Moody's report on bank credit loss estimates and their effects on ratings

June 01, 2009: In a new report, Moody's Investors Service presents its framework for estimating bank credit losses and their effects on bank ratings. The report also describes how Moody's calculates stress-level bank-credit losses and how they fit into the agency's global bank rating methodology. The agency is responding to the heightened interest regarding the role and nature of financial stress-testing, and how Moody's incorporates this process into its bank analyses.

According to Moody's Managing Director Gregory Bauer, "the application of a forward-looking view on bank capital ratios is not new. It has become more prominent in our rating methodology over the past several months," the analyst says, "because more asset classes are being affected by the global recession and we are placing more emphasis on capital." This analysis will continue to be a key component of Moody's analytical framework, Mr. Bauer states. "Because a more forward-looking approach is required to incorporate the loss potential resulting from current activities," he explains, "the risks and losses often only materialize with significant time lags."

Moody's approach to measuring expected credit losses begins with an analysis of the macroeconomy, highlighting historical economic cycles emphasizing recent crises. Moody's contrasts these periods with the current cycle in order to establish expectations about different asset classes and their impact on the banks' capital and profitability.

"Our analysis entails simulating the evolution of a bank's capital ratios under both our expected and worse-than-expected case scenarios," comments Mr. Bauer. Although the expected scenario establishes base expectations, Moody's believes that its worse-than-expected case is particularly helpful in understanding the sensitivities of a bank's credit worth in a more adverse environment. Accordingly, the rating agency's views on capital and profitability also incorporate the potential transition risk to harsher scenarios.

In the near future, Moody's will publish separate detailed reports that will describe the specific assumptions it uses for different regions.

The report is titled "Moody's Approach to Estimating Bank Credit Losses and Their Impact on Bank Financial Strength Ratings."



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