Following initial action on the most immediately impacted sectors, the rating agencies and other industry participants are taking a closer look at how the post-Sept. 11 reality will impact assumptions and criteria used for structuring securitizations.
While most argue it is too early to speculate given today's uncertainty, the agencies are already rethinking assumptions used in rating at least the following: pooled aircraft lease deals, rental car fleets deals and timeshare securitizations, according to agency sources.
"I think the agencies will definitely need to revisit ratings criteria," said Jeff Salmon of Barclays Capital, once a credit card analyst at Standard & Poor's. "The simultaneous confluence of all these events happening: this wasn't factored into the worst-case scenarios."
As Salmon notes, the incidents of Sept. 11, almost by definition, were unimaginable, and starkly different than other recent "unforeseeable" events bearing negative impacts. Examples of more typical forms of "event risk" include asbestos litigation and the California energy crisis, both of which caused waves of fallen angels, i.e. strong credits sinking below investment-grade.
Arguably, the impact of those examples are incomparable to Sept. 11, which, at the very least, has overhauled the outlook for the entire airline industry, globally, from soft to scoured literally overnight. "It poses questions such as, How do you diversify for whole industry risk?'" one analyst commented.
Some analysts, however, believe that events such as war, global and severe depression, and other types of large-scale calamities are frequent enough throughout history that the impacts should be more significantly part of ratings and risk assessment criteria.
"With respect to risk assessment, we had collectively dawned our rose-tinted glasses," said Mark Adelson, researcher at Nomura Securities, and ex-ratings analyst at Moody's Investors Service.
In a statement distributed last week, Federal Reserve Chairman Alan Greenspan argued that the U.S. financial markets may have been aware of the possibility of an event such as the terrorist attacks, but had not priced it into market dynamics.
"I suspect that those possibilities were deemed so remote that they were never seriously incorporated into most conventional assessments of economic risk," Greenspan said. "The shock of the tragedies at the World Trade Center and the Pentagon has reshaped those assessments of risk and required an abrupt realignment of prices in many markets to reflect the expected costs of operating in what we now recognize as a more hostile world."
Some heavily hit sectors
Since the terrorist attacks, the industry is rethinking assumptions, worst-case scenarios and other parts of criteria in several areas of securitization, most visibly in aircraft structured finance, fleet rental cars, and timeshare securitizations.
"In general, whenever one of these events happen, it causes us to do a frisk of all our ratings assumptions, and see which ones were challenged," said Tom Gillis, a managing director and chief quality officer for the structured finance department at S&P.
Following is a rough compilation of the current areas of focus and concern:
*Aircraft: Investors are concerned that the risk of weakening demand/resale value for aircraft might not be stressed adequately into the existing deals. Thus, the agencies are looking at residual and current jet value analysis, relating to whole industry risk. Data, such as residual value of passenger versus cargo planes in different scenarios will be incorporated.
"We haven't been able to gather enough data to see what aircraft values are, and if they have changed materially from original assumptions, and how permanent the changes are," said Kevin Duignan of the asset-backed group at Fitch. "Our expectations are that values have declined in the short term substantially, but we don't have the data points. But here's a fact: if someone was asking us to rate a pooled aircraft transaction today, our enhancements would be higher than six months ago."
Beyond resale value, assumptions on the volatility of the current value of aircrafts is also an area of interest. Lease payments are a function of how much an aircraft is worth. The underlying lease payments will decline as the aircraft value declines.
*Rental cars: Investors are wondering if the dependence of the rental car industry on the aircraft industry was adequately factored into assumptions. Because the deals that are in trouble are those from lower-rated corporations (Budget Group and ANC Rental Corp.), the economic stability of the underlying company has become more scrutinized.
*Timeshare: Analysts are watching to see how and if travel disruptions will have an impact on timeshares securitizations. "I don't think we assumed there would be a drop-off in travel going forward, which is a risk that would be factored in now," said Jay Eisbruck of Moody's Investors Service. A decline in travel could negatively impact the timeshare developers, which are generally the entities maintaining the existing timeshares. To the extent that the developers become economically impaired, the quality of service on the existing timeshares could deteriorate, prompting consumers to back out or default on their contracts.
Analysts will also be watching to see if there is a distinction in commitments between drive-to timeshare destinations and fly-to destinations.
Historical changes
Analysts have suggested that revising assumptions is part and parcel to the evolution of the securitization industry/technology. Throughout the short history of securitization, the rating agencies have continually revised criteria. In several cases, changing assumptions have actually been written into deals that are already outstanding.
For example, in several Toyota Motor Corp. auto lease deals from the late 1990s, the issuer was asked by the rating agencies to increase its residual value collateral accounts to meet new assumptions on the resale values of the leased autos, which were coming back below initial projections. Toyota devoted more capital to the reserve account and its ratings were maintained.
Similarly, Sears, Roebuck and Co. was asked to increase credit enhancement on certain outstanding private-label credit card deals to maintain its triple-A rating, as assumptions changed on the rate of personal bankruptcy filings.
"I think what we have is an adaptive-type ratings methodology," said Barclays' Salmon. "Especially in a situation like the present, when the global picture has changed radically in such a short time."
Other perspectives:
The long view
"Quite frankly, I think it's too early to be making changes in assumptions," said one investor. "I think it would be premature to use the current environment as a benchmark for stress levels for the life of transactions."
In fact, most analysts agree that it would be anti-productive for the criteria to radically overcompensate as a result of the current situation, although most believe there will be some tightening and conservative adjustments to credit enhancement.
However, others are more conservatively aligned with Greenspan's perspective, that the U.S. financial market had not adequately weighted the prospect of world altering events, when assessing risk.
"The real story is that this shouldn't have been the kind of thing that should change assumptions, if you're taking a reasonable historical view, and taking into account peace and war, and times of prosperity and economic cycles," said Nomura's Adelson.
Adelson, who earlier this year authored a piece critiquing credit enhancement levels in MBS, argues that the current ratings regime is based on economic data and assumptions incorporating little more than the past decade, which does not integrate into its world view events such as the depression of the 1930s, or the oil crisis during the 1970s.
"You've heard from people that a depression like the Great Depression can't happen again," Adelson said. "I agree that it's not likely, but can I imagine it? Of course. It has already happened once. It happened in the last hundred years."
According to the rating agencies, they do stress severe economic downturn into ABS transactions.
"Certainly there's no way that you could factor an event such as Sept. 11 because that event was unimaginable, however, our ratings typically factor in economic shocks that would cause adverse performance," said S&P's Gillis. "We don't specify or try to predict what is the cause of the shock, we just make sure our deals our tested for the effects of those shocks, and I think in this period, that serves us well."
