Reform Bill Targets Credit Raters

On Thursday, May 13, 2010, the U.S. Senate  took steps to overhaul the credit-rating agency business, which is widely maligned for its role in the 2007-2009 financial crisis.  An amendment by Democratic Senator Al Franken passed for a government clearinghouse to be set up to assign debt rating duties to agencies, with federal regulators developing their own standards of credit-worthiness rather than relying solely on credit rating agency assessments. In a subsequent vote, lawmakers approved a separate amendment by Sen. George S. LeMieux (R-Fla.) that would remove the government’s stamp of approval for a select group of ratings agencies as the standard for credit worthiness.

Questions:

1.  Who are the main credit agencies that controversial bill was aimed at?

2.  This bill is being touted as the biggest overhaul of financial regulation since the Great Depression.  What regulation(s) was enacted during the Great Depression that impacts accountants to this day?

3.  Briefly explain bond ratings and why it is important for an accountant to understand this concept.

Source:

CNBC. (2010) Amending FinReg, May 13 video (Retrieved online at http://www.cnbc.com/id/15840232?video=1493262393&play=1)

Timeshare Worries in a Recession

Marriott International, the well-known hotelier, saw operating losses in its third quarter of 2009, as a result of its venture to move into financing time-shares during a slowing real estate market. In addition, the sluggish economy has not helped its primary business segment that caters to cash-based lodging for business and leisure travelers. As a result, Marriott’s credit profile shows a somber ‘BBB-‘ debt rating assigned to its long-term debt, which some describe as on the border between investment and junk bond status. In fact, some analysts are worried that Marriott may violate its key loan covenant: its leverage ratio.

QUESTIONS:

1. What is a junk bond?
2. Why is this borderline rating a bad thing for Marriott?
3. Explain what a loan covenant ratio is. Assuming that Marriott’s covenant is tied to either the debt to equity ratio or the cash debt coverage ratio, describe how aggressively managing costs and accelerating debt reduction would help Marriott avoid a violation of its covenant.

SOURCE: Phillips, D. “Timeshare Business Unwelcome Guest at Marriott International,” BNET – Companies in the Buzz (Retrievable online at http://industry.bnet.com/travel/10003824/timeshare-business-unwelcome-guest-at-marriott-international/)

Debt Exchange

In an 11th-hour effort to avoid filing for Chapter 11 bankruptcy, commercial lender CIT Group Inc. offered its bondholders a debt exchange. The exchange offer expired on October 29, 2009. According to this exchange plan, CIT bondholders of older notes would receive between $700 and $900 in new debt plus between 0.41 and 3.26 of new preferred shares for every existing $1,000 bond tendered.

QUESTIONS:

1. Explain how this exchange would benefit CIT Group Inc. What are the potential costs or benefits for the bondholder?
2. Assume that you are a bondholder that takes advantage of the exchange. You hold 5 bonds and exchange them for $800 plus 3 shares of new preferred stock when the stock has a stated value of $1.20 per share. What journal entry would you make?
3. Assume the same information as in question 2 and make the journal entry that CIT Group Inc. would record on the exchange date.

SOURCE: Blandeburgo, B. “CIT Offers Debt Exchange, Draws Up Bankruptcy Plans,” Money Morning (Retrievable online at http://www.moneymorning.com/2009/10/03/cit-banking/)

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