In response to issues raised in last week's ASR article "The notching game: Market speaks out against Moody's CDO policies for CMBS," (see ASR 6/18/01, p.1) Moody's Investors Service issued a report late last week clarifying and outlining the exact analytical reasons for the severity of its notching practices, including numerous credit issues related to collateral-level CMBS analysis that have caused significant differences of opinion between the rating agencies.
Moody's insists that its long-standing notching policies are designed to protect senior CDO investors by helping to assure the analytical consistency of the rating inputs to a particular CDO. Most significantly, unlike other agencies, Moody's takes the leveraging of loss into account when rating CMBS, meaning that it takes into consideration the fact that even one or a few loans defaulting in a deal could cause a tranche to default with 100% severity.
"The market expects that our...rating will be independent, and we have to assess the risk of the underlying collateral to make sure our rating is right," said Noel Kirnon, group managing director at Moody's. "Unlike the other agencies, Moody's takes the leveraging of loss into account by seeking an extra credit enhancement buffer," which serves to lower the likelihood of default to compensate for the potentially higher severity of loss.
According to Kirnon, investors must understand that a rating approach based on expected loss could result in ratings that are significantly different from ratings based solely on default probability.
Further, notching is just one of several options that issuers have for attaching a shadow rating to non-Moody's-rated paper going into a Moody's-rated CDO. Issuers may also choose an estimated rating, or complete a "mapping" exercise to estimate the rating. In fact, notching, a practice which Moody's has used for 11 years, actually yields the most variable and least accurate results, Kirnon said.
In the release which, as of press time, was scheduled to be released last Friday, entitled "Moody's Approach to Notching' CMBS Ratings in CDOs," the rating agency outlines structural obstacles to notching, as well as several credit issues related to collateral analysis that may yield significant differences in opinion, including rent spikes, rising conduit leverage, portfolio concentration, use of actual versus stressed interest rates, and retail sales analysis.
"We're trying to protect senior CDO investors," said Tad Philipp, Moody's managing director of CMBS. "CMBS has benefited to date by mostly being exposed to the rising part of the real estate cycle, but over time the performance records will vary greatly. There have been several transactions where the discrepancy between the other agencies' rating and ours has been four, five or six notches."
In regard to Moody's policy of not notching Fitch-rated CMBS, Philipp said that over the last few years, the credit enhancement on Fitch transactions has characteristically been lower than either Moody's or S&P would require. "The Fitch credit enhancement is never higher than ours," Kirnon said. "Issuers and bankers working on these transactions acknowledge to us that they see enormous differences between our ratings."
Equivalent market share?
However, according to John Malysa, senior director at Fitch, the data just doesn't support Moody's contention. "We've run numbers ourselves...and we've looked at the deals for the first quarter at the triple-B level, and there are at least two ratings on every deal we rated. Forty-six percent were rated by Standard & Poor's/Fitch, 46% were Fitch/Moody's, and 8% were rated by all three. The same is true for tranches at the triple-B-minus level. What this tells me is that we're rating a similar number of deals and we're all pretty close to the same subordination levels," Malysa said. "The levels are within a small measure of each other.
"I'm curious to see Moody's analytics."