applied by financiers. Listed parties sometimes have public ratings, which bank analysts can use. For unlisted parties, there is rarely a public rating and the internal rating calculated by the financier is not shared with the borrower. 

An (internal) rating and associated risk profile can also be made transparent to unlisted parties. The importance of this unfolds in particular in case of refinancing or necessary extensions of financing. Because of the financier’s risk assessment versus a financier’s desired returns, insight into the risk profile is an essential element for negotiations. If a refinancing or negotiation on financing terms is imminent, it is therefore advisable to have an insight into the risk profile of the company to be financed.  

Benefits in a financing application

While discussing annual plans in conjunction with any funding requirements, it is advisable to also gain insight into the credit risk profile. This helps in answering questions such as: i) What are the consequences of additional funding? ii) Where is the maximum for a financier in terms of an acceptable profile? iii) To what level is a board willing to take on financing as well as conditions?

Insight into rating trends also guides the timing of refinancing. In good years, there is the possibility of securing long-term conditions and commitment. After all, in less favorable years you want commitment and certainty around your financing without this directly affecting the conditions.  With the insight of a rating and credit profile, these negotiations are easier and more substantiated

Conclusion

In summary, insight into the rating and credit profile has a number of advantages: i) It gives directors insight into how the financing market views the company. ii) It gives insight into the feasible conditions in the market and iii) It can be used in decision-making around investment decisions and timing in relation to necessary / desired financing. 

Get in touch

Would you like to optimise the continuity of your financing, or concrete advice on how your credit profile or rating can become part of the (re)financing process, or a second opinion on your current financing? Call us, we will be happy to assist you

Eelco van de Lustgraaf

Partner Corporate Finance & Debt Advisory