Ratings agencies provide an impartial analysis of the strengths and weaknesses of a company. Engaging proactively with them can help assess funding options, says ABN AMRO’s David Beardsall.

The number of European companies with a credit rating has expanded massively in the past five years as investors have sought guidance and transparency. Most of those seeking a first-time rating do so because they aim to tap the debt capital markets, but a significant minority do so just to raise their international profile.

Some companies defer getting a rating on the assumption that “things will look better next year”. However, ratings are forward looking and should therefore make allowances for industry cyclicality or short-term distortions in the financial profile caused by M&A activity, for example.

Impartial analysis

The recent high-profile failures of the rating agencies resulting from management fraud should not distract from the fact that generally they provide an impartial analysis of both the strengths and the weaknesses of a company. There is no single determinant of a rating and the agencies will certainly not penalise a company because one ratio falls outside a rating median. For an investment grade company, the business profile is going to be the main influence of the rating, because to a certain extent this determines the company’s ability to influence its financial profile. The rating agencies will look more favourably on a management team that has a credible story and a track record for delivering on promises.

Companies should always target their optimum ratings. For most, this will be the highest rating they can achieve because this naturally lowers their funding costs. However, if a longer-term strategy calls for a series of debt-funded acquisitions, it may be more positive for a company’s image to target a rating at a slightly lower level: it allows greater room for manoeuvre while retaining a stable rating. Companies must bear in mind that investors remember previous downgrades when a company returns to the market.

Subjective process

The approach of the three rating agencies (Fitch Ratings, Moody’s and Standard & Poor’s) is fundamentally similar, despite slight differences in the treatment of certain issues, such as structural subordination and the ability of a company to breach the sovereign ceiling. Split ratings – where the ratings agencies award disparate ratings – are usually a reflection of the fact that credit rating is a subjective process and analysts have different experiences, opinions and prejudices.

Given the basic similarities, the amount of effort required to obtain two ratings is not that much greater than is required to acquire one, other than the additional meeting that the senior management team will need to attend. The number of ratings that a company should obtain depends on the amount of debt it intends to raise and the investor base it seeks to attract. Many investors require companies to have two ratings and raising a sum in excess of €500m may therefore involve liquidity issues with only a restricted investor pool prepared to accept one rating (and even that may come at a price).

Companies that already have ratings can typically be divided into two categories: those that engage proactively with the agencies and those that regard the process as a necessary evil. Being proactive does not guarantee a better rating but it should provide greater certainty when it comes to assessing future funding options.

Information source

A company planning M&A activity should bring the agencies in at an early stage (confidentiality is guaranteed), so that the management team knows what the rating impact will be and the likely pricing implications of their actions. Such information will also give potential banking partners greater confidence to bridge transactions when they know what the likely refinancing options are.

Even a company with no such acquisitive aspirations should keep in close contact with the agencies, particularly if it has noticed there have been rating downgrades elsewhere in its industry sector. A good flow of information in addition to the quarterly or half-yearly press release and regular conversations with the analyst creates trust and comfort on both sides, especially if there has been a change of personnel at the agency.

If there are rating problems on the horizon, then regular contact with the agencies can give them time to get acquainted with the issues and possibly instigate remedies. By taking this course, a company may even be able to stave off a public ratings downgrade and the inevitable questions from banks and investors.

David Beardsall is head of ratings, Financial Markets Advisory, at ABN AMRO

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