Three letters, BBB, can decide whether a company borrows at 7% or 10%. This week you sit on the lender's side of the desk and rate the one borrower you know best: your own team.
Learning objectives. After this week you can (1) apply the five Cs of credit; (2) compute a debt service coverage ratio; and (3) read the rating scale and price a downgrade.
Remember this: lenders lend against cash flow. Coverage is the number they check first.
1) The five Cs of credit
- Character: the track record of keeping promises. For a team: a budget every week, no DNS, no panic swings.
- Capacity: cash flow available to pay the debt, income against payments due.
- Capital: the borrower's own money at risk. Your bank is your cushion.
- Collateral: assets the lender can claim on default. Your one hard asset is the $9M second car, but the arena gives you no way to sell it, and collateral you can't sell is weak collateral.
- Conditions: the economy around the borrower. A slump squeezes every borrower at once.
Lenders only see what is on the record, so when information is scarce they charge more. A credit memo is where an analyst writes down the evidence and commits to a judgment.
2) Capacity in one number
Debt Service Coverage = Cash income available ÷ Debt payments due
Example. A lender weighs an $800,000 interest bill. Your team's Winnings average $2,000,000 per race. Coverage is 2,000,000 ÷ 800,000 = 2.5×. At 1.0× every dollar of income is spoken for. If a bad run cuts income to $1,500,000, coverage falls to 1.875×. Higher coverage means a safer loan.
3) The rating scale
| Grade | Symbols | Meaning |
|---|---|---|
| Prime / high grade | AAA, AA | Payment near-certain; lowest rates |
| Investment grade | A, BBB | Solid; a modest spread over safe bonds |
| Speculative ("junk") | BB, B | Real default risk; high yields demanded |
| Distressed | CCC and below | Default likely |
Investment grade ends at BBB−; one notch lower, BB+, is junk. A downgrade raises the yield investors demand, so existing bonds fall in price (Week 8) and new debt costs more. Example: a $10,000,000 loan at 7% for a BBB team costs $700,000 a year; at 10% for a BB team, $1,000,000. One notch costs $300,000 a year.
Quick self-check
(a) Income $2,000,000 per race, interest due $800,000: coverage? (b) Which C covers a team's DNS record? (c) A $5,000,000 loan moves from 6% to 10%. Extra interest per year? (Answers: 2.5×; character; $200,000.)
Common mistakes
- Rating only the bank balance. Capital is one C out of five.
- Treating collateral as a substitute for income. It softens a default; it doesn't prevent one.
- Flipping coverage. Income goes on top, payments due on the bottom.
This week in the arena
Write a short credit memo on your own team. Average your Winnings per race so far, test them against a hypothetical $800,000 interest bill, and pick a letter rating. Be the unsentimental analyst: a DNS or a panic budget is exactly what a real memo would flag.