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It’s a difficult job being the final speaker at any conference, but especially one being held at such a beautiful location. Fortunately, though, I’ve got a topic worthy of your interest. As you all know, a day doesn’t go by without a news story about one or another of the corporate scandals that have so shaken the confidence of U.S. investors. Although there have been larger cases of investor losses, Enron, since it was the first, has become the poster child for corporate misdeeds.
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2. ENRON: The Movie
Hollywood will find a way to make this story an “entertainment”
But at its core it was a scheme to enrich management through a complex web of lies and misrepresentations
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3. WELCOME TO THE REAL WORLD
BEFORE ENRON, ALMOST ALL CREDIT RATERS BELIEVED THAT:
When you asked management a direct question, you would receive a fundamentally honest answer
Despite the potential conflicts of interest in providing both auditing and consulting services, accountants recognized that credibility rested on confidence in their independence, and acted accordingly
Positive spin OK, lying not OK

4. How Well Did The Rating Agencies Handle Enron?
Opinions that follow are purely personal observations

5. LONG-TERM DEBT RATING SCALE
INVESTMENT GRADE
AAA/Aaa
AA/Aa
A/A
BBB/Baa
SPECULATIVE GRADE
BB/Ba
B/B
CCC/Caa
CC/Ca
C/C D
Most of you, I’m sure, are familiar with the long-term debt rating scale & the fact that there is a break between the BBB and BB grades, reflecting investment grade and speculative grade.

6. What the Agencies Did Right!
For years, Enron’s ratings were in the “BBB/Baa” range, only one category above speculative grade
Met regularly with Enron management to perform normal due diligence
Communicated their credit opinions to the market

7. What the Agencies Did Wrong!
Didn’t recognize on a timely basis numerous “red flags” (i.e. extraordinary growth, lack of transparency, extreme corporate arrogance, inexplicable management changes)
Were overly concerned about domino effect on Enron’s liquidity of a decision to downgrade out of investment grade
When they finally acted, it didn’t matter!

8. After Enron the Agencies Considered Whether to:
Apply a shorter perspective when assigning long-term debt ratings (no more “rating through the cycle”)
Incorporate current market sentiment (i.e. market prices) directly into ratings
Investor reaction was overwhelmingly negative, so more subtle changes have been adopted
First two points closely related
Explain rating through the cycle concept

9. Changes in Agency Attitudes & Practices
More intense surveillance, particularly where there are liquidity and funding risks
1) recognize that changes in banking practices have altered liquidity risks
2) recognize that share and bond price changes can effect liquidity & funding risks
Syndication of risk
No longer lender of last resort
(slide 1 of 3)

10. Changes in Agency Attitudes & Practices
Ask more questions about ratings & equity price triggers & other contingent financial commitments
Incorporate assessments of corporate governance into rating decisions
(slide 2 of 3)

11. Changes in Agency Attitudes & Practices
Publish opinions more frequently on individual credits of market interest and importance
Use existing communication tools, including CreditWatch & Rating Outlooks, more effectively
Have far less patience, especially when there are perceived liquidity & funding risks
(slide 3 of 3)

12. Implications of Changes for Investors/Lenders
The number of rating changes may increase
Individual ratings may change more often
Greater ratings volatility may cause larger swings in regulatory capital, demanding more cautious investing/lending approaches
(slide 1 of 2)

13. Implications of Changes for Investors/Lenders
If agencies become more proactive, it may not be so easy to anticipate their actions
If agencies provide more predictive guidance, it will be necessary to become more of a “student” of ratings
If agency research improves, internal credit research will have to improve
(Slide 2 of 2)

14. Implications of Changes for Borrowers/Counterparties
Need to convince agencies you’re not another Enron and are deserving of their trust
Need for greater familiarity with the rating process and how different agencies work
Need to establish and maintain open lines of communication with key agency personnel
(slide 1 of 2)

15. Implications of Changes for Borrowers/Counterparties
Need to understand rating criteria being applied to your industry and be able to address them when you meet the agencies
Agencies have certain “hot buttons” - know what they are and how to address them
Managing the rating process will be harder, but the benefits of doing so and the penalties for not doing so will be greater
(slide 2 of 2)

16. A Treasurer’s Guide to Effective Rating Agency Relationships

17. Keys to Establishing/Reestablishing/ Maintaining Credibility
Continuity
Balance
Transparency
Continuity of policies, not just people
Balance between business and financial strategies
Accepting responsibility - not blaming poor market conditions or competitors

18. Meeting the Rating Agencies
Annual or semi-annual meetings are main communication forums
Opportunity for company to tell its story and for agency to ask its questions
But also a chance for dialogue and for company to question the agency
Thoughtful and organized presentations establish a good framework for discussion

19. Credible Written Presentations Will Include:

20. Credible Written Presentations Will Include:
A clear statement of business purpose and objectives
An analysis of business segments - candid evaluation of competitive strengths & weaknesses - key strategies
Explanation of financial policies and strategies
(slide 1 of 2)

21. Credible Written Presentations Will Include:
A discussion of financial goals and expectations ) explain key assumptions ) build bridges from the past ) provide evidence of flexibility & contingency planning
(slide 2 of 2)

22. Successful Meetings Require
Advance preparation
Having the right people present
Expanding on written materials, not reading them
Answering questions directly or not at all
Asking questions

23. Talking But Not Communicating
Company’s Agenda 1) Earnings growth 2) Efforts to enhance shareholder value ) external influences on performance ) belittle competitors 5) success of last financial deal
Rater’s Agenda ) financial flexibility 2) soundness of strategic plan ) take responsibility for performance ) respect competition 5) appropriateness of financial policies ) evidence of contingency planning

24. Current Rating Agency “Hot Buttons”
Corporate Governance
Triggers & Contingent Financial Obligations
Liquidity & Funding Risks

25. Corporate Governance
Ownership Issues ) transparency of ownership ) owner’s influence
Relationships with Financial Stakeholders 1) shareholder meeting & voting procedures 2) protection of owner’s rights
Information Disclosure & Transparency ) Quality of disclosure ) Timeliness & ease of access to information ) Independence & credibility of auditors
Board of Directors ) Structure ) Responsibilities ) Effectiveness

26. Triggers & Other Financial Contingencies
Rating and equity price triggers
Operating and synthetic leases
Explicit and implicit commitments under structured financings
Guarantees/commitments between affiliates
Make-whole commitments to third parties

27. Liquidity & Funding Risks
Internal liquidity
Quality of external liquidity supports
Dependence on asset/business unit sales to meet maturing debt
Dependence on refinancing to meet maturing debt
Magnitude and timing of contingent cash demands tied to performance triggers

28. Final Thoughts
Enron has severely shaken investor confidence in capital markets
Due to their role, the rating agencies reconsidered some long-standing policies
They concluded that drastic changes were not called for and could be even more disruptive
Still, the formal and informal changes are important for all users of ratings to understand

29. Credit Research, Advisory
Roy P. Weinberger
Credit Research, Advisory
Consultingsm
1004 Monarch Circle
Statesboro, GA, USA 30458
Tel/Fax