July 1 (Bloomberg) -- Moody's Corp. ousted the head of its structured finance unit and said employees violated internal rules in assigning ratings to last year's worst performing securities.
Noel Kirnon, 47, will leave after a company review showed some staff at Moody's Investors Service breached rules for ranking European constant proportion debt obligations, or bonds backed by derivatives, the company said in statements today. Moody's awarded Aaa ratings to at least $4 billion of CPDOs, as the securities are known, before they lost as much as 90 percent of their value.
U.S. and European regulators are tightening rules for Moody's, Standard & Poor's and Fitch Ratings after the companies provided top grades to securities backed by U.S. subprime mortgages that sparked $400 billion of writedowns and losses on Wall Street. Moody's, the world's second largest credit-rating company, said today that employees, not the company's practices, were to blame.
``Moody's have lost a lot of credibility,'' said Jeroen Van Den Broek, head of investment-grade credit strategy at ING Bank NV in Amsterdam, a unit of the biggest Dutch financial services company. ``It seems like they're looking for a scapegoat.''
Moody's, which is 19.6 percent owned by Warren Buffett's Berkshire Hathaway Inc., fell $1.18 to $33.26 in New York Stock Exchange composite trading at 12:38 p.m. The stock is down 45 percent over the past year.
Loss of Trust
``Some of the investors getting involved with complex structured assets like CPDOs that relied on the agencies may not trust them again,'' said Steven Behr, global head of principal strategies at Royal Bank of Scotland Group Plc in London, Britain's second-biggest bank. ``They have a serious credibility issue in admitting to flaws.''
ABN Amro Holding NV created the first CPDO in 2006, promising investors returns of as much as 2 percentage points above money-market rates combined with the highest ratings.
Banks attempted to boost returns by investing as much as 15 times the money raised in credit-default swaps. The contracts provided an income in exchange for CPDO guaranteeing the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise in the cost of the contracts indicates deterioration in the perception of credit quality; a decline, the opposite.
The CPDOs stood to gain from an improvement in credit quality and risked declines from any deterioration. Losses were meant to be covered by selling more of the credit-default swaps and charging a higher premium.
Computer Error
Dominion Bond Ratings Service said in 2006 that there may not be enough trading history to assess the risks. Fitch Ratings said in April 2007 that the securities may not have deserved the top grades.
Moody's began cutting its grades on CPDOs in September as losses on subprime mortgages spread across credit markets, causing investors to flee all but the safest government debt and driving up the cost of protecting against company risk.
Moody's said on May 21 that it had begun a review of its CPDO ratings after a report by the Financial Times said some senior staff were aware in early 2007 of a computer error. The glitch gave the top Aaa rating to CPDOs that should have been ranked as much as four levels lower, the FT said. Moody's altered some assumptions to avoid having to assign lower grades after fixing the error, the FT said.
Sullivan & Cromwell
Moody's hired law firm Sullivan & Cromwell to conduct the review. It found that personnel didn't make changes to the methodology for rating European CPDOs to mask any model error, Moody's said today. The staff engaged in ``conduct contrary to Moody's code of professional conduct,'' when considering whether to downgrade the securities after discovering the error, the ratings company said.
Under company guidelines, a committee may only ``consider credit factors relevant to the credit assessment and may not consider the potential impact on Moody's, or on an issuer, an investor or market participant,'' Moody's said.
Some 11 CPDOs worth just under $1 billion were affected by the error in the model, Moody's said. They would initially have been rated in the range of Aa, or one to three steps lower. The firm has since removed its rating on four of the deals after investors sold them back to the sponsor bank or reorganized them.
`Deeply Disappointed'
Employees involved face disciplinary proceedings that may include termination, Moody's said.
``I am deeply disappointed by the conduct that occurred in this incident,'' Chief Executive Officer Raymond McDaniel said in the statement.
Moody's is providing ``enhancements'' to the supervision of ratings, Chief Compliance Officer Michael Kanef in New York said in a telephone interview. The company has appointed an executive and analysts to improve surveillance, he said.
``This is not a circumstance where we have initiated disciplinary proceedings and come to a halt,'' said Kanef. ``We are moving forward with several important progressive actions that are designed to ensure that we are addressing and improving our policies and procedures.''
Kirnon, who oversaw the credit policy committee, started working on collateralized debt obligations at Moody's in 1990. He will leave the company July 31 and will be replaced on a temporary basis by Andrew Kimball, 58. A search for a permanent replacement is under way, Moody's said. It didn't give a reason for Kirnon's departure.
Richard Cantor, 50, will take over as chief credit officer and chairman of the company's credit policy committee.
To contact the reporter on this story: Emma Moody at emoody@bloomberg.net
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