Good morning, Mr. Chairman and members of the Committee. My name is Daniel Gates, and I am a Managing Director of Moody’s Investors Service. I am pleased to be here today to discuss the credit ratings process, and the role of disclosure requirements in that process, particularly for the Tennessee Valley Authority. I hope that Moody’s views add to the Committee’s consideration of this issue, though I also appreciate that our opinions represent only one perspective on this matter.
Moody’s Role in the Financial Markets
To understand the relationship between financial disclosure requirements and our work at Moody’s, a summary of Moody’s role in the financial markets may be helpful. For over one hundred years, Moody’s has played an important part in providing independent credit analysis and opinion to investors. Moody’s assigns credit ratings to debt instruments and to other obligations to reflect the relative creditworthiness of those obligations. Moody’s is the oldest credit rating agency, founded by John Moody in 1900 to rate the creditworthiness of railroad bonds. As early as 1924, Moody’s was rating nearly every bond in the United States market, as well as many international bonds.
Today, Moody’s is a leading global credit rating and research firm with more than 800 analysts worldwide. Our credit ratings cover a broad range of debt instruments totaling over $30 trillion, and our analysts publish research that covers thousands of institutions. Moody’s ratings are valuable informational tools used by: (1) institutional investors to analyze the credit risks associated with fixed-income securities and other obligations; (2) issuers seeking access to the capital markets; (3) regulators, for such purposes as measuring the capital adequacy of banks, broker/dealers, and insurance companies; and (4) governments, economists, the media, academics, and other market observers.
Ratings contribute to efficiencies in financial markets by providing credible and independent opinion forecasts of credit risk. The predictive quality of our credit ratings is empirically verifiable, and is evaluated by Moody’s and by independent third parties. Our track record is published annually in our default studies. We make our historical ratings and default data available to subscribers, interested scholars and regulators. Although Moody’s rates a wide range of debt obligations, the heart of our service lies in rating long-term bonds, for which we have nine primary debt rating categories. Investment-grade ratings range from a high of Aaa, down to a low of Baa. Ratings from Ba to C are considered non-investment grade or speculative grade. Overall, Moody’s ratings are designed to provide a relative measure of risk, with the likelihood of credit loss increasing as the rating decreases. The lowest probability of default is expected at the Aaa level, with a higher expected default rate at the Aa level, a yet higher expected default rate at the single-A level, and so on down through the rating scale.
It is equally important to note what our work at Moody’s does not include. A rating of Aaa is neither a buy recommendation, nor is it a seal of approval; rather, the Aaa rating, like all of our ratings, reflects Moody’s opinion of the relative creditworthiness of a fixed income security. Furthermore, just as we do not insure the bonds we rate, we do not audit the financial information provided to us. Accordingly, our ratings rely heavily on the completeness and veracity of both the public financial statements and any proprietary information that may be provided to us by issuers.
The Moody’s Rating Process
Moody’s takes a number of steps to ensure the rigor of our ratings process. We assign ratings by committee. Rating committees vary in size, and generally include senior and junior analysts and one or more Managing Directors. A Credit Policy Committee (CPC) and credit standing committees under the control of the CPC review ratings practices and policies internally.
Moody’s takes active steps to maintain the integrity of our ratings process. Moody’s analysts are not evaluated or compensated based upon the revenues associated with their portfolios, nor are they permitted to hold or trade the securities of the issuers they rate except in diversified funds managed by professional managers. Moody’s also does not create investment products, or buy, sell, or recommend securities to users of our ratings, or invest in securities for its own account. Furthermore, although we derive ninety percent of our annual revenue from the issuers that we rate, we recognize that the long-term value of our franchise depends on our independence and objectivity, and ultimately on the predictive value of our ratings, an analysis of which we publish annually. The influence of individual issuers is further limited because Moody’s does business with over four thousand issuer groups.
The Role of Disclosure Requirements for Moody’s
In order to analyze a company’s ability to meet its debt obligations, Moody’s analysts rely on a variety of information sources, including publicly available information that is filed with regulatory authorities or is otherwise available, audited financial statements, third-party analyses of the company and the industry sector, and information provided by the company directly to our analysts. Moody’s ratings are based primarily upon the issuer’s published financial reporting, and we believe that SEC disclosure requirements are strong enough that, in the great majority of cases, we have sufficient public information to express an opinion. In addition, as a Nationally Recognized Statistical Rating Organization, companies are permitted to share material non-public information with Moody’s. Each Moody’s analyst and managing director has a portfolio of companies that he or she tracks. Moody’s analysts speak periodically with issuing companies to obtain additional information, and all of these data are incorporated into the ratings process.
In an ideal world, the rating agencies always would have access to complete and accurate financial and operational information. The disclosure requirements created by the Securities Act of 1933 and the Securities and Exchange Act of 1934 (“1933 and 1934 Acts”) contribute to the integrity of the financial information Moody’s receives by creating civil and criminal penalties for inaccurate or incomplete reporting. As a general matter, our preference is that all financial information provided to our analysts be complete and reliable. We strongly believe that in the United States, the federal securities laws add to the reliability of that information. Outside the United States, and for some classes of issuers within the U.S., however, Moody's conducts analysis without SEC-mandated disclosure by obtaining information directly from the companies and other sources. Moody’s and the other ratings agencies for many years have rated companies not subject to reporting requirements, such as foreign issuers and government agencies, including the Tennessee Valley Authority. For these entities, Moody’s relies on the completeness and veracity of issuers’ public and private disclosure of information, along with industry-specific knowledge and macroeconomic analysis.
While we prefer that all financial reporting be subject to the disclosure standards set forth in the 1933 and 1934 Acts, we believe that the TVA has operated in good faith in providing accurate and reliable financial information to facilitate our rating analysis of the Authority’s power bonds. Moody’s analysts have a constructive working relationship with multiple contacts at TVA, and Moody’s analysts regularly call on these contacts to provide, for example, additional background on operational developments, industry news, or government proposals. We receive annual and quarterly reports from TVA and regular briefing material.
As with any issuer, Moody’s analyzes multiple factors when rating TVA. To illustrate, we have considered TVA’s cash flow, balance sheet, capital structure, prospects for raising or lowering debt in the near future, protected service territory, power costs, ability to set electric rates, and at the macro level, the growth rate of the region it serves. We have obtained all of this information from the company directly or from third-party sources. Furthermore, as a general rating approach to Government-Sponsored Enterprises such as TVA, Moody’s uses an integrated analysis of both the fundamental creditworthiness of the enterprise as a business, and the enterprise’s relationship with the U.S. Government.
As I have stated, Moody’s supports steps to improve the quality and reliability of the information that market participants, including investors and our analysts, receive. This support for higher quality information, however, should not be interpreted as reflecting any particular concerns over the reliability of the financial information we have received from TVA. Rather, as a major consumer of financial data and SEC filings, Moody’s generally supports efforts to enhance financial disclosure, because they improve the overall reliability of financial information in the marketplace, and thus contribute to more efficient capital markets.
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