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Rating Agency Settles On Hybrid Rules

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Moody’s Investors Service says it is sticking with its current rating system for most hybrid securities.

“Except for hybrid securities with meaningful mandatory deferral triggers, all preferred stock and hybrid securities will continue to be rated according to existing notching guidelines with no rating distinction made among cumulative, non-cash cumulative and non-cumulative obligations,” Moody’s, New York, said today.

Meanwhile, regulators at the National Association of Insurance Commissioners, Kansas City, Mo., are preparing to hold a discussion Wednesday on regulatory treatment of hybrid securities as an investment product.

NAIC meeting participants will review a proposal being developed by the American Academy of Actuaries, Washington, which is looking at insurers’ investments in hybrid securities.

The draft includes questions that would ask insurers to describe how hybrid securities are managed and whether there are any experience studies to “support or quantify the risk associated with each hybrid feature, both in terms of frequency and severity.”

Moody’s says in its announcement that hybrids with a “meaningful mandatory deferral trigger” will be rated 1 notch lower than indicated by existing guidelines. No obligation of an investment-grade issuer will be rated more than 2 notches below the issuer’s senior unsecured or issuer rating, the rating agency says.

Unless otherwise stated, Moody’s says that no obligation of a speculative-rated individual issuer will be more than 4 notches below the issuer’s senior rating.

Issuers with unsecured ratings or corporate family ratings at Ba2 or higher will receive the following treatment: senior subordinated, subordinated and junior subordinated debt will be rated 1 notch below senior unsecured debt, and preferred stock will be rated 2 notches below senior unsecured debt.

Issuers with senior ratings below Ba2 will receive the following treatment: 2 notches for subordinated debt; 2 or 3 notches for junior subordinated debt; and 3 or 4 notches for preferred stock.

Hybrid securities under review for downgrade include:

- Allianz A.G., A2-rated Perpetual Junior Subordinated Notes, EUR 1,500,000,000 issued in February 2004 and EUR 800,000,000 issued in February 2006.

- ELM B.V., A1-rated Perpetual Subordinated Step-Up Loans of Swiss Reinsurance Company, EUR 1,000,000,000 issued in May 2006.

- Metropolitan Life, A3-rated Junior Subordinated Notes, USD 1,000,000,000 issued in December 2006.

- Swiss Reinsurance Company, A1-rated Perpetual Subordinated Step-Up Preferred Securities, USD 750,000,000 issued by Swiss Re Capital I LP in May 2006.

- Zurich Financial Services, Baa2-rated Enhanced Capital Advantaged Securities – “ECAPS” – USD 600,000,000 issued by ZFS Finance (USA) Trust I in November 2005; USD 700,000,000 issued by ZFS Finance (USA) Trust II in December 2005; USD 400,000,000 issued by ZFS Finance (USA) Trust III in December 2005.

Hybrid ratings put on review for upgrade include:

- Assured Guaranty US Holdings Inc., A3-rated Junior Subordinated Notes, USD 150,000,000 issued in December 2006.

- Financial Security Assurance Holdings Ltd., A1-rated Junior Subordinated Notes, USD 300,000,000 issued in November 2006.

- Morgan Stanley Capital Trust VII, A2-rated Preferred Stock, USD 1,000,000,000 issued ion October 2006.

Moody’s says that it proposed a new notching system in November 2006 that called for lowering ratings by 1 notch on non-cumulative preferred stock and other hybrid securities ranked as either “moderate” or “strong” for “no ongoing payments” by Moody’s New Instruments Committee.

“Negative” reaction such as a “lack of strong statistical evidence supporting greater notching for non-cumulative securities” resulted in the rating agency deciding to keep its notching system “largely unchanged,” according to Moody’s.


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