Moody’s defends debt revamp
MOODY’S Investors Service today published the revised framework the rating agency will use to assess the relative debt and equity characteristics of hybrid securities for the purposes of calculating an issuer’s debt and capital-related financial ratios.
The revised approach will change these calculations for many firms, but will not lead to changes in the issuers’ ratings, solely as a result of the revisions.
The new framework will mean that some hybrids will receive more “equity credit”, which is beneficial for a company’s overall credit rating. Moody’s decided to review its classification of hybrids because of the credit crisis, when some of these instruments did not absorb losses in the way they were expected to. Hybrids are securities with a mixture of equity and debt features. Banks have been heavy issuers of hybrid instruments over the past decade as some can count towards a bank’s capital because they can absorb losses in certain circumstances. “What became clear is that many of the ‘bells and whistles’ used in hybrid design over the last five years do not necessarily enhance their loss absorption characteristics for a ‘going concern’,” Moody’s said.
Hybrids with greater loss-absorbing characteristics will receive more equity credit under the new system, Moody’s said. Non-cumulative preferred securities – where the issuer has the option to miss a coupon payment altogether – will have the highest 75 per cent equity credit, given that these instruments allow for losses to be absorbed well before a company defaults. Cumulative subordinated debt securities, whereby the issuer has the option to defer a coupon payment, will receive a 50 per cent equity component.