Moody’s plans rating methodology revision

Moody’s rating methodology looks set to be the latest casualty of the collapse of the US energy trading company Enron. The rating agency has announced that it is discussing changing its rating policy “to improve the flow of timely credit opinion”.

Christopher Mahoney, chairman of Moody’s credit policy committee, says the changes are in response to investors paying greater attention to issues of credit quality following the US terrorist attacks, the global slowdown and some high-profile corporate bankruptcies – most notably that of Enron.

During the collapse of Enron, both Moody’s and Standard & Poor’s (S&P) were heavily criticised for their slow reaction to the crisis. Enron’s rating from Moody’s was only reduced to sub-investment grade, B2, on November 28 – just hours before Dynergy, a smaller energy trading company, pulled out of takeover talks that essentially signalled Enron’s bankruptcy.

According to a Moody’s press release the proposed changes include: “More comprehensive analysis of rating triggers; enhanced research on the liquidity risk of investment-grade and speculative-grade issuers; more extensive use of market information; and consideration of other enhancements to the rating process.”

But Moody’s adds that it will not make any major changes to its rating process before market participants have been given a chance to respond.

Fund managers have given the proposals a warm welcome. One London-based fund manager says: “Moody’s has always been too theoretical in its ratings methodology, as if it’s operating in an ivory tower. So it is a good thing that it is asking for proposals from the market.”

However, there are fears that the changes could cause increased volatility in the debt markets. Another London-based fund manager says: “I’m not sure if investors want ratings changing as rapidly as Moody’s suggests. Credit quality is continuously changing, but we do not want rating changes after every piece of news.”

A London-based credit analyst at an asset management company says rating agencies have been reluctant to make quick downgrades in response to bad news for fear of precipitating a default. But the Enron embarrassment has forced Moody’s to admit that it may not be able to measure the market without affecting it, he says.

“Ideally investors want a rating agency to predict when a company is going to go bankrupt, but they don’t have a crystal ball,” says the analyst. “It is up to investors themselves to determine the price of credits. Rating agencies are best suited to offering an additional independent insight into a company.”

As to whether S&P is also considering making changes to its rating process, a spokesperson for the company says: “We are always reviewing the rating process and criteria. But we are not making any definite changes following Enron.”