The text contains a 'Comparative Analysis of Internal and External Credit Ratings'. It compares and explains both concept, and concludes what impact both have on the Mid-Market Companies in Germany.
In 2012, mid-market companies (KMU) based in Germany generated revenues of 2,149.0 billion Euros. They are responsible for 35,3% of all revenues generated in Germany. These mid-market companies employed 15.97 million people, a workforce of 59,6% of all employees in Germany (IFM Bonn, 2014). Clearly, mid-market companies are elementary for the German economy. To continue to be a primary motor of the economy, they need sufficient funding. Nevertheless, financing for mid-market companies in Germany will become more difficult. Standard & Poor’s Ratings Services (2015, pp. 2-3) estimated that European mid-market companies are going to have difficulties to meet their financing needs, as banks reduce their lending to the mid-market sector as consequence of stricter regulations. Especially, smaller mid-market companies face problems to access credit loans (Standard & Poor's Financial Services LLC, 2014, p. 3). The reason for these difficulties is the implementation of Basel III. Financial institutions have to deleverage their business during the next years (Zainzinger, 2013). The problem is that mid-market companies traditionally relied on bank funding. Especially German mid-market companies relied on credit loans from financial institutions (Huber & Simmert, 2007, p. 167-196). The new regulations for deleveraging create a “scarcity of finance for European companies”; it will generate an acute financing problem for mid-market companies (Dimitrijevic & Wade, 2014, pp. 1-2). In 2013, the German mid-market financing gap already amounted to 38,9 billion Euros (KfW, 2014, p. 7). Therefore, these companies have to find new funding sources. They have to find solutions to improve the access to external financing. Credit ratings provide an opportunity to help in this process.
The existence of credit ratings is widely known. They often appear in several newspapers, and magazines (Handelsblatt, 2014). Nevertheless, various mid-market companies cannot estimate the impact and importance of credit ratings. Specifically, differences between internal credit and external ratings are often unclear. [...]
Table of Contents
1 Introduction
1.1 Problem Definition and Objectives
1.2 Course of the Investigation
2 Credit Ratings
2.1 Definition of Credit Ratings
2.2 Function of Credit Ratings
2.3 Development of Credit Ratings
3 External Credit Ratings
3.1 Producer of External Credit Ratings - Credit Rating Agencies
3.2 Regulations of External Credit Ratings
3.3 General Credit Rating Process
3.4 Credit Rating Process for a Mid-Market Company at Standard & Poor´s
3.4.1 Methodology of Mid-Market Company Evaluation
3.4.2 Modifier of the Mid-Market Evaluation
3.5 User of External Credit Ratings
3.6 Criticism of External Credit Ratings
4 Internal Credit Ratings
4.1 Producer of Internal Credit Ratings - Financial Institutions
4.2 Regulations for Financial Institutions
4.2.1 Basel I
4.2.2 Basel II
4.2.3 Basel III
4.3 Rating Process of Internal Credit Ratings of Mid-Market Companies
4.3.1 Analysis of Quantitative Factors
4.3.2 Analysis of Qualitative Factors
4.3.3 Other Influencing Factors
4.3.4 Adjustment of Internal Credit Ratings
4.4 Use of Internal Credit Ratings
4.4.1 Credit Decision
4.4.2 Costs of Debt
4.5 Problems of Internal Credit Ratings and Their Assessment
5 A Comparative Analysis of Internal and External Credit Ratings
5.1 Motivation of Credit Ratings
5.2 Use, Risks, and Transparency of Credit Ratings
5.3 Cost of Credit Ratings
5.4 Assessment of Credit Ratings
5.5 Accuracy of Credit Rating Assessment
6 Impact of Credit Ratings for Mid-Market Companies in Germany
6.1 Definition and Situation of Mid-Market Companies in Germany
6.2 Necessity of External Financing for Mid-Market Companies in Germany
6.3 Risks of External Credit Ratings for Mid-Market Companies in Germany
6.4 Opportunities of External Credit Ratings for Mid-Market Companies in Germany
6.5 Requirements for Positive Credit Ratings for Mid-Market Companies in Germany
7 Conclusion
7.1 Key Differences and Similarities of Internal and External Credit Ratings for Mid-Market Companies
7.2 Key Factors for Mid-Market Companies in Germany
7.3 Further Scientific Research
Objectives and Topics
This thesis examines the differences, importance, and impact of internal and external credit ratings on German mid-market companies. It aims to clarify the ambiguity surrounding these rating types and provides a framework to help mid-market companies improve their financial standing through a better understanding of rating procedures and regulatory requirements.
- The divergence in motivation and utility between internal and external credit ratings.
- Regulatory frameworks, including Basel I, II, and III, and their impact on banking and credit availability.
- Methodological differences in how credit agencies and banks assess creditworthiness.
- Strategic opportunities and risks associated with obtaining an external credit rating for mid-market entities.
- Practical requirements for improving credit profiles in the German mid-market sector.
Excerpt from the Book
3.4.1 Methodology of Mid-Market Company Evaluation
The methodology of a mid-market company evaluation follows certain steps (Figure 6). In order to determine a credit rating of a company, a business credit profile and a financial credit profile will be rated individually and then combined. The business credit profile includes the country risk (regulation, tax, political stability), the industry risk (growth, trends, new technology), and the competitive environment. The financial credit profile includes the level of debt to equity, and the cash flows analysis. Both profiles will result in an “Anchor”, a pre-rating for the mid-market company. This “Anchor” can be adjusted by four additional factors: capital structure, management/governance, financial policy, and liquidity. After the adjustment, the mid-market company will receive a final credit rating (Standard & Poor’s Financial Services LLC, 2014a). In order to provide an example of an evaluation, a prototype mid-market evaluation has been attached in the appendix (Figure I). This should clarify the complex process.
Summary of Chapters
1 Introduction: Provides an overview of the significance of mid-market companies for the German economy, highlights the growing challenge of external financing, and defines the research scope.
2 Credit Ratings: Defines credit ratings as subjective opinions on credit risk and explains their historical development as an essential information intermediary in financial markets.
3 External Credit Ratings: Analyzes the market concentration of rating agencies, current regulations in the EU, and details the specific evaluation methodology used by Standard & Poor's for mid-market companies.
4 Internal Credit Ratings: Discusses the regulatory constraints imposed by the Basel Accords and describes the quantitative and qualitative factors banks use to assess borrower risk for internal lending decisions.
5 A Comparative Analysis of Internal and External Credit Ratings: Compares the two rating systems regarding their motivation, transparency, associated costs, and overall accuracy in risk assessment.
6 Impact of Credit Ratings for Mid-Market Companies in Germany: Evaluates the financial situation of German mid-market firms and examines how credit ratings affect their ability to secure external financing.
7 Conclusion: Summarizes the key insights, emphasizes the need for companies to actively manage their credit profile, and suggests areas for future research.
Keywords
Credit Ratings, Mid-Market Companies, Basel III, Internal Ratings, External Ratings, Credit Rating Agencies, Financial Institutions, Debt Financing, Default Probability, Risk Assessment, Corporate Finance, Germany, Financial Regulations, Capital Requirements, Liquidity Management
Frequently Asked Questions
What is the core focus of this academic work?
The work provides a comprehensive comparative analysis of internal and external credit ratings, focusing specifically on their impact on and application within German mid-market companies (KMU).
What are the central themes covered?
The central themes include the regulatory influence of Basel Accords on bank lending, the methodological differences between agency-led and bank-led rating processes, and the strategic importance of ratings for mid-market financing.
What is the primary objective of the research?
The primary goal is to close the knowledge gap for mid-market company leaders regarding credit ratings, explaining why they are essential and how companies can optimize their rating outcome to improve financing conditions.
Which scientific methods are employed?
The study utilizes a structured analysis of relevant academic literature, regulatory frameworks from the Basel Committee, and empirical documentation and prototypes provided by major rating agencies like Standard & Poor's.
What does the main body address?
The main body breaks down the rating procedures in detail—explaining both the external agency process and the internal banking approach—and analyzes the differences in cost, transparency, and risk-bearing responsibilities.
Which keywords best characterize this thesis?
Key terms include Credit Ratings, Basel III, Mid-Market Companies, Financial Institutions, and Credit Risk Assessment.
How does Basel III specifically impact mid-market lending?
Basel III increases capital requirements for banks, which forces them to deleverage and reduces their willingness to provide loans to higher-risk borrowers, thus making a positive credit rating critical for mid-market financing.
What is the role of the 'Anchor' in S&P's rating process?
The 'Anchor' acts as a pre-rating determined by combining business and financial credit profiles, which is then adjusted based on specific factors like capital structure, management quality, financial policy, and liquidity.
Why do mid-market companies often struggle with rating transparency?
Many mid-market companies execute accounting for tax optimization rather than financial clarity, which often results in insufficient data presentation and negatively impacts their evaluation by rating agencies or banks.
- Quote paper
- Kevin Elsäßer (Author), 2015, A Comparative Analysis of Internal and External Credit Ratings, Munich, GRIN Verlag, https://www.grin.com/document/333723
