Price dislocation in the CDO market has not only halted new issuance but has made the value of existing CDO securities almost impossible to assess. In an effort to address these valuation issues, Moody's Investors Service's Wall Street Analytics (WSA) recently launched Credit Values DCV (Discounted Cash Value), a product the rating agency hopes will enhance the transparency of CDOs by providing investors with valuation information about their securities.
Pricing troubles first came to light after the summer RMBS downgrades sent the value of many ABS CDO securities tumbling and left investors unable to value their portfolios. "What drove the launch of the product was a response to the market," said Gus Harris, managing director and president of Moody's WSA, who noted that many of Moody's WSA customers, primarily investors in CDOs, were calling up during the summer crisis asking for help finding the true underlying value of their investments. "It was [the investors'] view at the time and it continues to be [their] view today that some of the market prices that are currently available appear to be unreasonable and reflect a very harsh haircut for the current volatility and lack of liquidity in the market."
Indeed, some investors indicated that the Moody's product may help them identify "bargains" in the currently distressed market by allowing investors to easily compare current market prices to fundamental values based on investor inputs. The product could also enable them to question dealer bids.
The new platform offers both a standard model service and a customized service.
The standard service creates four basic scenarios through which the customer is able to look at the DCV under various predefined default and loss possibilities and determine how sensitive that particular tranche might be to those changes. "You can get a view of the variability of discounted value of the cash flows and see how the value of the security changes when you alter assumptions about LGD or default rates," said Roger Stein, managing director of research and analytics at Moody's. Investors can also use their own analysis in conjunction with the product, which is where the customized service comes in, Stein added. "People can look at a specific assumption and may agree with 90% of the assumptions that Moody's WSA uses but have a different view, for example, on LGD or interest rates, and the analytic framework has the flexibility to change that."
The custom service applies investors' own assumptions about inputs such as default rates and timing, market spreads, correlation and loss given default. Then these are used with Moody's models to generate a customized DCV calculation.
Another feature of the product is a large library of individual transactions containing detailed information about their structures.
Moody's built this by stripping out the structural information from trust indentures for structured securities and storing this information in a database. Moody's WSA updates the underlying data for the portfolios in those deals so that it can match fairly closely the cash flows being generated by the assets and the cash flows that the bondholders receive, Stein said.
While the need to increase transparency in the CDO market is something nearly all market participants agree on, not all investors think the product will make a significant impact. Moody's DCV might be helpful for smaller investors or for those who do not have a large IT infrastructure or research staff, many agreed. However, the product sends mixed messages, one CLO manager said. "Moody's has previously said it does not make buy recommendations, but this product crosses the lines in that direction. If people transact on those valuations and lose money, [is Moody's] going to say, We are just a valuation company, we don't make recommendations?'"
Another CDO manager was skeptical of the product, because it does not provide the same level of access as having an in-house team of analysts to provide guidance and discuss valuation outcomes. He said he would probably use the product as a secondary resource.
In response to market concerns about Moody's mixed-business models, the rating agency maintains that securities information gleaned through the use of DCV is intended for the valuations process - a different purpose from ratings, which provide an opinion on credit quality that reflects qualitative and quantitative factors. At the same time, Moody's WSA is a subsidiary of Moody's Corp., and a different entity from the ratings agency. Therefore, it can provide valuation information more easily and in the same way that other Moody's subsidiaries provide quantitative analysis and economic projections, Harris said.
The Credit Values DCV Standard Service is currently available for U.S. corporate cash flow CDOs, primarily CLOs. However, it will be expanded to include European CDOs, RMBS and ABS CDOs (both high grade and mezzanine).
The custom service is currently available for a broad range of cash-flow CDOs, including corporate CDOs, some European CLOs, ABS CDOs and TruPS CDOs. While there are synthetic valuation products, Harris said, Moody's DCV is the only valuation product of its kind on the cash flow side that he was aware of.
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