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Announcement:

Moody's publishes its new bank rating methodology

 The document has been translated in other languages

16 Mar 2015

Paris, March 16, 2015 -- Moody's Investors Service has published its updated methodology for rating banks globally, which incorporates several new components: a Loss Given Failure (LGF) analysis; the introduction of a Macro Profile into the elements that Moody's considers when it assigns a bank's baseline credit assessment (BCA); a BCA scorecard which now incorporates not only financial ratios but also a broader range of metrics and qualitative considerations; and a Counterparty Risk Assessment (CR Assessment).

The revisions to the methodology reflect insights gained from the crisis and the fundamental shift in the banking industry and its regulation. The revised approach to establishing BCAs helps to more accurately predict bank failures, while Moody's LGF framework assesses how different creditor classes are likely to be affected when a bank enters resolution based on the relevant resolution policy and balance sheet structure.

The updated methodology, "Rating Methodology: Banks," is now available on www.moodys.com, and can be accessed via this link: http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_179038. The introduction of this new methodology follows a market consultation initiated via a Request for Comment published on 9 September, 2014.

"The first key change is the introduction of a Loss Given Failure (LGF) analysis, which addresses expected loss and assesses the impact a bank's failure would have on its various debt instruments and deposits in the absence of any support. For banks subject to operational resolution regimes, the LGF analysis will incorporate the cushion against loss that each creditor class derives from the amount of debt subordinate to it in a resolution," says Gregory Bauer, Managing Director Global Banking, Moody's.

"With the recent dramatic shift in public policy toward implementation of resolution regimes, it has become increasingly important for investors to know their position in a bank's liability structure, and thus the potential losses they are exposed to in the event of a resolution," continues Bauer. "LGF analysis directly addresses this key investor concern."

Moody's employs both a basic and an advanced LGF analysis. The basic LGF analysis applies to banks that are not subject to operational resolution regimes. The advanced LGF analysis applies to banks that are subject to operational resolution regimes, whereby losses can be imposed selectively on creditors outside of a liquidation, and through which specific legislation provides a reasonable degree of clarity on how the bank's failure could affect depositors and other creditors.

Basic LGF analysis entails an approach wherein senior unsecured debt and deposits are positioned at the level of the adjusted BCA (the adjusted BCA is the BCA plus Moody's assessment of support from affiliates being forthcoming in the event of need), before government support and additional coupon-related notching considerations. Subordinated instruments are positioned at one notch below the adjusted BCA, excluding support and additional notching, reflecting increased loss severity. This basic LGF analysis continues the previous notching practice and, in the rating agency's view, remains an appropriate guide to loss severity for banks in systems without operational resolution regimes.

Under the advanced LGF analysis, which would be applied, for example, to banks subject to the European Union's Bank Recovery and Resolution Directive and to US banks subject to Titles I and II of the Dodd-Frank Act, Moody's bases its notching on (1) the likely bank-wide loss rate in failure; (2) the amount of subordination below a given instrument class; and (3) the volume of a given instrument class itself. In Moody's view, taking these together provides a more refined and predictive view of expected loss for each instrument class under new resolution regimes.

"The second key change is the revision of our framework for assessing the risk of bank failure, expressed by our baseline credit assessment. This includes the introduction of a Macro Profile, which allows us to place greater emphasis on potential system-wide pressures that we believe are predictive of the propensity of banks to fail," explains Frederic Drevon, Managing Director Global Banking, Moody's.

Moody's framework for assigning BCAs is structured around a new Scorecard that more comprehensively integrates Moody's analytical judgments. The Scorecard begins by focusing on five core ratios that Moody's has found to be predictive of bank failure covering five main financial factors: asset risk, capital, profitability, funding structure and liquid resources. Additionally, analysts and rating committees may consider supplementary ratios, as relevant, for each institution. Individual scores for each factor will now directly incorporate not only financial ratios, but also a broader range of metrics, Moody's forward-looking judgments and qualitative considerations relative to each.

Moody's new Macro Profile complements the bank-specific analysis reflected in the Scorecard and will be expressed on a scale ranging from Very Strong+ to Very Weak-. It comprises six elements: economic strength, institutional strength, susceptibility to event risk, credit conditions, funding conditions and industry structure. The Macro Profile, combined with the results of the Scorecard, helps establish the bank's Financial Profile. This results in the BCA, representing Moody's view of a bank's probability of default, in the absence of support.

Lastly, Moody's has introduced a Counterparty Risk (CR) Assessment into its analysis. This is not a rating, but an assessment of an issuer's ability to avoid defaulting on certain senior bank operating obligations and other contractual commitments. The CR Assessment takes into account the issuer's standalone strength as well as the likelihood of affiliate and government support in the event of need, reflecting the anticipated seniority of counterparty obligations in the liabilities hierarchy. The CR Assessment also takes into account other steps authorities can take to preserve the key operations of a bank in a resolution.

When credit rating methodologies are revised, the updated methodology is applied to all relevant credit ratings. Accordingly, in the coming days, Moody's will place on review the ratings of those banks that are likely to be affected. Regulation requires that rating actions related to methodology changes be completed within six months of the release of the methodology. However, Moody's expects to conclude the large majority of the reviews in the first half of 2015. In conjunction with the methodology-driven review, Moody's expects to incorporate revised views on government support in Europe, driven by the introduction of resolution regimes. For any banks whose ratings are placed under review, CR Assessments will be assigned when the reviews are concluded; for other banks, CR Assessments will be assigned in the coming months.

Moody's preliminary assessment of the anticipated impact of the new methodology and revised support assumptions shows that the ratings impact is likely to vary across countries and regions. Moody's anticipates the following key outcomes:

(1) An overall net neutral impact on banks' BCAs globally, with around 15% of BCAs changing. About half of these changes are anticipated to be within Europe, with a modest positive bias;

(2) in the US, a significant positive effect on bank deposit ratings and a material negative effect on senior unsecured bank debt ratings. This reflects the nature of deposit preference, which benefits depositors at the expense of senior unsecured debt. However senior unsecured holding company ratings are expected to be little changed, overall;

(3) in the EU and western Europe, a modest positive effect on deposit ratings and a broadly neutral effect on senior unsecured ratings, reflecting the changes in BCAs coupled with the counterbalancing effects of the new resolution regime and reduced likelihood of government support. While support is expected to decline, banks' most senior creditors, especially depositors, will benefit from the lower loss rates expected in an orderly resolution and the subordination that protects them from loss;

(4) in Asia Pacific, the Commonwealth of Independent States, Western Asia, Latin America, the Middle East and Africa, a small negative effect on senior unsecured and deposit ratings in some systems. This reflects Moody's view that the capacity for government support is henceforth limited to the government bond rating, and that there is little scope for other policy tools to provide durable support beyond this constraint.

***

NOTE TO JOURNALISTS ONLY: For more information, please call one of our global press information hotlines: London +44-20-7772-5456, New York +1-212-553-0376, Tokyo +813-5408-4110, Hong Kong +852-3758-1350, Sydney +61-2-9270-8141, Mexico City 001-888-779-5833, São Paulo 0800-891-2518, or Buenos Aires 0800-666-3506. You can also email us at mediarelations@moodys.com or visit our web site at www.moodys.com.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Nicholas Hill
Managing Director
Financial Institutions Group
Moody's France SAS
96 Boulevard Haussmann
Paris 75008
France
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Gregory Winans Bauer
MD - Global Banking
Financial Institutions Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's France SAS
96 Boulevard Haussmann
Paris 75008
France
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's publishes its new bank rating methodology
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