Debt capital to finance the company is becoming more and more important these days. More and more companies are ready to change the financing structure of their company and use more outside capital for their own company. The problem with this, however, is that if you don’t know the banks’ credit and evaluation criteria, you quickly end up with a relatively high interest rate. This increasingly presents entrepreneurs with the challenge of efficiently lending outside capital at low interest rates.
However, these credit and evaluation criteria are increasingly difficult to see through for entrepreneurs who do not deal with the matter due to the constant change in banking supervision. Without knowledge of the credit and evaluation criteria, the problem is very clear that as an entrepreneur you run the risk of paying far too high interest on this debt.
Capital requirement and risk weight
In order to understand how the rating of a bank works, one has to start with the capital requirement and the risk weight of the loans, because these are determined by the banking supervisory authority as a necessary criterion.
A bank must provide its own funds in order to be able to grant loans at all, as otherwise the bank could get into financial difficulties in the event of defaulting loans. The capital adequacy is made up of the factors loan amount, risk weight and the total capital ratio.
The risk weight is made up of the following factors: default rate, default probability and the factor for the effective remaining term. The probability of default corresponds to the unsecured portion of the loan. Depending on the rating, this results in risk weights of 20% over 50% up to 150%.
The total capital ratio, i.e. the percentage of the loan that must be backed by own funds, is 8% for each bank plus additional capital buffers determined by BaFin or the ECB.
However, the risk and equity costs are also included in the assessment. It follows that a company with a bad rating has to pay a much higher interest rate, as the loan has to be backed by much more of the bank’s own funds (cost of equity) and these own funds cannot be used for other loans. Furthermore, the bad rating results in a higher risk (risk costs). It is therefore to be understood that the loan interest is composed of the factors of the risk-free interest rate, the processing costs, the equity costs and the risk costs.
Quantitative factors
The quantitative factors also play a major role in the credit decision to finance the company. In order to determine this, the annual financial statements for the last three years are analyzed and a check is made to see how the company to be financed compares to the respective industry.
In order to be able to refer to current data, the bank uses interim financial statements and accounting figures, among other things. Depending on the legal form of the company concerned, private statements of assets and liabilities, as well as private income and expenses, are also analyzed.
In order to have future-related data at hand, future order books and the resulting annual financial statements are forecast.
Qualitative factors
Qualitative factors that capture the creditworthiness-relevant aspects of a company also play an essential role in lending to finance the company. The state of the market, the quality of management, as well as general, potentially existence-threatening facts and bottleneck areas are of particular interest. Further qualitative factors are, for example, explanations of the annual financial statements, the use of funds (assessment of the project to be financed) and many more.
Determination of the credit rating before collateral
The preliminary credit rating is important when it comes to financing the company and making the credit decision. It evaluates the company for the first time without considering the collateral and is determined from the quantitative and qualitative factors. Each key figure and factor group is weighted with points to form a credit rating.
With a good rating system, insolvent companies are identified one to two years in advance, whereby as few companies as possible are unjustifiably identified as insolvent.
Rating for collateral
In the previous section, the composition of creditworthiness before collateral was presented. Now, however, the security of the loan plays a major role in the financing of the company. A company with a poor credit rating can limit the probability of default by providing collateral. Creditworthiness and collateral can more or less replace each other. However, the securities are assessed according to different rules than the qualitative and quantitative factors. If a loan is fully secured, if the company has a bad credit rating, the rating is still raised to the highest level. However, a very low partial collateralisation (eg 30%) in the case of a bad rating prior to collateralisation will hardly increase the rating.
Profitability
Profitability is also very important when making a loan decision regarding the financing of the company. The profitability of the loan for the bank does not change the rating, but it does influence the credit decision. Profitability is influenced by risk-dependent pricing by the bank. If the lending rate is too high for the customer, the business will be very profitable for the bank, but the customer will hardly accept the business.
In addition to considering the individual loan, profitability also includes the entire customer calculation (all transactions with the customer). Because in the event of a loan refusal, the customer could reduce or terminate the entire relationship with the bank as a reaction. On the other hand, banks will only take out loans with a certain probability of default.
Financing of the company: bvm GmbH
But how can bvm GmbH, management consultancy for medium-sized companies, provide support in financing the company? First of all, the quantitative factors are determined when determining the credit rating. Here bvm GmbH can support you in optimizing your balance sheet for a better credit rating. By reducing the balance sheet or taking other measures, the key figures for the quantitative factors are improved, which leads to a better credit rating and thus to a lower interest rate. The bvm GmbH also supports you with the qualitative factors. Furthermore, we determine for you which collateralisation of the loan is most optimal for the company and most efficient for the loan.
