Not too surprising to anyone following the situation but Bloomberg has a story about an experimental division of Moody's that generates ratings based on CDS (credit default swaps). According to those CDS-derived ratings, Ambac and MBIA should be rated junk.
Moody's Investors Service has created a new unit that surprises even its own director.
The team from Moody's Analytics, which operates separately from Moody's ratings division, uses credit-default swap prices as an alternative system of grading debt. These so-called implied ratings often differ significantly from Moody's official grades.
The implied ratings frequently show that swap traders think debt is in more danger of defaulting than Moody's credit ratings signify. And here's the kicker: The swaps traders are usually right...
The credit quality of bond insurers, which have been at the center of the subprime storm, differ dramatically. The official ratings of these companies say the insurers are in great shape; the alternative ratings say they're in dire danger of defaulting on their debts...
Moody's implied-ratings group paints a completely different picture. Using the CDS market, Munves's unit rates both MBIA and Ambac Caa1. That's seven notches below junk and 15 below the official Moody's rating.
This isn't really a surprise to anyone given that CDS swaps have been extremely high for the bond insurers for over 6 months. The stock market also shares the CDS swap market opinion and that's one reason the stocks of the bond insurers have dropped so much without actual insurance claims or any liquidity issue.
It'll be interesting to see what actually ends up happening. I personally think there is a lot of irrational behaviour out there. For example, CDS on 1 yr MBIA and Ambac holding company debt implied high probability of default even though there was enough money at the holding company to pay dividends (optional--can be cut at will) and pay operating expenses. Having said that, the real question is the longer term (say 5yr) CDS and how correct they will end up being.
Munves says that over one year, the implied ratings have been a more accurate predictor of defaults than Moody's ratings. The Moody's unit reports that implied ratings for one year have a 91 percent accuracy ratio compared with an 82 percent ratio for Moody's official ratings.
``The Moody's accuracy ratio is consistently lower,'' he says.
He says Moody's company debt ratings are designed to remain stable so they aren't influenced by short-term ripples, unlike the more volatile swap-implied ratings.
``The CDS market often ends up coming back towards Moody's rating,'' he says.
I'm not really sure what the definition of accuracy is in the comment by the Moody's employee above. I'm not an expert on bonds or credit instruments but one thing to keep in mind is that the rating agency ratings are not volatile. They move in steps infrequently and only upon actual changes in the underlying company. In contrast, CDS is highly volatile and is a speculation on what may or may not happen at the underlying company. Because CDS prices change in real-time, they should be smoother and change gradually over time. In contrast, rating agency ratings can be abrupt with 3+ notch downgrades in one move. Tags: Ambac (ABK), bonds and credit instruments, MBIA (MBI)