Case 2: Research on Credit Rating Agency

Brandon Crook, Lora Helmich, Danielle Holt, Danny Kruoch, and Johnathan Sanders

What is a Credit Rating Agency?

A potential source of information for market participants who are trying to determine the creditworthiness of borrowers

History of Credit Rating Agency

First Published in 1909 SEC changed the rules in 1975

Introduction of the NRSRO

What Factors Determine a Companys Bond Rating?

Likelihood of default Repayment priority ranking History of payments Ability to overcome past difficulties Risk Taking philosophy Industry default patterns

Global Credit Rating Agencies

Global credit rating agencies assign ratings to governments and countries based upon sovereign risk Creditworthiness as an issuer and credit quality of debt issues; Probability of default capacity and willingnessto service its debt with maturity dates and in accordance with the conditions agreed with the creditors

What Factors Determine a Countrys Bond Rating?

Macroeconomic Variables Available stock of foreign currency reserves Balance of payment flows Economic growth prospects Capacity to generate tax receipts Budget deficit, measures, burden Economic state Effective government

Country Risk

Broader term; includes political, social, transfer, exchange rate risk

S&P Sovereign Credit Ratings

Credit Rating Agencies Role in 2008 Financial Crisis

From 2002-2007 - Home Mortgage Loans

F-rated securities to Arated securities without reason.

given to homeowners with bad credit and undocumented incomes.

Sacrificed quality ratings for large share of structured products business.

Until 2008, their earnings were up

Millions of dollars in revenue from structured finance.

Credit Rating Agencies Role in 2008 Financial Crisis

In 2008

Estimated Loan Amounts

Agencies downgraded almost all securities from AAA to F

Blamed Agencies Over Banks

$3 trillion.

Banks need approval from agencies to loan money CRA failed to publish any verifiable data about their rating performance Just very complex models

Securities and Credit Rating Agencies

Must Register Securities

Long, tedious process

Short Forms Dodd-Frank Wall Street Consumer Protection Act

Improve financial accountability Protect Tax payers from bailouts Required Credit Rating Agencies

Short Form Registration

Two Types of Short Forms

S-3 for domestic companies F-3 for foreign private users

Previous Requirements for Short Forms

Must have investment grade by NRSRO

Allow companies to use SEC filed reports for future registration

For non-asset backed securities

Timely SEC reporting for 1 year Meet minimum of 1 transactional requirements

New Rules : Short Form Registration

July 26, 2011 Remove Credit Ratings to Determine Eligibility Replaced with Four Tests

Issued at least $1 billion over the prior three years. Has outstanding at least $750 million of nonconvertible securities other than common equity, A wholly-owned subsidiary of a well-known seasoned issuer as defined under the Securities Act. A majority-owned operating partnership of a real estate investment trust that qualifies as a well-known seasoned issuer.

Benefits of the New Short Form Rule

Tremendous Cost and Time Saving

Easier to register securities

Shelf Registration

Register future or multiple offerings on the same registration

Issuing Securities

Flexibility

New Rules : Large Trader Reporting

Unanimous Vote : July 26, 2011 Establish large trader reporting requirements

Identify large market participants Collect information on trading Analyze trading activity

SEC assigns ID number Benefits

SEC accurately monitor market events

Impact of U.S. Credit Rating Downgrade

Questions?