A suite of risk analysis tools developed by Banc of America Securities has been harnessed by Standard and Poor's Risk Solutions, a move that is being perceived, initially, as a boost to synthetic CDO ratings.
The analysis of corporate credit risk is the trend du jour this year, as lenders and investors clamor behind the scenes for the next generation of analytical tools. While BofA has offered its proprietary Credit Option Adjusted Spread (COAS) and Lighthouse platforms to it clients for several months now, the collaboration announced this month marks the first time a dealer has pushed out a platform to the forefront of ratings.
The collaboration is not with the rating agency of S&P itself, said a spokesperson for Risk Solutions. "The ratings operation makes independent decisions about the tools it uses. Our analysts services are performed as an entirely separate activity." Risk Solutions was established in 2001 and provides services such as customized credit risk to financial institutions.
As explained by sources close to the deal, Risk Solutions will use the BofA platform to further the development of a new set of quantitative risk tools based on COAS. This new platform could be used in rating CDO structures and would specifically harness Lighthouse for synthetic CDO ratings. Lighthouse has been utilized, primarily, by single- tranche CDOs (STCDO), which have seen a rise in activity since their introduction approximately two years ago.
"COAS provides a forward-looking estimate of risk and return, bringing unprecedented transparency to the credit markets," said Jeffrey Rosenberg, head of credit strategy and the COAS development team at BofA.
Lighthouse and COAS are tools that analyze risk and return by looking forward rather than analyzing historic data. The platforms are more transparent in that they take into account the bond market, the equity market and the equities options market. Information is not ratings-based. COAS is the front end of the platform, looking at issuer-level, while Lighthouse delves down to credit portfolios.
"It is import to note this is entirely different from Delta Hedge Models used by correlation traders to price and hedge single-tranche CDOs. Moody's has KVM but that looks only at default and relies predominately on historical equity prices and default migration," said one source.
S&P plans to use Lighthouse to provide risk ratings on synthetic CDOs, in a method similar to its proprietary CDO manager ratings. Lighthouse will act as an additional tool for rating and evaluating risk in CDO reference portfolios. However, officials cautioned the joint venture in no way replaces S&P's ratings based CDO Evaluator tool.
"This is the first time a dealer is actively doing something to combat adverse selection or ratings arbitrage risk, which has largely been responsible for poor synthetic CDO performance," said Lang Gibson, director for structured credit research at BofA.