Capital Markets

Moody’s Derivative Probe Prompts Changes

After review of ratings process for constant-proportion debt obligations, it replaces head of it Structured Finance business, strengthens processes.
Stephen TaubJuly 1, 2008

After a review of its ratings process for a risky credit derivate product, Moody’s Investors Service has replaced the head of its global Structured Finance business, initiated employee disciplinary proceedings, and accelerated measures to strengthen its rating and monitoring processes.

As head of the business, the credit rating agency replaced Noel Kirnon, who left immediately. Named as acting head of Structured Finance was Andrew Kimball, while Moody’s said it would seek a permanent replacement.

Richard Cantor will assume acting responsibility for the role Kimball previously held as the chief credit officer for Moody’s, and chairman of its Credit Policy Committee.

Moody’s said that, after review its ratings process for European constant-proportion debt obligations (CPDOs), it disciplined certain employees and accelerated measures to strengthen its rating and monitoring processes. Moody’s said that the probe, conducted by the law firm Sullivan & Cromwell, found that some members of a European CPDO monitoring committee considered factors inappropriate to the rating process when reviewing CPDO ratings following the discovery of a model error.

According to Moody’s code of professional conduct, a committee may consider only credit factors relevant to the credit assessment and may not consider the potential impact on Moody’s, or on an issuer, an investor or other market participant.

“I am deeply disappointed by the conduct that occurred in this incident,” said Moody’s Chairman and CEO Raymond McDaniel. “The integrity of our rating process is core to Moody’s values and is essential to the market. If an error occurs, it is crucial that rating committees consider possible rating changes and disclosures in an appropriate manner. In this instance, monitoring committee members considered issues not relevant to the rating process in reaching their conclusions. In response, we are taking immediate and appropriate action to address the lapse in our rating process and to ensure that a similar event does not occur again.”

In May, Moody’s said it had launched an external review of its European CPDO ratings process in response to an article in the Financial Times concerning the analytical models and methodologies used in its CPDO ratings process. Moody’s rated 44 European CPDO tranches, representing approximately $4 billion in rated securities.

In this week’s announcement, it said errors were found involving the ratings of 11 CPDOs with an aggregate value of slightly less than $1 billion.

Testing of the CPDO model’s output, after correction for the error and without consideration of qualitative factors, indicated that an initial rating of Aaa would have been in the Aa range, it added.

During 2008, Moody’s said it withdrew ratings on four of the 11 CPDO securities because of the repurchase or restructuring of the notes, or at the request of the issuer and investors. Moody’s also said that it had taken various ratings actions on the seven remaining transactions due to extraordinary market conditions, including spreads far outside of historical experience. Today, those securities are rated between Ba1 and B1.