200 Renaissance Center - Detroit, Michigan 48265
Executive Office

November 8, 2002

Johnathan G. Katz
Securities and Exchange Commission
450 5th Street NW
Washington, DC 20549-0609

Subject: File #4-467

Dear Mr. Katz:

I have been invited to be a participant at the upcoming Hearing on Credit Rating Agencies to be held November 21, 2002. In this regard, I submit the following document as my written statement.

Please be advised that this document was written originally in April 2001; and, because of time constraints, the statistical data contained within has not been updated. However, this fact does not change or detract from the arguments presented in the document.


            Jerome B. Van Orman, Jr.
            Vice President, Finance
            Chief Financial Officer, North American Operations

Commercial Paper Credit Ratings

Jerome B. Van Orman, Jr.
Vice President, Finance
Chief Financial Officer,
North American Operations

General Motors Acceptance Corporation

Original: April 17, 2001
Word Revisions: November 8, 2002

Commercial Paper Market

  • As the capital markets have progressively disintermediated the role of commercial banks in corporate financing over the past twenty years, commercial paper has come to play an even more critical role in the U.S. money markets, both as an asset and a liability

  • Over this period, the unsecured commercial paper market has grown in the number and type of issuers and in total size

    • Commercial paper outstandings have increased at a 12% CAGR since 1981

      • 1981:     $160 Billion

      • 1991:     $530 Billion

      • 2001:     $1,550 Billion

    • Outstandings of other securities within the realm of the U.S. money markets (e.g., Treasury bills, bankers' acceptances, and bank certificates of deposit) cannot match this growth rate of unsecured commercial paper

    • In addition, over the last ten years, an asset-backed commercial paper market has developed, with $645 billion outstanding currently

  • Consistent with bank disintermediation, commercial paper (as a liability) has evolved into a critical source of direct short-term financing for large non-financial U.S. corporations

    • Moreover, commercial paper has become the most important source of short-term funding for the non-bank financial institutions in their intermediary role of financing the credit requirements of smaller U.S. corporations and individuals

  • At the same time, commercial paper (as an asset) is the largest holding of most money market funds in which individuals and institutions place their short-term funds, often in lieu of federally-insured bank time deposits

    • As a result, it can be argued that the creditworthiness of commercial paper, as the principal asset in which most money market funds invest, is critical to the soundness of the U.S. money market and money itself (as our society defines it)

Rating Agencies

  • Given the integral role commercial paper now plays in the U.S. money markets both as an asset and a liability, the credit rating of this financial security, as determined by the three major U.S. rating agencies--Moody's, Standard & Poor's, and Fitch--has taken on increased significance

  • Essentially, any credit rating is the assessment by the rating agency of the likelihood of timely repayment of the interest and principal of an issuer's debt security

    • In the case of commercial paper, the rating agencies are evaluating the creditworthiness of an unsecured promissory note, with maturities ranging from 1 to 270 days

  • In the U.S., the three rating agencies utilize three generic commercial paper ratings in order of credit quality from high to low: tier-1, tier-2, and tier-3

    • Standard & Poor's and Fitch have also used a plus (+) with respect to their tier-1 rating to denote overwhelming safety (not so Moody's)

  • According to rating agency literature, because the analytical approach in assigning a commercial paper rating is virtually identical to the one followed in assigning a term debt rating (i.e., medium-term note and/or long-term bond), a strong link or "correlation" between a corporation's commercial paper and term debt ratings has evolved for the three rating agencies, as follows

    Term RatingCP Rating
    AAA to AA Tier-1+
    AA- to A Tier-1
    A- to BBB Tier-2
    BBB- and lower Tier-3 and lower

  • The above commercial paper/term debt rating correlations have been in place since the late 1970's

    • Term debt rating tiers expanded in the late 1970's to include pluses (+) and minuses (-) to existing letter categories

    • In contrast, commercial paper rating tiers remained unchanged at the time (and subsequently) despite the tremendous increase in its size and importance to the U.S. money markets

    • As a result, note in the table above that there are three term debt ratings for each commercial paper rating (although, if the two commercial paper tier-1 ratings are combined, similar to the Moody's practice, six term debt ratings apply to that tier)

  • With this background, the author offers three personal observations:

    • Contrary to rating agency literature, each rating agency in practice first develops a term debt rating for a particular corporate issuer and then reverts to the correlation table above when assigning the short-term commercial paper rating

      • Put simply, rating agency analysts think in terms of long-term ratings, not short-term commercial paper ratings

    • The current commercial paper tiers, virtually unchanged since inception and despite changes in term debt tiers, are archaic given the changes in the money markets, particularly commercial paper, over the past twenty years

    • As markets change and evolve over long periods of time, the rating agencies have not considered it their responsibility to evaluate whether the market impact of a corporation's "linked" short-term and long-term credit ratings remain roughly consistent across the yield curve with respect to availability and cost of funds

Rule 2a-7

  • The importance of an issuer's commercial paper credit rating has never been greater because of not only the growth in the market and its critical role in short-term fund raising in the U.S. money markets but also the SEC's Rule 2a-7

  • Rule 2a-7 of the 1940 Investment Company Act limits the credit risk that money market mutual funds may bear

    • It restricts their investments to "eligible" securities

    • Rule 2a-7 was implemented around 1990 to ensure the quality of assets held by money market funds (which are, in turn, public and/or private liabilities) is unquestioned, thereby protecting money fund holders who view their investments as being similar to "money" or federally-insured bank deposits

  • An eligible security must carry one of the two highest ratings ("1" or "2") for short-term obligations from at least two of the SEC's nationally recognized rating agencies

    • Currently, there are three recognized rating agencies-Moody's, Standard & Poor's, and Fitch

    • When first implemented, there were four (Fitch and Duff & Phelps subsequently merged)

  • A tier-1 security is an eligible security rated "1" by at least two of the rating agencies; while a tier-2 security is an eligible security that is not a tier-1 security and with no ratings lower than tier-2

    • The move from four to three U.S. rating agencies has made it more difficult for the securities of "split"-rated commercial paper issuers to qualify as tier-1

  • Money market funds may hold no more than 5% of their assets in the tier-1 securities of any individual issuer and no more than 1% of their assets in the tier-2 securities of any one individual issuer

    • Moreover, a money fund's holdings of tier-2 securities may constitute no more than 5% of the fund's assets

  • In practice, Rule 2a-7 contributes to severely limiting the outstanding size of tier-2 money market securities, including commercial paper

    • Currently, outstandings in the U.S. commercial paper market are rated for creditworthiness as follows:

      ($ Bil).
      % of Total
      Tier-1 1,375 88%
      Tier-2 105 7%
      Tier-3/Non 2a-7 Eligible   75   5%
          Total 1,555 100%

    • Note in the table above that, between tier-1 and tier-2, a "credit cliff" exists for large commercial paper issuers, typically non-bank financial institutions

    • A large non-bank financial institution, if it were to decline to tier-2, generally would be forced to shrink its asset base because comparable funding alternatives to commercial paper are simply unavailable in the bank and money markets

Disproportionate Funding Impact

  • Because of rating agency policy with respect to commercial paper ratings (in conjunction with the effects of 2a-7), there is a much sharper "tier distinction" in terms of size for commercial paper than there is for "comparable" term debt in the U.S. money and capital markets, as shown below

    Commercial Paper Term Debt Rating Outstandings Rating Issuance
    Rating 1st Q 2001
    Tier-1 88%
    Tier-2 7%
    Tier-3 1%
    Non 2a-7 Eligible 4%
    Total 100%
    Rating 1998-2000
    AAA to A 68%
    A- to BBB 20%
    BBB- and lower 10%
    Unrated 2%

  • Currently, tier-1 commercial paper outstandings total $1,375 billion which is a multiple of 13 greater than tier-2 commercial paper outstandings of $105 billion

    • In contrast, in the three year period 1998-2000, U.S. corporations rated AAA through A (correlated with tier-1 commercial paper) issued $1,120 billion in term debt which is a multiple of 3.5 greater than the $325 billion in term debt sold by comparable A- through BBB issuers (correlated with tier-2 commercial paper)

  • In short, in the U.S. money and capital markets, a tier-2 commercial paper rating imposes significantly greater liquidity constraints and proportionately higher interest costs on corporations than the "correlated" term debt ratings of A- through BBB

    • There is a "credit cliff" in the commercial paper market which does not exist to the same extent in the term debt capital market, as the gradation in outstandings present in the term debt markets are much more gradual than those inherent in the commercial paper market

    • This fact is no surprise when there are six term debt ratings (AAA, AA+, AA, AA-, A+, A) correlated with the tier-1 commercial paper rating alone

  • Ironically, there are examples where an "A-" rated U.S. corporation can more easily issue 5-year notes than 30-day commercial paper to satisfy its funding requirements

    • It is illogical that there is an implicit higher credit risk at 30 days than at 5-years when it comes to raising funds

    • The rating agencies appear not to think that their commercial paper and term debt ratings, as correlated currently, are an issue when discussing the "credit cliff" in the commercial paper market and the comparable lack thereof in the term debt market

      • In fact, they appear to view the idea that the impact of credit ratings on the availability and cost of funds should be roughly equivalent across the yield curve as one for which they bear no responsibility

    • To some extent, the agencies may believe that any discussion of the existing commercial paper/term debt rating correlation and its market impact is just a smokescreen for what they believe may be the true motivation of issuers-namely, a desire to see ratings standards diluted

      • However, the issue is not absolute rating standards but the consistency of impact across the yield curve of two distinct credit ratings

Possible Improvements

Rating Agencies

  • Short-term

    • Published correlations by the rating agencies between commercial paper and term debt rating categories allow for an A- (term) and tier-1 (CP) combination

      • Exceptions have been rare in practice, but usage could be increased by the rating agencies without raising issues related to declining ratings standards

      • Certainly, the market's message is that an A- issuer in the longer-term term debt capital market is worthy of tier-1 access in the shorter-term commercial paper market

  • Intermediate-term

    • Given that nine term debt tiers currently are correlated with tier-1 and tier-2 commercial paper outstandings, it seems reasonable for the rating agencies to consider additional tiering in the short-term ratings category to more fairly characterize the credit quality of issuers

      • Put simply, the ratings agencies should add pluses (+) and minuses (-) to both the tier-1 and tier-2 commercial rating categories

    • With greater equivalency between the number of tiers for commercial paper and term debt ratings, new "correlations" between short- and long-term credit ratings with more comparable market impact would then be possible

      • Having once decided upon additional commercial paper tiers, the agencies would then take responsibility to explain to investors (and the SEC) that rating standards have not deteriorated but that their commercial paper ratings have entered the 21st century


  • When Rule 2a-7 was first promulgated over ten years ago, there were four nationally-recognized rating agencies, whereas three exist today

    • As a result, Rule 2a-7 has never been more restrictive than today

  • In response, the SEC should consider a fourth rating agency be added to its nationally-recognized group (perhaps DBRS in Canada) or redefine its three tiers of commercial paper to incorporate a term debt rating element as well (i.e., a commercial paper issuer's tiering under Rule 2a-7 would also reflect that issuer's standing in the term debt market)

    • For example, the SEC could redefine tier-1 commercial paper issuers to include those companies with either a tier-1 short-term rating or an investment grade long-term debt rating (i.e., BBB or higher)