Attaining a Corporate Credit Rating I

What is a credit rating?

Credit Rating - A public opinion on the creditworthiness of an issuer of debt, be that a sovereign, a bank or a corporate. Specifically, it is an opinion on the ability of a borrower to repay its debt in a timely fashion.

What is Step 1?

Project Set Up - The project plan for obtaining the credit rating should be produced and should cover:

• Objectives
• Governance structure
• Resources & Costs
• The timetable with key milestones
• Information requirements

What are the benefits of credit ratings?

• Increases the type and number of investors who are willing to buy a company’s debt. Unless the business is very well-established and has a strong brand recognition, it is going to need a credit rating in order to access the corporate bond market
• Many investors such as some pension funds, insurance companies, and banks can only invest in rated debt
• Gives a company access to a wider range of debt structures, including those with longer maturities
• A rating reduces the cost of debt and increases a company’s financial flexibility
• Increases the level of confidence in the company from other stakeholders such as customers, suppliers, derivative counterparties and regulatory bodies

What are the disadvantages of credit ratings?

• Requires management time - time that staff must dedicate to obtaining and maintaining the rating
• The company pays fees to the agency for the rating and pay fees when a bond is issued, based on the size of the bond issue
• Open to more public scrutiny - A rating agency will have to provide more public information and a credit rating comes with the risk of a rating downgrade
• A rated company might find its flexibility reduced if maintaining a certain rating level requires it to adhere to specific covenants, such as limits on financial ratios like leverage or interest coverage
• A particularly weak credit rating may produce lower credit scores from bank models, leading to more adverse outcomes than if the company didn’t have a credit rating at all

How many ratings should the company have?

1. Investor requirements
   • How many ratings do investors require? The company can ask its investment banking advisers for this information, along with which agencies do investors prefer
2. Peer group standard
   • The company should find out how many ratings its peers use and which ones. Investors may question a companies selection if it uses a rating agency that is not common among peers in its sector
3. Diversification
   • Having more than one rating ensures the company is not reliant on just one agency. For example, the company’s rating could be adversely affected if its agency decides to change its methodology and iw will not have the mitigant of having another potentially higher rating

What are the disadvantages of having more than one rating?

• Increased management time required to manage the rating
• Increased rating agency fees

How can the company be structured more efficiently in the ratings process?

Governance structure for managing the ratings project will need to be put in place so that the Board of the company can be satisfied that decisions are properly authorised, project risks are minimised, resources used efficiently and the objectives are met. Management can be structured by:

• Board of the company could delegate authority to a single person, i.e. Finance Director to approve rating-related documents, presentations and data requirements
• A steering group can be set up to manage the process with membership made up of key decision makers and information providers in the company such as the heads of finance
• Appoint a project manager, whom is responsible for the whole rating agency process and held accountable for all aspects of the project including project management, rating estimate, production of the ratings information for the agencies, and communication with the agency

What high-level milestones should be included in the project timetable?

1. Initial ratings analysis
2. Rating agency meeting prior to appointment
3. Decision to proceed with rating
4. Finalisation of information requirements
5. Finalisation of the ratings pack
6. Management rehearsals
7. Meeting with the rating agency or agencies
8. Rating agency decision
9. Rating agency announcement

Early in the process, management will need to decide whether to use a ratings advisor to assist with the ratings process.

What are the benefits of using a ratings advisor?

• The ratings advisor can help plan all aspects of the process which could save the company time and resources
• They can provide dedicated resources to help with the ratings process if the company is short of staff
• They can help model the rating. It is likely they will have models already set up. They can produce scenario analysis to provide the rating level under different capital structures
• They can help prepare presentation materials. They will most likely have guidelines and templates they can send to the company
• They can help position the company by highlighting credit strengths and coach management who may not be familiar with credit ratings. They may have experience of rating peers, and are likely to know the main areas of concern of the agencies in the sector
• They can review all rating-related material including the agency engagement letter, data sent to agencies, press releases and full rating reports
• They are a second channel of communication with the agencies. This could be useful for the company if more feedback is required from the agency analysts, if there are complaints about the agency or if there is an appeals process
• The ratings advisor can act as a general sounding board for the company throughout the ratings process

What are the disadvantages of using a ratings advisor?

• There is likely to be a ratings advisory fee
• Confidential information will have to be shared with the ratings advisor which could be a sensitive issue if the chosen ratings advisor is new and not in the existing relationship group
• The company is getting another party involved with its relationship with a key stakeholder, the rating agency. It is important that the company ensures the ratings advisor doesn’t become overly dominant in the relationship and the key messages and instructions go directly between the company management and the rating agency

How do you choose a ratings advisor?

• The advisor should have significant relevant ratings experience. For example, by having rated companies recently in the industry sector and/or being a current ratings advisor to peer companies
• The advisor should have strong relationships with rating agency analysts and business development officers at each of the main agencies
• The ratings advisor should have a strong reputation in the market as the provides credibility when dealing with the agencies
• The ratings advisor should create realistic expectations on the expected rating level, and work in partnership with the company
• It can be helpful for the ratings advisor to draw upon the expertise of other departments such as Debt Capital Markets and Corporate Finance

What is Step 2?

Desktop Analysis (Modelling the rating) - To estimate the potential credit rating the company could realistically achieve.

What are the benefits of using in-house modelling?

• Provides information to management on the feasibility of achieving the desired rating
• Highlights potential options to achieve a higher rating, i.e. by reducing leverage
• The modelling will be valuable preparation for meeting with the rating agency as the analysis may point out the potential credit weaknesses of the company and potential mitigants

What sources can management use to help model the rating?

• The current rating criteria used by the rating agency. The agency will have rating criteria for different industry sectors, and so the relevant criteria for the company should be used
• The actual ratings and rating reports of similar rated companies should be reviewed. The key rating drivers and rating agency ratios can be compared with the company’s current and projected profile
• Sector reports from the agencies should be reviewed because often these contain peer group analysis from the agencies which set out their rationale for rating peer companies. Sector reports also set out the current key areas of focus of the agencies for the sector

What is Step 3?

Meet the Agencies - The company’s management should meet with the main rating agencies prior to making a decision on getting a rating and choosing which agency to use. The company should prepare its own list of questions for the meeting.

What should the questions cover?

• Rating criteria
• The rating agency itself
• Ratings process
• Information requirements