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Working Capital Financing^359

Risk Classes. Bank typically classify credit applicants into a series of risk classes. The
balances may also use Credit Rating Agencies ratings to sulestatide than credit
worthiness. Selected risk categories which may be maintenance as follows:

Class 1. Highest rated. Long-term debt is AAA or AA rated. Stable cash flows, interest
coverage.

Class 2. High quality. Long-term debt is rated A. Good interest coverage.

Class 3. Upper-medium quality. Debt is rated A. Interest coverage, though good, may
be impaired under adverse economic conditions.

Class 4. Medium quality. Debt is rated BBB. Adequate interest coverage. Access to
alternative financial markets limited except during favourable economic
periods.

Class 5. Lower-medium quality with debt rated at BB or B. Interest coverage is
acceptable but is subject to severe fluctuations.

Class 9. Collections of loans is questionable. Not enough collateral to cover existing
debt.

Class 10.Debt is not collectible.

Loan Pricing Matrix. Once a credit applicant has been assigned a risk class, the
interest rate applicable will be established from using a loan-pricing matrix. The loan-
pricing matrix of a bank is shown in Table 3. According to this loan pricing matrix, a
firm in risk class 3 that borrows on a line of credit would be paying the prime rate plus
0.7 per cent as interest rate on its loan. A firm in risk class 4, seeking an unsecured
transaction loan for 60 days, would incur an interest rate of prime plus 1.5 per cent.

The assignment to risk classes is based strictly on conservative financial considerations.
On occasions the bank may feel that the need to develop the market for the bankís
commercial lending practices requires that marketing considerations be given precedence
over financial considerations. A risk class 2 firm may find that a bank, eager to land its
borrowing business, is willing to assign the firm to risk class 1. However, very rarely if
ever will a bank be willing to treat a risk class 9 or 10 firm as a risk class 5 firm.

Table 3: Commercial Loan Pricing Matrixa

T ype of Loan Rick Class

        







    


   

    

                                             

    

    

                                             


  

        

                                                     

    

        

                                                     

a P stands for the lending rate at the time loan is issued. Interest rate are in per cent.