Moody's Investors Service has enhanced its analysis of highly concentrated structured finance CDOs - largely as a result of the ever-increasing exposure to RMBS in recent deals. As the largest sector of the ABS market, it's not uncommon to see RMBS concentrations to top 50%, of a CDO's collateral, but concentrations have trended upward to 75% and even 85%, according to Moody's.

The so-called Correlated Binomial Methodology builds upon its previous methodology for assessing correlation risk, the Binomial Expansion Technique. Correlated Binomial Methodology models asset correlations explicitly in order to find increasing concentrations of real estate securities, according to Moody's. The methodology uses the rating agency's recently revised asset correlation assumptions for structured finance securities.

"For these more concentrated deals, you'll see more of a difference, but which way it goes, if there is any tendency, I'd say it would be the deals with the lower rated collateral," said Moody's Managing Director Gary Witt. "This methodology tends to be more conservative."

Whereas this method incorporates the correlations among representative assets as a modeling parameter, Moody's had previously treated representative assets within CDOs as being independent of one another. In all, the new metric uses four parameters: the number of representative assets included in the pool; the common default probability of each asset; the common recovery rate of each asset; and the single asset correlation between each pair of assets. The change brings Moody's asset correlation modeling in-line with the same process it began using last November for synthetic structured-finance CDOs.

The CBM approach was developed for structured finance cashflow CDOs, but can be used on synthetic CDOs with complex payment schemes and CDOs with certain collateral types.

Witt pointed out that the model will still only constitute a portion of the rating process.

"We definitely think it is an improvement, but we wouldn't want to overstate it. We're still using the weighted average rating factor as the most important aspect," Witt said, adding that the change is likely to have marginal implications in areas such as required credit enhancement levels, but that even a marginal change could make a difference to investors.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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