Moody's to issue liquidity ratings on speculative-grade companies

By Peter Heap

New York, Sept. 12 - Moody's Investors Service said it will starts assigning liquidity ratings to issuers of high-yield bonds and leveraged loans.

The new ratings will indicate Moody's assessment of a company's ability to meet its obligations through internal resources and committed financing over the next 12 months.

Moody's said it was introducing the new system - to be known as SGL (speculative-grade liquidity) ratings - in response to market interest in more information about issuers' liquidity, particularly in light of the persistent high default rates over the past year.

"The key short-term liquidity risk for the speculative grade issuer is its ability to meet its obligations through its internal resources and the availability of committed sources of financing," said Moody's group managing director Mike Rowan in a news release announcing the new ratings. "The SGL ratings have been developed to evaluate these elements of the speculative grade issuer's liquidity."

The new ratings will have four possible levels:

- SGL-1 indicates "very good" liquidity. Issuers rated at this level are most likely to have the capacity to meet their obligations over the coming 12 months through internal resources without relying on external sources of committed financing.

- SGL-2 indicates "good" liquidity. Issuers at this level are likely to meet their obligations over the coming 12 months through internal resources but may rely on external sources of committed financing. Access to committed financing is highly likely based on Moody's evaluation of near-term covenant compliance.

- SGL-3 indicates "adequate" liquidity. Issuers at this level are expected to rely on external sources of committed financing. Based on its evaluation of near-term covenant compliance, Moody's believes there is only a modest cushion and the issuer may require covenant relief in order to maintain orderly access to funding lines.

- SGL-4 indicates "weak" liquidity. Issuers at this level rely on external sources of financing and the availability of that financing is highly uncertain in Moody's opinion.

Moody's noted that liquidity is already a core element of any issuer's senior implied, leveraged loan and high yield bond ratings. The assessment heavily affects Moody's opinion of an issuer's probability of default.

Probability of default, in turn, is part of Moody's senior implied rating, which reflects both the probability of default and the severity of loss in the event of default.

Probability of default depends on an issuer's capacity to meet obligations and also its willingness to meet obligations. Moody's said the new SGL ratings will capture its opinion of an issuer's capacity to meet obligations.

Only junk-rated issuers will be assigned SGL ratings. Liquidity for Prime-rated issuers is already the subject of additional research through the Liquidity Risk Assessment product introduced in the year.

Both SGL and Liquidity Risk Assessment look at an issuer's free cash flow, cash on hand and committed sources of financing, in relation to its obligations coming due over the next 12 months.

Projected cash flow incorporates factors such as performance volatility from industrial cycles, seasonal demands, competitive position and the need for investment in operations in order to meet growth objectives.

Given that cash flow may fall short of projections, Moody's also assesses alternative sources of liquidity available to cover shortfalls. For speculative-grade issuers, the primary source of alternative liquidity is a committed bank line.

Analysis of access to bank credit looks at future compliance with financial covenants, an evaluation of material adverse change (MAC) clauses, triggers and other conditions.

Moody's added that SGL will be assigned in the same way as long-term debt ratings. All liquidity rating assignments will go through Moody's rating committee process and the agency will issue a press release every time an SGL rating is assigned, changed or confirmed.

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