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Published on 3/21/2002 in the Prospect News Convertibles Daily and Prospect News High Yield Daily.

Moody's: Enron event underscores need for disclosure, evolution of credit rating process

By Ronda Fears

Nashville, Tenn., March 21 - Moody's Investors Service managing director John Diaz told U.S. lawmakers that the Enron situation highlights the need for full disclosure in the financial markets and continuing evolution of the credit rating process.

Diaz testified before the Senate Committee on Governmental Affairs on Wednesday, also parroting other credit rating agencies' assessment that Enron Corp. officials lied to rating agencies about the state of its affairs.

"Going forward, we are enhancing the ratings process by putting increased focus in several areas. We have substantially intensified our assessment of liquidity risk for issuers with both investment-grade and speculative-grade ratings. We are also focusing on corporate governance and how aggressive or conservative are accounting practices," Diaz said.

"Beyond enhancements in the rating process itself, the Enron situation underscores the critical importance of full disclosure for the effective functioning of the marketplace. As a major consumer of financial data and SEC filings, Moody's strongly supports efforts to enhance financial disclosure."

Rating agencies, he said, depend on the availability and reliability of information. The combination of the financial disclosure regime in the U.S., audited accounts, information provided directly to Moody's and issuers' good-faith dealings have normally been sufficient.

"Enron was an anomaly, partly in the nature of its activities, and certainly in the disclosure of its activities," Diaz said, describing the company's information as "misleading and incomplete."

Established methods of credit analysis that have been proven to predict relative creditworthiness were undermined by Enron, he said, but it also spotlighted a problem that has been the subject of a concentrated effort to improve the process.

"The integrity and reliability of our ratings and rating processes are the essence of our business," Diaz said.

"We are constantly striving to enhance rating processes and quality, and we have examined the circumstances around the Enron bankruptcy to see what lessons can be learned."

Moody's has met with over 20 asset management firms this year to seek comments on the role of ratings in the marketplace, he said, which led to Moody's taking special comments on proposed enhancements to the rating process.

Comments received from market participants, he said, showed investors want ratings to continue to be a stable signal of medium- to long-term fundamental credit risk and support shorter review periods for reassessing ratings in light of changed company or market circumstances. He said investors indicated they use and appreciate the current rating review and outlook processes and desire issuers be given an opportunity to act on correctable conditions that could otherwise lead to credit deterioration.

Also, Diaz said, investors "want us to focus more on issues of accounting quality, corporate governance and disclosure."

In addition to that effort, he said Moody's began looking more comprehensively at the role of so-called rating "triggers," which can cause payment obligations to accelerate or require posting of collateral based upon a rating downgrade, in December. The report on ratings triggers describes how these mechanisms work, why they are employed and how they can have unexpected and sometimes highly disruptive consequences for lenders and borrowers alike.

"We have enhanced our analysis of short-term corporate financial capacity, that is, liquidity, reviewing more thoroughly the sufficiency and certainty of an issuer's near-term sources of cash and credit under conditions of stress," Diaz added.

"While our desire to assign and communicate predictive ratings remains unchanged, the bond rating system, like the financial markets themselves, is subject to ongoing evolution."


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