Failing to consider all the key factors in rating bank loans may leave investors with a "false sense of security," according to a report from Moody's Investors Service released last week.
Of particular importance when considering secured bank loans is an accurate evaluation of the value of underlying collateral, not only in liquidation but also based on its importance to the borrower as a "going concern," according to the new report.
"Any analysis of collateral that proceeds solely on the basis of calculating likely liquidation value overlooks the important fact that liquidation is less likely than is reorganization for a large corporate entity," writes Pamela Stumpp, vice president of Moody's global credit research and author of the report.
The study also turns a skeptical eye on the market convention of rating secured bank loans one notch above the same firm's senior unsecured rating.
"The rating differential between a firm's bank loans and other debt obligations is not a reflection of a greater or lesser probability of default. Rather it is a consideration of higher expected recovery values for bank loans over the same borrower's bonds as a result of loan structure and security," Ms. Stumpp writes.