Capital Markets

Moody’s to Change Downgrade Process

The credit rating agency is reevaluating how it scores companies that cross over from investment to speculative grade.
Stephen TaubJuly 18, 2006

Moody’s Investors Service is planning to change the way it downgrades investment-grade debt issuers affected by what it calls sudden and potentially “transforming” credit events. More important for issuers, the credit agency is soliciting public comments and suggestions from market participants by August 18.

Moody’s defines a transforming event as one that exposes an investment-grade company to the likelihood of a sudden shift in capital structure and, by extension, to a sizable ratings downgrade into the speculative grade range.

For these kinds of situations, Moody’s is recommending a series of gradual interim rating actions as opposed to a one-time, multi-notch rating adjustment after the event. “Our proposal aims to balance a number of objectives, including the need to weigh accuracy, timeliness, and market relevance against the potential for added market volatility or the possibility that we will have to reverse a rating action—particularly after it has crossed from investment to speculative grade,” said Moody’s Managing Director Pam Stumpp, in a statement.

Transforming credit events usually occur when corporations decapitalize using debt to finance a substantial stock buyback; spin off a material business to shareholders and then leverage the remaining business; or accept a largely debt-financed buyout offer.

The rating agency explained that its proposal would implement progressive rating actions based on the anticipated degree of movement from the current rating and “ongoing assessments of the cumulative likelihood that the transaction will consummate.” The latter evaluation is based, in part, on milestones achieved.

“The emphasis of this approach is to try to better incorporate the evolving likelihood of continued transition in our ratings as events unfold,” noted Moody’s Managing Director, Eric de Bodard, in a statement. “Our ultimate goal is to improve timeliness while retaining precision.”