Examination of Witnesses (Questions 1060
TUESDAY 13 NOVEMBER 2007
Q1060 Mr Dunne: That is a good line.
How carefully do you look at what is going into the individual
products as they are evaluated? Let us look at a complicated one.
How about a first default basket? How closely do you get into
what comprises the first default basket?
Mr Drevon: The analysis would
be on each individual instrument that goes into that transaction,
and we would take a view on what is the likelihood of default
of that specific instrument, what is the correlation between those
different instruments, model that and come to a conclusion.
Q1061 Mr Dunne: If we take something
else, a CDO square, which is new expression to me, that essentially
is a CDO vehicle investing in pools and tranches of other CDO
Mr Drevon: That is correct.
Q1062 Mr Dunne: Do you go down to
the underlying individual asset across a pool?
Mr Drevon: That is correct, yes.
We do what we call a "look-through", so we go, in fact,
not at the first level, but we go for the underlying assets, which
is the corporate risk.
Q1063 Mr Dunne: Is the issuer able
to provide access to the underlying data in every case?
Mr Drevon: In most cases the underlying
corporate names are rated; so we use the rating information.
Q1064 Mr Dunne: Let us suppose we
are not dealing with corporate names, we are dealing with packages
of securities which do not have to issue accounts and do not have
to issue public statements.
Mr Drevon: Typically those instruments
would be rated by us and we would use the rating as an input.
Q1065 Mr Dunne: So you rely on your
own rating of an underlying instrument.
Mr Drevon: That is correct, yes.
Q1066 Mr Dunne: Without necessarily
going in to look at whether that rating is correct or not?
Mr Drevon: No, we believe that
our ratings are correct as a policy for our rating system.
Q1067 Mr Dunne: How frequently do
you reassess ratings of individual instruments? Particularly I
am interested in the financial products rather than the corporates,
which have a natural publication cycle.
Mr Drevon: It is on-going work
at Moody's. The day we assign the first rating is also the first
day we start monitoring the rating; so there is no specific day
in the year we decide we are going to review the ratings, it is
an on-going review.
Q1068 Mr Dunne: Once a year, once
every two years, once every three years?
Mr Drevon: It really is instrument
specific. In some instruments we will review them every week because
there are very specific events surrounding that instrument. In
some other instruments, take a high quality sovereign risk, we
know that the likelihood of that changing is going to be lesser,
and so the monitoring is going to be on an annual basis.
Q1069 Mr Dunne: Who monitors the
monitors? Is there any independent assessment of any of your methodologies?
Perhaps I will ask somebody else. Mr Bell, you are nodding.
Mr Bell: The independent assessment
is basically conducted by the investors. Our criteria are public.
Therefore, it can be conducted by anyone who wishes: the regulators,
CESR, the investors.
Q1070 Mr Dunne: Do any investors
in your experience ever analyse your methodology, other than in
relation to questioning your decision? Do they go back to first
principles? Do they ask for all of your data to cross-check with
their own models
Mr Bell: Yes.
Q1071 Mr Dunne: in relation
to that instrument.
Mr Bell: Certainly in Europe I
have come across a number of investors. Also we do do exactly
that. If the information that we have received suggests that we
should change our criteria, we will often request a comment from
the investors. We sometimes get quite vociferous comments for
or against any proposed change, so is there an on-going debate
with the investor community.
Mr Hancock: I would just add,
it is exactly the same on the corporate and government side. We
have an enormous number of phone calls from investors and other
interested parties questioning our opinions every day and, as
a matter of policy, we put the names and phone numbers of the
analysts on each piece to encourage that.
Q1072 Mr Dunne: Do you publish your
methodology in relation to individual instruments and your model?
Can somebody actually come in and look at your model?
Mr Bell: Yes. In CDOs, for example,
our model is available for free on the website. I believe that
is the case for the other agencies.
Q1073 Mr Dunne: Do any regulators
overlook your methodologies or models? Do you have discussions
with them at all?
Mr Bell: We have had discussions
with regulators where they have asked questions about our methodologies.
Q1074 Mr Dunne: Any question of whether
it is valid, or was it more to do with the conclusions that you
have come to for a particular instrument that they are interested
Mr Drevon: I believe the regulators
have been looking more at the conclusion than the methodology
Mr Taylor: The experience that
I have had is just that they are trying to understand how we look
at things, how the process works.
Q1075 Mr Dunne: So they are looking
ultimately at how you arrive at the outcome, but they are not
seeking to question whether the methodology itself is correct
Mr Taylor: Correct.
Q1076 Mr Dunne: Can you explain why
it is that different credits with the same rating have such widely
different spreads in the market place? To give you an example
which was given to me the other day, if you take an emerging market,
Peru 2016, which is trading this spring at 96 basis points above
the relevant US treasury and you compare that with a US corporate
dollar bond, say General Motors, 2031, which had a 250 basis point
spread over Treasury, whereas a foreign corporate dollar bond,
KazCommerce Bank 2013 had a 263 basis point spread, that is a
significant difference, all of which have got a double-B plus
rating, I think it was from Moody's in that case, so perhaps Moody's
can answer. Why is it that the spread is so significant if the
rating is the same?
Mr Madelain: I think the spread
speaks to more than just credit risk but also to the liquidity
of the instruments, and there may be also some diversions of view
between our perspective on the credit risk as a suitable security
and the general consensus of the market.
Q1077 Mr Dunne: So the credit rating
is not a guide to an investor as to the performance of the underlying
instrument, it is merely a guide as to whether it is going to
repay at the end of its maturity.
Mr Madelain: If you define performance
as return, that is correct.
Q1078 Mr Dunne: What about the default
rate of different types of instruments? What has the experience
been of that?
Mr Drevon: We published a very
significant amount of statistics looking at the performance of
our ratings, and if you look over long periods of time, particularly
15 years or more, the performance of structured finance ratings,
in fact, are in line with the performance of other bonds, such
as corporate bonds.
Q1079 Mr Dunne: That is interesting,
because there was an article in the FT in August that suggested
that actually the performance of CDOs was ten times riskier than
corporate bonds, and that was from a Moody's study?
Mr Drevon: I think you always
have the possibility to drill down and say, if we look for a period
of six months at a specific asset category and specific rating
level, there will be differencesthat is absolutely normalbut
the work we do is based on long-term statistical data and when
we look over the long-term horizons, there is a high degree of
convergence in terms of the performance of the ratings on the
structured final side and the corporate side.