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It's who you owe, not who you kno... Banks credited for streamlinin... A question of adding up the number... Rating agencies owe corporations... Insurance industry fights bac... |
QUOTE: Credit ratings are an integral part of establishing the price at which corporate paper is issuedJEREMY GLYN Credit rating by independent agencies has become increasingly important as business and the government seek new sources of financing. CIARAN RYAN reports on the country's biggest credit agency --> It's who you owe, not who you knowCREDIT RATING is a relatively new development in South Africa. The abolition of financial sanctions in 1994 paved the way for the return of hundreds of multinationals - some 50 banks among them - while dozens of SA corporations sought to remedy a decades-long preoccupation with the domestic market by acquiring interests abroad. Inevitably, this brought them into contact with off-shore financiers and the ratings industry. Credit ratings are an out-growth of something called "disintermediation", where borrowers by-pass the banks and borrow from non-banking sources, such as the bond market. Ratings agencies have become an indispensable part of the financial services sector by offering opinions on the debt-servicing capacities of borrowers. This is essential in establishing pricing benchmarks for new debt issues. The higher the risk, the more borrowers should be prepared to pay for debt, be it in the form of debentures, bonds or corporate paper. IBCA, the third largest ratings agency in the world, entered the SA market in the early 1990s through the acquisition of Republic Ratings. Its growth in South Africa parallels that of the financial services sector and the burgeoning demand for debt capital. Multinationals seeking local partners and alliances typically start their search by establishing the credit ratings, based on internationally accepted benchmarks, of potential partners. Local companies schooled in the rites of financial secrecy found themselves forced to submit to the probing scrutiny of these ratings agencies. Three years ago, those prepared to submit to such scrutiny were the exception rather than the rule. Today, the reverse is true. So it should come as no surprise that most ratings reflect positively on the ratee's financial health and debt-servicing capacity. "The reason for this is that most businesses seeking debt financing are in strong financial positions," says Mike Berry, managing director of IBCA South Africa. "Those who don't want to be rated will also generally not want to borrow. Companies prepared to undergo a credit rating are typically confident of a positive outcome." Several factors are driving the growth of the credit ratings industry: ý Black empowerment and corporate unbundling. Because most black empowerment and unbundling deals are debt financed, credit rating is essential in establishing debt-pricing benchmarks. ý Disintermediation. Corporate borrowers are finding it cheaper to by-pass the banking system, where huge administration and infrastructural costs are factored into the price of debt. ý The entry of provincial and local governments into the capital market following the promulgation of provincial borrowing powers legislation. ý Debt restructuring. To reduce costs, borrowers are seeking to convert short-term debt underwritten by the banks to short-term debt underwritten by the issuers themselves. ý The foreign invasion of corporate South Africa and the quest for local partnerships based on internationally accepted credit ratings. ý The internationalisation of SA business, funded by way of foreign debt issues. ý Securitisation, where individual loans are bundled together and floated as a tradable instrument, is one of the fastest growing segments of the global financial services market. A credit rating is a prerequisite for a successful securitisation issue. Despite the post-Rubicon annihilation of the rand in the 80s, when dozens of companies with large off-shore borrowings were almost brought to their knees, local corporations are once again tapping international capital markets, this time more cautiously and with adequate hedging policies in place. With interest rates of about 7,5% in the US as against South Africa's prime rate of 20,25%, the attractions of off-shore borrowing are obvious, notwithstanding the steep decline of the rand last year. Such disparities in the costs of borrowing are challenging the prevailing wisdom that equity is the cheapest form of capital. "Equity must be serviced for the rest of time, while debt has a finite term," says Berry. "Despite this, gearing ratios in South Africa tend to be low by international standards, but this is undoubtedly a function of the high level of interest rates in this country." One factor which could radically change this is the launch of money market funds in May this year. These funds will allow private investors to obtain money market rates, currently about 15,5%, on their investments. The funds will fall under the Unit Trusts Control Act and will allow fund managers to invest in a range of approved money market instruments such as bankers acceptances, promissory notes and bills of exchange - all of which are forms of short-term borrowings underwritten by the banks. One exception is "corporate paper", also an approved money market instrument, which is a form of short-term borrowing underwritten by issuers, usually corporations. "Once these money market funds get under way," says Berry, "the corporate paper market should take off. The market for corporate paper has been somewhat stifled up to now." Credit ratings are an integral part of establishing the price at which corporate paper is issued. The emergence of a strong corporate paper market opens new funding possibilities for local borrowers. Borrowing is also essential in facilitating black empowerment and unbundling deals, although Berry cautions that where these are debt-financed, the new owners will find themselves under intense pressure to crank up dividends to meet the debt servicing costs. "Paying out higher dividends means less is retained in the business for future expansion. As a result, many of these companies may have to recapitalise in a few years. Where dividend ratios rise, we can expect price-earnings ratios to fall, which makes equity financing less attractive. "So we can expect to see more use being made of debt instruments in black empowerment and unbundling deals in future." Cash flow rather than profitability determines a business entity's ability to meet its debt obligations.
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