With its secured loan recovery scale in place since December, Standard & Poor's has begun applying the modified criteria to CLOs.

Separate from a corporate credit rating - which is based on a likelihood of default - the new scale is tailored towards loan recoveries. S&P Managing Director David Tesher said the agency has broadened the scope of the recovery rating scale to CLOs, which have experienced an uptick in the marketplace that began in 2003.

"The growth in the underlying leveraged-loan market has fueled CLO issuance," said Tesher. Most of the nearly $1 trillion in outstanding loans rated by S&P are secured by collateral. However, "not all secured collateral is created equal," he said. S&P has focused on the categorization and assumptions related to secured and unsecured loans included in cashflow CLOs increasingly via asset-specific recovery assumptions.

Tesher stated S&P will review collateral-backed loans on a "loan by loan basis" and not craft specific definitions. Some loans marketed by issuers, for example, as secured second liens loans, are not secure in every instance. One loan may have a lien on all corporate assets whereas another could reference intangible assets, such as future-issued company stock.

Second lien loans have catapulted to the top of the headlines due to a strong uptick in their issuance over the last two years. S&P-rated loans tallied $3.1 billion in 2003, up from $570 million in 2002. Managers should be aware, said Tesher, that loan recovery ratings are a collateral-intensive approach so managers shouldn't expect similar ratings across the board. Moreover, despite definitions in offering documents, S&P reserves the right to differ on the surveillance side.

It is not clear how the additional transparency and scrutiny will impact the marketplace. It's possible that collateral spreads could be impacted by this development and the other new methods of differentiating loans offered that have been implemented by Fitch Ratings and Moody's Investors Service.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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