Tougher OBS Scrutiny by Moody’s

Several credit-rating agencies faced wide criticism after the collapse of Enron Corp. for not providing earlier warnings about off-balance-sheet exposures.

Moody’s Investors Service has published a report that for the first time details its broad framework for assessing off-balance-sheet (OBS) exposures as part of the ratings process.

“Our purpose is to provide greater analytical transparency for issuers, investors, and analysts,” said the author of the report, senior vice president Barbara Havlicek, in a statement.

Moody’s and other credit-rating agencies, such as Standard & Poor’s and Fitch Ratings, faced wide criticism after the collapse of Enron Corp. for not providing earlier warnings about problems in the energy company’s OBS exposures.

The rating agency said its objectives are to include greater consistency in its global rating practices, potentially to refine its methodologies, and to develop new methodologies as OBS exposures evolve. “OBS exposures cover a broad range of obligations, commitments, and structures,” explained Havlicek. “They can be as simple as a guarantee or as complex as a project financing.”

Havlicek stressed, however, that in general Moody’s tries first to determine what is the risk associated with the exposure; second, who is exposed to the risk and how the risk should be apportioned; third, how the risk should be quantified; and, fourth, what adjustments are necessary to financial statements to assure comparability among companies.

Moody’s explained that OBS exposures arise in two ways. In one case, a company retains the risks and rewards associated with certain rights and obligations that meet the definition of assets and liabilities, but the accounting treatment does not recognize these assets and liabilities. In the other case, a company has contingent obligations that do not currently meet the accounting definition of a liability because the contingency is not probable — but it nonetheless remains possible.

Havlicek also stressed that assessing off-balance-sheet risk is already an integral part of Moody’s fundamental credit analysis.

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