Addressing industry sentiment, last week Moody's Investors Service announced it would sponsor an independent, academic investigation into the differences in ratings methodologies, transitions and other disparities between the agency's structured finance ratings, tackling head-on (so says Moody's) the current debate over notching (see ASR 6/18/01, 6/25/01 and 9/3/01). Moody's expects to announce its candidates for carrying out the study this week.

"We're trying very hard to be above board and be very transparent about this issue," said Brian Clarkson, senior managing director of asset finance at Moody's. Since it's announcement, Moody's has received positive feedback from the securitization community, Clarkson said.

"We haven't heard any negativity," he added. "People have asked, though, Are you really addressing the issue?' Our response is, We think we're addressing the issue. If anyone can come up with a better way for us to address it, we're certainly willing to listen.'"

As for Fitch, which has argued its business is negatively impacted by Moody's current notching policies, the rating agency is still skeptical.

"We think the theory of an independent study is a good one, but such a study should be fully independent of undue influence by any market participant," said Charlie Brown, general counsel for Fitch. "We believe an organization such as the Bond Market Association would be in the best position to take a lead on organizing such a study."

As a matter of happenstance, the issue of notching was brought to the floor last Wednesday at a meeting for BMA members. According to George Miller, general counsel of the BMA, the members at the meeting agreed that broader industry participation and public dialogue about the issue can only be a good thing for the market. "It is appropriate for the Bond Market Association, on behalf of its members, to be meaningfully involved in this dialogue," Miller said. "What would appear to make the most sense is to have a broader public dialogue, and to benefit from any data or light shed on the underlying issues. We enthusiastically support the idea of one or more independent studies."

"To the extent that Moody's conducts a study that promotes transparency, elucidates notching practices and gives us a better understanding of the rationale and justification for these policies, then that is something we are supportive of and that our members are supportive of," added Laura Gonzalez Marcano, assistant general counsel for the BMA.

Miller also said that it is wise to have an outside party examine the issues, especially one that specializes in the scope and methodology of identifying research outputs and testing hypotheses. "It makes sense for the industry to coalesce on a single study," Miller said.

Notching historically

Notching became a hot topic of debate this year when the issue was brought up at a CMBS conference in June, with panelists arguing that current notching policies for structured finance CDOs have created an artificial spread dislocation in the market.

According to Moody's, notching for high-yield bonds in CDOs has been a practice dating back more than 10 years. For structured finance CDOs, Moody's policy has not changed in the last year and half.

Beyond the current issues and debates, Moody's believes an independent study examining the differences between the ratings and methodologies (S&P/Fitch rating to probably default, Moody's rating to expected loss and severity) is long overdue.

"[For corporates] we notch off S&P because there's been a lot of academic research that compares our ratings with S&P's ratings," said Noel Kirnon, head of the derivatives group at Moody's. "And that's something that has been missing in the structured finance market. And that's what this research is meant to address." - MG/AT

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