Recommendations for ensuring sustainable financing and for managing the credit rating in the current environment

Recommendations for ensuring sustainable financing and for managing the credit rating in the current environment

The current environment poses significant challenges for debt financing. We therefore discuss below how to ensure sustainable financing and how to manage the credit rating. In this context we also provide specific recommendations for implementation.

 

The resilience test will follow in the medium term

Having secured short-term liquidity, companies are now faced with the task of ensuring their financing and thus their liquidity in the medium to longer term, i.e. sustainably. This task is made more difficult by the highly uncertain, recessive and thus challenging environment for financial management.

 

Reduction in debt capacity and simultaneous increase in debt capacity utilisation

A negative business outlook and the associated uncertainty about future cash flow generation make credit financing considerably more difficult for companies. This negatively affects companies’ debt capacities. In addition, the current crisis is likely to lead to an increased need for funds and thus to rising financial liabilities for many companies. Therefore, the crisis will likely reduce their debt capacity and at the same time increase the utilisation of this reduced debt capacity with additional financial liabilities on the balance sheet. This is important because debt capacity utilisation is a key criterion for credit-granting banks when assessing the financial sustainability of a borrower. In the context of raising debt capital, special attention should therefore be given to ensuring that free debt capacity is adequately high. The following figure summarises the concept of debt capacity utilisation schematically.

 

Debt capacity utilisation (schematic representation)

Auslastung-Debt-Capacity-EN

Securing short-term liquidity is not sufficient

Depending on economic developments and the economic conditions in the “new normal” (situation after the crisis has subsided), the financing challenges described above are likely to persist or become even more pronounced. Under such conditions, new borrowing and the refinancing of existing debt can become a challenge for many companies. This also affects companies that have currently secured short-term liquidity. It is therefore advisable to monitor and actively manage the company’s ability to obtain debt financing on the basis of its debt capacity utilisation.

 

Significance for the credit rating of the company

A sustained deterioration in the ratio of financial debt to future free cash flow often also has a significant negative impact on the credit rating and thus on the terms for debt financing. The negative influence on the credit rating is amplified when not only the financial profile but also the business profile of a company is negatively affected in the crisis. This is particularly the case if the business model in the new normal could be less successful than in the past or if a “broken business model” could even be the result of such a crisis. Such effects are now hitting companies at a particularly unfavourable time, as the return required by lenders is generally already higher in uncertain times. This in turn highlights the importance of a diversified debt capital structure in order to mitigate financial cluster risks.

 

Decreasing credit ratings

A look at the current rating developments in Western Europe shows that many credit ratings have already been downgraded in the first and second quarters of 2020. By contrast, improvements in credit ratings were observed much less frequently during the same period. The number of negative outlooks for credit ratings in Western Europe indicates further credit rating downgrades.

Ratingentwicklung-in-Europa-EN

In order to anticipate the development of the financial profile as a proxy for changes in the credit rating, suitable industry-specific financial ratios can be defined and included in financial planning. By means of scenario-based planning, it is thus possible to gain insights into the possible development of the credit rating depending on economic developments. This allows the monitoring and, if necessary, active management of financing risks.

 

Recommendations for ensuring sustainable financing and for managing the credit rating in the current environment

Below, we provide recommendations for action in connection with ensuring sustainable financing and for managing the credit rating. These insights based on our long-standing financing experience significantly reduce financing risks for the company.

  • Build a suitable analysis basis:
    Establishment of scenario-based rolling planning and definition of the company’s target credit rating

 

  • Monitoring key financial figures:
    Identification, analysis and monitoring of the relevant financial key figures for recording financing risks related to debt capacity utilisation and the financial profile as part of the credit rating assessment

 

  • Analysis of funding needs:
    Analysis of the maturity profile and financing needs of the company

 

  • Implementation of measures:
    Depending on the results of the relevant analyses, any necessary measures are to be implemented in order to ensure the financing as well as the previously defined target credit rating of the company. Possible starting points for this can be found, for example, in the following areas:
    – Financing policy
    – Dividend policy
    – Investment policy
    – Portfolio management (e.g., divestments)
    – Other operational measures that strengthen cash flows or reduce cash needs (e.g. optimising net working capital)

An overview of our recently completed corporate finance mandates can be found here.

IFBC Team

info@ifbc.ch