13 Investment credit rating

This unit looks at the role of the corporate credit-rating agencies

in the global economic crisis which started in 2007.

BEFORE YOU READ

Discuss these questions.

1 If you wanted to borrow money, what would the lender do to assure themselves that you
would be able to pay it back in the future?
2 If you were going to make an investment in a company or financial product, how would
you check whether your investment would be safe?

READING

Understanding the main points

Read the article and say whether these statements are true (T) or false (F).
Correct the false ones. Identify the part of the article that gives this information.
1 At the time of its failure, Northern Rock was a building society.
2 It provided money for borrowers to buy homes and property.
3 It suddenly experienced financing problems and had to ask the Bank of England for help.
4 Northern Rock's customers feared they would lose their savings and started taking them
out of the bank quickly.
5 The UK government blamed only Northern Rock for this crisis.
6 Corporate credit agencies advise investors on the riskiness of companies and
investment products.
7 Standard & Poor credit-rating agency admitted that it had never warned the
investor community of the danger of these 'securitisation' products.

Understanding details
Read the article again and answer these questions.
1 Over which period did Northern Rock increase in size very quickly?
2 Which particular financial problem made it difficult for Northern Rock
to find money to finance its lending activities?
3 Which three credit-rating agencies dominated the world market at that time?
4 Which rating do they give to the safest investments?
5 Which rating do they give to the riskiest investments?
6 Who pays the credit agencies for their work?
7 What was Jean-Claude Trichet's opinion about the number of credit agencies in the market?
8 Which organisation decided to investigate and improve the credit-agency sector?

52
 UNIT 13 INVESTMENT CREDIT RATING

A The Northern Rock Building Society converted into a public limited company in 1997.
Over the next 10 years, the Northern Rock Bank rapidly grew into one of the largest
mortgage lenders in the UK, relying on a system of securitisation - repackaging most of
the loans it had originated into securities and selling them on to institutional investors.
B In 2007, the US subprime crisis hit Europe. That source of financing dried up, so
the bank was forced to borrow emergency money from the Bank of England. When
customers found out about this financial lifeline, many withdrew their savings in the
first run on a bank in Britain for around 140 years.

G In 2007, the US Securities and

Exchange Commission (SEC) listed
seven credit-rating agencies as nation-
ally recognised statistical rating
organisations. Two of these, Japan
so Credit Rating Agency and Rating and
Investment Information, were new
additions in June.
H However, the much larger S&P,
Moody's and Fitch still dominated the
55 market. This led Jean-Claude Trichet,
the President of the European Central
Bank, to complain about the lack of
choice between global credit-rating
agencies. So European Union market
60 watchdogs started questioning the
rating agencies about their role in
the subprime mortgage crisis, and the
International Organisation of Securities
Commissions (IOSCO), representing
65 more than 100 securities regulators,
E Corporate credit-rating agencies set up a taskforce to improve their
Rating the 20 assess the creditworthiness of bonds
and bond issuers. They assign different I
regulation.
In their own defence, the rating
grades to corporate bonds, using their agencies maintained that their job
credit agencies own grading system. The highest-
ranked 'investment-grade' bonds are
70 was to provide an opinion on the prob-
ability of a company defaulting on its
by Elaine Moore 25 rated triple-A. Those at the lowest end debt repayments, not market perfor-
of the spectrum, with 'junk bond' mance. Added to that, they stressed
C In response to the Northern Rock crisis status, are rated either C or D, depend- that their ratings should never be used
in 2007, the UK Parliamentary Trea- ing on the agency. Fund managers and ?5 as the sole reason for an investment
sury committee was fierce. 'You all other investors use the information decision. Furthermore, S&P pointed
failed,' was one member's verdict on 30 to assess the potential return on out that it had reported the 'possible
5 the role of the credit-rating agencies. investment. risk' for investors of 'creative financing
Admittedly, with predictions for a F Unfortunately, the agencies had opportunities within the residential
global economic slowdown, politicians given many assets securitised with so mortgage realm' as early as April 2005.
were keen to find scapegoats. So banks, subprime mortgages triple-A ratings. It seemed, however, that nobody had
central banks and regulators all faced When the global credit squeeze hit, been listening.
10 criticism for their failure to foresee the their credibility was called into ques-
consequences of the US subprime tion. Should these assets ever have
mortgage lending crisis.
D One group in particular was heavily
been given the top rating? Should
investors have been warned of the risks FT
criticised. The Treasury Committee earlier? They were accused of reacting
is interrogated representatives of the too slowly to changing situations and
three largest credit-rating agencies: of facing a conflict of interest because
Fitch, Moody's and Standard & they earned a fee from the issuers
=. Poor's (S&P). whose securities they rated.

53
UM1T13 INVESTMENT CREDIT RATING

VOCABULARY

Definitions
Match these phrases from the article (1-8) with their meanings (a-h).
1 the Treasury a) the government department in charge of the money that a
government collects in taxes and from borrowing, and the money
that it spends
central bank b) a company that provides loans of money for people to buy houses
corporate credit-rating agency c) in Britain, this entity's shares are freely sold and traded with a
minimum share capital of £50,000
4 public limited company d) a company or bank that makes certain assets or securities such as
shares or bonds available for sale
5 mortgage lender e) a company that calculates the risk of lending to or investing in a
company or its financial products
6 bond issuer f) the official bank of a country, which is responsible for setting
interest rates, controlling the money supply, producing banknotes
and keeping the country's supply of foreign currency and gold
7 subprime mortgage g) a restraint or limitation of credit; usually (although not always) a
government measure designed to reduce inflation, by methods
such as increasing interest rates
8 credit squeeze h) a loan to buy a house which has been given to a borrower with a
poor credit rating

Vocabulary development

bond rating
Moody's Standard & Poor's
Aaa AAA investment lowest risk
Aa AA investment low risk
A A investment low risk
Baa BBB investment medium risk
Ba, B BB, B junk high risk
Caa/Ca/C CCC/CC/C junk highest risk
c D junk in default

Complete the sentences using the chart above and the phrases in the box.

as risky as as safe as considerably safer than much riskier than

slightly riskier than the riskiest / in default the safest

1 Moody's Caa rating is Standard and Poor's CCC rating.

2 An A-rated investment is an Aa- or AA-rated investment.
3 An Aaa or AAA rating is
4 An Aa or AA rating is a Caa or CCC rating.
5 AC or D rating is
6 An Aa rating is an AA rating.
7 A B rating is an AAA rating.
 UNIT 13 »* INVESTMENT CREDIT RATING

Word partnerships
Match the verbs (1-6) with the noun phrases (a-f) to make expressions similar to those in the article.

to assess a) different grades to corporate bonds

to assign b) corporate bonds and bond issuers
to default c) the creditworthiness of bonds and issuers
4 to rate d) on debt repayments
5 to improve e) an asset
6 to securitise f) regulation

Text completion
1 Use the words in the box to complete the explanation of securitisation below.

bank bond borrower interest investor lender repayments securitised

1 2
A financial institution, such as a buys a loan from a (such as another bank), who has
3
already lent an amount of money to a (another person or institution). This means that the
financial institution now has the right to collect the "on the original borrower's loan. It then uses
5
the expectation of receiving these as security for a , which it issues to an individual or corporate
6
in return for a specific amount of money, which the financial institution promises to repay the
investor at a later date. The financial institution also uses the original borrower's repayments to make
7
payments to the bond holder until the date when the bond is repaid. Both the financial institution
8
who bought the loan and it in the form of a bond, and the bank who originally sold the loan to the
financial institution, use the capital they have received from their sales to improve their financial situation
or increase their activities. They lend that money to more borrowers, and sell on these loans to other
institutions, who then securitise them. And so it goes on.
2 Use the words and phrases in the box to complete the paragraph below.

bond issuers credit-rating highest risk investment-grade

securities regulator subprime mortgages treasury committee
J
The which led an inquiry into the Northern Rock financial collapse blamed almost every player
2
in the financial sector. It particularly pointed the finger at the - agencies, who had assigned
3 k
- credit ratings to bank securities which turned out to be some of the investments
5
in the market. These junk-bond grade assets, based on (those granted to borrowers who
would be unlikely to repay them), were used to fund further loans to customers. It was pointed out that a
fundamental problem lay in the fact that credit-rating agencies were paid by the very whose
corporate bonds they rated. As a result, the International Organisation of Securities Commissions (IOSCO),
7
the global , was called in to improve regulation of this sector.

OVER TO YOU

Do an online search of the credit ratings of a number of companies or financial institutions which you
are interested in. Write a short report, explaining which rating agency has rated each company, which
rating each company has received, and why you think this is. Use the chart in Exercise B to help you.

55