Standard & Poor's put 1,981 structured finance tranches in Europe, Middle East and Africa (EMEA) on creditwatch negative yesterday as a result of the revision of its counterparty criteria.
S&P's new counterparty and supporting obligations rating methodology changes became effective as of Jan. 18.
The new criteria apply globally to all new and existing structured finance securities and covered bonds. However, the effective implementation date for covered bonds was delayed. Additionally, specific aspects of the new framework also apply to ABCP programs.
According to a report published by Unicredit analysts, the counterparty rating criteria was updated to better establish a more precise link between the rating of an issue and the counterparty's rating based on the type of support provided by the counterparty.
"The overall principle behind S&P's counterparty criteria is the concept of counterparty replacement in a structured finance deal in case its creditworthiness deteriorates," the Unicredit report stated. Analysts said that without such a replacement mechanism or any other mitigating factors, S&P sets the standard that the security's rating would usually be no higher than the counterparty's credit rating. They explained that any uplift for a structured finance note will depend on the type of counterparty obligation.
Counterparty risk is classified in three ways by the agency: direct support, derivatives, and other support obligations. Also, the agency is distinguishing between limited or substantial counterparty support. This type of support and the counterparty's rating are basic factors in S&P's determination of the maximum potential rating that can be applied to a supported structured finance offering.
In terms of derivatives, the agency also takes into consideration whether the obligation is collateralized or not. S&P will generally assign a rating that is higher than the counterparty rating if the counterparty will, automatically and legally binding, be replaced once its rating falls below the minimum counterparty rating.
As a result of the new criteria, S&P has put on credit watch negative 28% of its ABS universe, 68% of its CMBS universe and 62% of its RMBS universe, as well as 15% of its CDO universe. Unicredit analysts said that in total, 964 European deals were affected.
The results have so far been less drastic than originally anticipated. As of last month, S&P expected around 80% to 90% of its European RMBS universe to be affected.
"In relation to U.K. prime RMBS, Dutch RMBS and auto ABS, the outcome is not as bad as expected," Barclays Capital analysts said in a report. "This is because S&P did not take review action if it received a written action plan that in their opinion 'outlines a viable timeline and is suitable to enable the transaction to comply with the criteria by 18 July 2010."
Analysts said that the likelihood of deal restructuring in order to avoid downgrades is higher for securitization programs and originators that plan future issuance. The fact that many U.K. RMBS, Dutch RMBS and auto ABS transactions were not affected by review actions confirms this view. "We can only assume that many issuers in these sub-sectors have provided S&P with an action plan to bring the transactions into compliance with the new criteria," analysts said.