Explain the role and importance of the bond rating agencies in the issuance of debt.

Background

Corporate debt markets represent a major share of capital markets activities. Corporations require a balanced structure of debt and equity to provide for the requirements of growth, renewal of assets and expansion through acquisitions. The debt markets serve the interests of investor groups whose financial positions focus on stable sources of predictable return from creditworthy borrowers. The case of “WorldCom Inc.: Corporate Bond Issuance” presents a fascinating view of debt financing at the highest levels of importance and complexity. The case reviews the efforts of World Com to fuel its aggressive expansion program through the acquisition of competitors. The capital market alternatives for WorldCom enabled it to select among variables in the pricing, timing, size and structure of debt instruments. The environment of the market with a combination of financial stress originating from international developments and aggressive investment policies reflecting the boom in the telecommunications industry provides another dimension of key alternatives. From the perspective of later events the ultimate deterioration and bankruptcy of MCI World Com, the entity supported by the debt provided in this case, provides many valuable insights into the capabilities and deficiencies of the capital markets. The reading selection “World Com – What Went Wrong” enables further understanding of the situation.

Factors

The case focuses on the following principal considerations:
1. The Company – Acquisition Strategy
2. The Company – Financial Strategy and Choices
3. The Debt Market – Conditions and Stresses
4. The Debt Market – Financial Alternatives
5. Market Factors – the Rating Agencies
6. Market Factors – Investor Attitudes and Actions

Assignment

The report should address the following:
1. Strategic Analysis – evaluate WorldCom’s aggressive business strategy as it pursued its expansion with anticipation of extraordinary growth in the telecommunications industry. From the viewpoint of business organization, management and risk control what were the issues for WorldCom and how did it manage these issues?
2. Situation Analysis – the capital markets at the time of the case involved strong and contrasting currents of stress in international conditions and heavy demand for debt issues in the U.S. market. What were the implications of these trends in terms of existing and projected interest rates, the “spreads” on the costs of debt for corporate borrowers, and the impact on possible terms and conditions for debt?

3. Bond Ratings – explain the role and importance of the bond rating agencies in the issuance of debt. What is the responsibility of the major agencies to the investment market? Review the Moody’s Bond Rating Definitions (Exhibit 5) and apply its standards to the corporate condition of World Com at the time (Exhibit 3 – Financial Information). Evaluate the ratings for the WorldCom debt with comparable ratings in the market for other corporations and explain the possible factors in the differences.
4. Financial Strategy – consider WorldCom’s financial alternatives in financing the MCI acquisition in terms of other bank and borrowing facilities, additional equity and possible combinations of approaches. Comment on WorldCom’s intention to issue the largest corporate debt package in capital market history. Did the company follow an appropriate financial strategy in terms of facts available at the time?
5. Financial Structure – examine the combination of debt tranches in the World Com bond package. Analyze and explain the amount, maturities and applicable interest rates for the debt instruments. Separately review the covenants in the company’s banking and bond facilities (Exhibit 1) in terms of the protection for the various creditors and the constraints on and commitments of the company.
6. Investor Approaches – review the enthusiastic attitude of investors to the WorldCom bond issue and to other corporate debt (especially in the telecommunications industry) at the time. What were the fundamental objectives of investors in terms of risk and credit, reward in terms of interest rates and commitments in terms of the length of the maturities on debt instruments? How did investors attempt to confirm their expectations and what assurances did they find to encourage their investment commitments? How much protection did debt ratings and covenants provide?
7. Outcomes – ultimately WorldCom failed as a company, entered bankruptcy and created large losses for investors. The company’s failure came within a few years of the capital markets’ commitment of unprecedented funding in the debt package.
Comment on the ability of the markets and its participants to accurately evaluate risk and reward in view of the WorldCom experience. Did the market fail in this case?
What changes in process and policy could have led to other outcomes?
8. Grades – assign responsibilities for the market failures to the key participants—WorldCom, its investment banks, the rating agencies and the investors. Consider the quality of the decisions made by each and the rationality and sufficiency of their choices.

Individual reports should respond to each of the questions above. The reports may draw upon sources in addition to the case. Suitable attribution should be provided as well as a listing of the additional sources.