Size Doesn’t Matter when it comes to Credit Pricing (in a bank funded world) David Gustin - August 11, 2014 3:05 AM | Categories: Trade Credit Commentary | My esteemed colleague Pierre Mitchell has been doing a piece on the finance cost to operate a supply chain. He would like to show that small companies pay dearly for finance. I think while intuitively easy to accept the small guy gets stuck with high rates from his banker, the reality is actually based on a few simple facts. First, companies can finance themselves in three ways: Assets – use their receivables, cash, inventory, etc. to obtain funds. Liabilities – companies can issue debt and the interest expense is tax deductible Equity – this is the most expensive, as there is no tax benefit for equity (Google Weighted Average cost of capital to learn more) The big differentiator is does a company have a debt rating. If you have a rating, you have more financing options, plain and simple. Now one thing we should all understand is that banks’ risk rate all their customers, from the smallest to the largest. This risk rating is in line with S&P or Moodys on a scale of 1 to 25. (note: low numbers correspond to AAA type companies, and very high numbers are not good, indicating a company is in default or about to go bankrupt). Now take a $10 billion dollar company and a $10 million dollar company. If the bank rated each 17 out of 25 (probably akin to a CCC S&P rating), the cost of finance would be based on the banks regulatory capital that would need to be allocated. And that cost of capital has mushroomed under Basel III. Banks have to hold way more equity than they did pre 2008. And equity is really expensive. Now you will find situations where the larger company does have a lower interest rate. Why? I see three reasons: Scale – it’s cheaper to issue a larger loan than a smaller one. Size-based subsidy – big companies get lower rates because there is more potential business. The company is going to buy more stuff – FX services, cash management, etc. Banks can offload big company exposure to other parties or use Credit Default swaps, etc. Bottom line, for bank funded credit, there is no reason why small is necessarily more expensive than large. please feel free to sign up for the Trade Financing Matters Weekly Digest by clicking here https://spendmatters.com/tfm/weekly-tfm-digest/ Related Articles Discuss this: Cancel reply Your email address will not be published. Required fields are marked *Comment Name * Email * Website Notify me of new posts by email.