One of the big public company ratings agencies, Moody's Investor Services, is making a change to its ratings system that will affect the way home builders' debt and risks appear to institutional lenders.
The change in effect breaks out “expected credit loss upon default” into its component parts, “probability of default” and “loss severity.” Companies, including home builders, will continue to get a corporate family rating, which is Moody's benchmark rating for companies' debt.
Now, there will be a “probability of default rating,” specifically referring to the likelihood of default of the issuer. This rating will be assigned only at the corporate family level, and in most cases, will be the same as the corporate family ratings.
The other new ratings–called loss-given-default assessments–will put companies' respective debt obligations each on their own scale, telling lenders “what goes into” a rating on each separate part of the capital structure.
For example, Moody's research shows that historically recovery on bank loan default is much more positive than that for other types of debt instruments. Companies whose debt structure is weighted heavily toward those loans may have been penalized by the blended ratings, while companies with higher levels of bond and unsecured debt may have been getting a ratings break from the old ratings methodology.
Joseph Snider, vice president and senior credit officer at Moody's, says that the new methodology might “notch up” ratings on some of home builders' specific debt instruments and obligations and at the same time “notch down” other, typically more junior and unsecured instruments and bonds.
Initially, Snider expects consternation among home building finance executives as some of their debts get tagged with ratings that infer a greater risk to lenders.
However, once they have experience with how the new ratings work, they'll come to see the methodology positively, “more consistent, and more reflective of historical experience,” says Snider.
Snider also notes that Moody's is rolling out the change across all of its industry sectors and that the Sept. 22 roll-out among home builders has nothing to do with housing's deteriorating market conditions.