Standard & Poor's published revised methodologies and assumptions it uses to rate global CDOs backed by corporate debt.
Analysts said that the revision represents a significant recalibration of the agency’s CDO criteria that will enhance the comparability of CDO ratings with ratings in other sectors.
The rating agency said it expected that the criteria update would result in downgrades to many rated corporate CDO tranches. Globally, the agency anticipated it will place on CreditWatch negative approximately 4,790 public rated corporate CDO tranches.
"Our preliminary estimates are that outstanding synthetic CDOs will likely experience an average downgrade of 4 notches,” said Thomas Gillis, chief credit officer, structured finance ratings.
Super senior 'AAA' tranches of such transactions will probably be affected less, with an estimated average downgrade in the 2 to 3 notch range.
Tranches rated 'AAA' will likely be affected more, with an estimated downgrade of 4 to 5 notches.
Outstanding cash flow CDOs will probably have an average downgrade of 3 notches while the senior most 'AAA' rated cash flow tranches that are above other junior 'AAA' rated tranches will probably be affected less, with an estimated average downgrade of 1to 2 notches.
The most notable update in the criteria is the addition of qualitative and quantitative tests that supplement the default simulation model used in S&P’s portfolio analysis.
The updated criteria also adjusted the asset default rates, correlation, recovery, and other model parameters to produce asset portfolio default and loss results commensurate with the agency’s rating definitions.
"We believe that adding quantitative and qualitative elements to our analysis — entirely apart from the Monte Carlo default simulations we run — will provide a more robust analysis than using only simulation models,” said Henry Albulescu, global criteria officer, structured credit at S&P. “By achieving specific targeted portfolio default rates in the CDO Evaluator, we have made it easier and more transparent for investors to understand our ratings and analysis."
Another important update to the criteria is that a review of a corporate CDO transaction now also includes sensitivity to model parameters. This tests what the effects would be on a CDO tranche's ratings if the rating agency changes four key portfolio parameters. These are correlation, recovery, spreads, and default bias. This aspect of the criteria will assess whether the model results and deal structure display high sensitivity to changes in input parameters.