Credit Ratings… – How relevant is it to SMEs?

 

Today’s companies are facing business landscapes that are changing at accelerated speeds. The importance of credit risk management rose to prominence particularly following the Asian Currency Crisis of 1997, which propelled its relevance and importance.

 

A credit rating is an independent, third party opinion of a borrower’s ability to service its financial obligations. It is developed based on a combination of mathematical modeling, expert rules and an experienced understanding of insolvency trends. A credit rating assesses the probability of business failure.

 

The only thing worse than being kept waiting for payment is not being paid at all. If a company does go bankrupt, then it is very likely they will go bust owing hundreds of thousands of dollars to a long line of creditors. And if your business is in that line-up, chances are you will have to wait a long time for a settlement and be lucky to recoup even a fraction of what you are owed.

 

Credit rating is a useful tool to aid SMEs in business operations. It provides them with valuable information on risk assessment when dealing with potential customers or partners. The credit rating allows the company to make informed decisions and enables it to transact with its eyes open rather than closed.

 

As the banking sector increasingly focuses it’s lending and other financial services on the SMEs, credit ratings can play the same pivotal role as they do for larger listed corporates. Credit ratings can make SMEs’ access to financial services more efficient by the provision of such benchmarks and improving transparency.

 

In the recently concluded SME Development Survey 2006, more than a third (37%) of SMEs regard the adoption of a nationwide SME Credit Rating as the key to better access external sources of funds

 

With the implementation of Basel II (An international banking regulation) on With the implementation of Basel II (An international banking regulation) on further accentuate the importance of credit ratings.

 

Basel II will impact the way banks do business. This regulation serves to Basel II will impact the way banks do business. This regulation serves to banks will set (i.e. A well rated borrower will be accorded a lower interest margin charge while a borrower that exhibits poorer financial health would no doubt be charged a higher interest fee). Come year-2008, banks in Singapore would be operating under the new Basel II regulation. This would only allow companies a short window period to ascertain and understand their financial health and if need be, find ways to improve their credit rating. The rating concept is based on the concept of Probability of Default (PD). Currently, DP Information Group is the only other independent 3rd party that is able to rate a company based on the PD concept.

 

Credit ratings can provide an important impetus in raising standards through better financial discipline, disclosure and governance practices. Many large corporates & / or enterprises have benefited from the value of credit ratings and some of which goes well beyond the rating just merely as a rating symbol. DP Credit Ratings can also be an important feedback tool for managements in the SME Sector. A rating exercise can help SMEs better understand what initiatives they need to take to improve their operating and financial positions. Additionally, as the number of rated players in the SME sector increases, there will be greater transparency, as more and more information is demanded and made available.

 

There are several misconceptions about SME Credit Ratings:

 

1) “That SMEs will only have weak credit ratings.”

 

While it may be true to a certain extent that there is a higher probability of Default for new SME start-ups, it is not true that SMEs in general will only be accorded weak credit ratings. Based on our recent SME Development Survey of 2006, slightly less than a third of companies surveyed had ratings that fell in the range of weak DP Credit Rating (i.e. DP7 to DP8).

 

2) “How is the information provided for a reliable source for rating purposes?”

 

When rating a company, it is imperative that the financial statements obtained of that company, are audited by a recognized and authorized third-party. This ensures that the financial figures reported by the company are true and fair. The DP Credit Rating would however not be able to pick out elements of fraud.

 

3) “That the fee of obtaining a credit rating is Exorbitant”

Where getting rated could mean forking out tens or even hundreds of thousands for large corporates who would like to raise funds via bonds issues, DP Credit Ratings at the SME level is charged at a mere S$250 for a comprehensive credit rating report. This rating report enables financiers and suppliers of these SMEs to gauge their creditworthiness, which can help determine the credit line to be offered. These are two of the key benefits that SMEs reap through DP Credit Rating,

 

DP Information Group is a leader in the SME credit rating field. While DP has the ability to rate large corporates, it is widely regarded as a rating agency for SMEs. Given DP’s rich experience and commitment to the SME sector, DP Info initiated Singapore’s first SME Credit Rating Website in response to the Singapore’s growing SME sector. The rating benefits SMEs greater as investors and lenders are able to use DP Credit Rating to differentiate the credit quality of their SMEs (where credit rating information may not be so forthcoming).

 

Benefits of getting rated

 

• When you get rated from a credible rating agency, you improve your standing with bankers, customers, suppliers and employees.
• A good rating could allow companies obtain an easier and cheaper source of bank funding.
• Your rating is an indicator of your company’s performance capability and financial strength. A good rating will give comfort to your lenders, customers and suppliers.
• The rating report provides a detailed analytical report on your company’s strengths and weaknesses. The report will help you have a better idea of your company’s financial position and point you to areas that require improvement.

 

DP Info’s Credentials

 

• We have been appointed by the Building Construction Authority (BCA) as their credit rating agency for the construction industry.
• The Ministry Of Finance (MOF) has appointed us as the bureau to perform financial evaluation of potential government suppliers.
• Major international banks adopt our ratings.

 

DP Credit Rating Scale

 

Default Frequency	DP Credit Rating	Explanation	Status*
<0.1%	DP1	Possess extremely strong financial fundamental with high incentive and capability for repayment of obligations.	Premium
0.1%- < 0.2%	DP2	Has strong financial health with above average capability for meeting payments.	Premium
0.2%- < 0.4%	DP3	Stable financial health and above normal operational environment. General unfavourable factors are not likely to cause distress.	Strong
0.4%- <1.0%	DP4	Overall financial health and operation are considered normal. Capable of meeting its commitments. May be susceptible to difficulties in the event of drastic changes in economic conditions.	Strong
1.0%- <3.0%	DP5	Adequate financial capabilities to meet normal commitments. However, adverse changes in economic condition could lead to doubtfulness in the ability to pay.	Moderate
3.0%-<8.0%	DP6	Sufficiently sound financial ability to meet normal obligations. Capabilities in reacting to adverse operational condition are limited or consider doubtful.	Moderate
8%-<14.0%	DP7	Weakness in financial ability is apparent. Vulnerable to unfavourable changes in the economic and operational environment and is likely to fall into a weakened financial condition.	Monitor
14.0% and above	DP8	Apparent weakness in financial health with limited capability to meet its obligations especially in the event of any adverse changes in operating environment.	Monitor