To Advance: Click Screen Anywhere or Click Next 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. To Advance: Click Screen Anywhere or Click Next Back to Main Page Next Page

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 Previous Page Next Page

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

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

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.

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

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!

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

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)

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)

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)

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)

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)

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)

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)

A Treasurer’s Guide to Effective Rating Agency Relationships

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

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

Credible Written Presentations Will Include:

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)

Credible Written Presentations Will Include: A discussion of financial goals and expectations 1) explain key assumptions 2) build bridges from the past 3) provide evidence of flexibility & contingency planning (slide 2 of 2)

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

Talking But Not Communicating Company’s Agenda 1) Earnings growth 2) Efforts to enhance shareholder value 3) external influences on performance 4) belittle competitors 5) success of last financial deal Rater’s Agenda 1) financial flexibility 2) soundness of strategic plan 3) take responsibility for performance 4) respect competition 5) appropriateness of financial policies 6) evidence of contingency planning

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

Corporate Governance Ownership Issues 1) transparency of ownership 2) owner’s influence Relationships with Financial Stakeholders 1) shareholder meeting & voting procedures 2) protection of owner’s rights Information Disclosure & Transparency 1) Quality of disclosure 2) Timeliness & ease of access to information 3) Independence & credibility of auditors Board of Directors 1) Structure 2) Responsibilities 3) Effectiveness

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

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

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

Credit Research, Advisory Roy P. Weinberger Credit Research, Advisory Consultingsm 1004 Monarch Circle Statesboro, GA, USA 30458 Tel/Fax 912 564 5073 rweinberger@frontiernet.net