22Nov

The wide dispersion of credit spreads

FILED IN banking | credit | credit advice | credit score | crisis Comments Off

3Ratings are designed to reflect credit risk over time. Two bonds from different issuers that share the major characteristics, for example with respect to the degree of structural and legal subordination, coupon and embedded optionality, and additionally have the same rating, should trade approximately at the same level. Bond spreads of course also depend on maturity, yielding a term structure of credit spreads. The average spread of an issuer within a particular rating class furthermore depends on the liquidity of the individual bonds and its sector classification.

Despite the wide dispersion of credit spreads within the rating buckets the general link between credit spreads and ratings is clear, with average spread increasing as credit quality decreases. However, as our study illustrates there are large overlaps between individual rating distributions. Myriad examples can be found to show that market participants often perceive the risk of one company in comparison to another to be completely different, even if both have the same rating. It should be noted that our sturdy includes bonds with rather different maturities and coupons.
Altman (1989) and Taylor and Perraudin (2001) have shown the presence of highly persistent inconsistencies between credit ratings and bond spreads, even after adjusting for liquidity and potential tax effects.

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12Oct

So, is big credit beautiful?

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Many commentators, such as management guru Tom Peters, view major mergers such as that between Daimler-Benz and Chrysler as a recipe for disaster. If a firm is strong, then a merger will introduce sources of weakness, or at best take attention and resources away from sources of strength. If a firm is weak, then it is better to focus on the sources of weakness rather than divert resources into negotiating and implementing a merger. There is an argument that rapidly enlarged businesses leave themselves open to leaner, quicker and less bureaucratic competitors.

The counter argument is borne out by the DaimlerChrysler merger. Although success may be difficult to achieve it is still possible to prosper, and despite its many problems, DaimlerChrysler is evidence of this. Furthermore, for many organisations it represents the best, or only, option.

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10Oct

Attention focused on sealing the credit deal

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Short-term issues. Attention focused on sealing the deal, not on the longer-term, all-important issue of how to make it work.

Leadership issues. The leadership at all levels of DaimlerChrysler clashed as the new company drew its leaders from two radically different firms: Daimler-Benz and Chrysler (see point 1 above).

Corporate identity and communications issues. There are dangers in replacing familiar brand names with those of a new brand. The magic of the old may be destroyed, or at least diminished, by the logic of the new. The degree of emotional attachment felt by stakeholders to a company’s name should not be underestimated. In the case of DaimlerChrysler, Daimler-Benz’s stakeholders were offended by their company’s renaming as they believed the process was really an acquisition, and Chrysler stakeholders were similarly offended by the renaming of their company.

Once a deal is agreed in principle, the chances of it succeeding will be greatly enhanced if the messages sent out from both organisations are consistent. This rarely happens in a thoroughly convincing way, but when it does it makes a big
difference.

Potentially conflicting objectives. It is hard for employees to focus on the corporate objectives of a merger if they are worried about their own position. All mergers involve reorganisation and job cuts, so to keep employees as “on side” as possible there must be regular and honest communication.

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