Agencies pull rating trigger

Investors have been surprised by the hard-line stance adopted by the rating agencies in recent weeks, as the list of companies subject to multiple-notch downgrades grows.

The five-notch downgrade of Cable & Wireless to BB from BBB+ by Standard & Poor’s is one notable example. Although spreads were only marginally affected by the news, one London-based analyst says: “We expected aggressive downgrade action by S&P following the Moody’s downgrade to Ba1 in December, but we did not expect this severity.”

At the same time, Moody’s has issued double-notch downgrades on a number of issuers, including Deutsche Telekom, German utility E.on, Dutch retailer Ahold and German bank HVB. And shortly before Christmas, Moody’s downgraded Avon Energy, a UK electricity generator, five notches to B2.

While S&P’s approach, say investors, is relatively transparent and possible downgrades are simpler to anticipate, Moody’s has undoubtedly shifted to a more aggressive stance, with the agency now attempting to factor in event risk to corporate credit ratings.

In January, Moody’s announced its intention to place greater emphasis on liquidity and free cashflow generation, ratings triggers and parent-subsidiary support structures in anticipation of the potential for greater turbulence in Europe’s bond markets. Chris Mahoney, chairman of Moody’s credit policy committee, says: “Apart from adopting these three new points of emphasis, Moody’s has improved the reliability of its corporate bond ratings through portfolio monitoring techniques, default ‘postmortems’ and focusing on risks related to accounting, derivatives and corporate governance issues.”

S&P and Moody’s new attitude towards corporate credit ratings is believed to be a response to market criticism of the rating agencies’ failure to enact timely ratings actions for distressed companies, such as Enron and WorldCom. Enron carried investment-grade ratings as late as four days before it filed for bankruptcy, while last year saw a record number of investment-grade companies falling to junk. In Europe alone, 16 issuers joined the crop of fallen angels, representing €57 billion of rated debt.

However, investors are concerned that the rating agencies are under such pressure not to be behind the curve that they are taking an unduly aggressive approach. Duncan Sankey, head of credit research at Nomura, says: “In an attempt to atone for past sins of complacency, the rating agencies have now veered towards overreaction. I am also wondering whether Moody’s has been relying too heavily on the KMV model.”

Andrew Burton, head of utilities and structured finance research at Royal Bank of Scotland, says: “Moody’s has erred on the upside on a number of issues, so they are going through their ratings and realigning them to where they should be.”

Roger Appleyard, senior credit analyst for telecoms at ABN Amro, adds: “Moody’s has shifted the goalposts. The agency now wants to see results on debt ratios instead of giving the benefit of the doubt and then being forced to downgrade after things have gone awry.”

The utilities sector particularly has suffered from this new aggression: WPD Holdings, Swalec, E.on, Powergen, Innogy, Yorkshire Power, CE Electric and Avon Energy have all been downgraded in the past two months. RBS’s Burton says: “Moody’s rating for Avon is too low. They kept Avon on Baa3 for too long and then all of a sudden downgraded the credit by five notches. With hindsight, they probably would have wanted to downgrade the credit to junk last summer, but moving five notches at once is a bit much.”

Nevertheless, some analysts say that in a market with greater volatility, the rating agencies are simply seeking to bring ratings closer to the market view, preferring to rate conservatively and leave a credit on stable outlook for a longer period of time, rather than frequently changing the signals. Steve Best, credit research analyst at Nomura, says: “Although some individual decisions have been questionable, there is a backlog of downgrades in the utilities sector which the agencies have been addressing.”

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