Moody’s Investors Service has released a new report entitled Assessing the Importance of an Originator's Retained Interest to Moody's Structured Finance Ratings.

The credit implications of an originator retaining a financial interest in a structured finance transaction vary and are generally limited, the report said.

The authors stressed that the potential credit impact must be assessed in the context of the interests of all parties and the details of the transaction, and may also change over time.

The presence or absence of a retained interest has a limited impact on ratings, according to Team Managing Director David Teicher

This is because the potential credit impact of a retained interest can be either positive or negative, and because of the originator’s other incentives, such as wanting to maintain its reputation through positive performance.

An originator, servicer or collateral manager may retain an interest in the pool of assets underlying a transaction, typically the most junior or equity tranche, according to the report. This investment may or may not more closely align the interests of such parties to those of the senior tranche investors.
 
In general, these interests are aligned when asset performance is strong, but are more likely to diverge when performance is weak. In these circumstances, the originator might have an incentive to maximize cash flow to the tranche that it retains, thus reducing the cash flow or credit protection that may be available to the more senior tranches.
 
Teicher said the interests of an originator holding a retained junior interest across transaction types could conflict with those of holders of more senior classes should the assets backing the transaction perform poorly. The holding of a retained interest may become a negative factor for the outstanding ratings on the senior notes in this situation.
 
Other considerations for credit quality include whether the originator has the ability to sell its retained interest, or whether its financial interest is hedged, limiting the originator’s concerns over financial performance.
 
Moody’s new assumption volatility scores for structured products, to be introduced this quarter, will include a sub-component that addresses the alignment of interests.

These scores will consider not only whether an economic interest is retained by the originator, but additional indicators of alignment such as the originator’s history of honoring representations and warranties and the importance of the transaction to the originator’s funding strategy.

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