Lobster Case

Credit Risk Midterm: BP & the 2010 Oil Spill Jack O’Connell, Sameer Rana, Suresh Venkataramani January 16, 2014

Executive Summary

BP currently has a Moody’s credit rating of A2 and S&P rating of A. However, not long ago, BP held a Moody’s rating of Aa1 and an S&P rating of AA+. We intend to show that BP’s rating suffered as a result of the 2010 Gulf of Mexico oil spill. We will also illustrate that BP’s downgrade was idiosyncratic and not due to the business cycle. We will highlight what exactly in the company’s financials caused the divergence from its peers. Finally we will describe the current credit risk of the company and attempt to predict its future credit health. Most importantly we will utilize the various tools at our disposal – including Altman’s Z-Score, bond spreads, the Merton model and distance to default, and credit default swap data – to reach our conclusions.

Section 1: Altman Z-Score

The Altman Z-Score is touted as an early indicator of movement in credit rating. We used Bloomberg’s modified version of the Z-Score for our analysis: Z-Score = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + X5 where: X1 = Net working capital / Tangible assets X2 = Retained earnings / Tangible assets X3 = EBIT / Tangible assets X4 = Market value of equity (not preferred) / Total liabilities X5 = Sales / Tangible assets It was important to use this modified version as the original Z-Score yielded results above 20 for some of BP’s peers. This made comparison difficult as idiosyncratic trends were hard to spot since the data was so noisy. Using the figures below, we calculated BP’s 2012 Z-Score as 2.63. =1.2*(28,641/264,291) + 1.4*(102,107/264,291) + 3.3*(7,961/264,291) + 0.6*(132,029/180,573) + (375,580/264,291) = 2.63 Working Capital Tangible Assets Retained Earnings EBIT Common Equity (market value) Total Liabilities Revenue $28,641 $264,291 $102,107 $7,961 $132,029 $180,573 $375,580

This figure is in the 1.81 to 2.99 zone of ignorance. The original Z-Score formula...