Approximately USD 13 million of debt securities affected
New York, January 21, 2009 -- Moody's Investors Service announced today it has downgraded its ratings
on two classes of notes issued by Edelweiss Capital Plc.
This synthetic CDO refers to a portfolio of Equity Default Swaps (EDS).
The portfolio comprises 60 EDS in the so-called "Risk Portfolio",
on which the SPV is protection seller, and 60 in the so-called
"Insurance Portfolio", on which the SPV is protection
buyer. At maturity of the transaction (in 4.1 years),
the number of Net Equity Events (i.e. the difference in
number of Equity Events in the Risk Portfolio and in the Insurance Portfolio)
defines the amount of loss to be paid by the SPV to the protection buyer.
The number of Net Equity Events is the total number of Hits experienced
in the Risk Portfolio less the total number of Hits experienced in the
Insurance Portfolio. During the equity observation period (described
below), each reference entity's stock price is observed on
a weekly basis. A Hit is recorded if the spot is below 35%
of the reference entity's initial stock price. The protection
amount paid by the SPV to the protection buyer then corresponds to one
tenth of the reference entity's initial notional amount.
In other words, the protection buyer will get the full protection
amount related to one reference entity if, within the observation
period, the related stock price is below 35% of the price
at closing for ten weeks or more.
The primary performance indicator of an EDS is the Barrier, which
is the Initial Barrier multiplied by the ratio of the EDS Price at closing
and its Current Price. Note that stock prices are adjusted when
corporate actions affect a reference entity according to the ISDA Equity
Derivatives Definitions. The Initial Barrier (i.e.
the Barrier at closing) was set at 35% for all underlying swaps,
and Barriers are computed using the 50-day moving average stock
price.
Today's ratings actions are the results of an adverse evolution
of the underlying portfolio shares, which may be illustrated by
looking at the average of the Barriers (capped at 100%) for each
of the two portfolios. In general, if the transaction is
performing, the difference between the average Barrier of the Risk
and Insurances portfolios should not widen when being negative.
In January 2009, the average of the Barriers for the Risk Portfolio
was 71% (resp. 53% for the Insurance Portfolio).
In September 2008, the same indicator was 48% for the Risk
Portfolio (resp. 41% for the Insurance Portfolio).
The difference between the average Barrier for the Risk and the Insurance
Portfolio hence deteriorated since September 2008 (from -7%
to -18%.)
As a consequence, should all stock prices remain the same until
maturity, one tranche would experience partial losses and one tranche
would be wiped-out -- note that this information may be subject
to marginal evolution due to late substitutions, moving-average
calculation and actual determination of losses. The Equity Events
observation period will start in February 2010 and will last until the
maturity of the transaction, such that no Equity Event related losses
have occurred at this stage.
Moody's main rating methodology is summarized below. Other
methodologies and factors that may have been considered in the process
of rating this issue can also be found at www.moodys.com
in the Ratings Methodologies subdirectory of the Credit Policy & Methodologies
directory.
Today's rating actions are as follows:
Edelweiss Capital - Series 2007-1:
(1)Class A Series 2007-1 Asset-Backed Floating Rate Notes
Current Rating: Caa1
Prior Rating: Ba3, on review for possible downgrade
Prior Rating Action Date: 10 October 2008, downgraded and
left under review
Edelweiss Capital - Series 2007-1:
(2) Class B Series 2007-1 Asset-Backed Floating Rate Notes
Current Rating: Caa2
Prior Rating: B2, on review for possible downgrade
Prior Rating Action Date: 10 October 2008, downgraded and
left under review
MOODY'S MAIN EDS RATING METHODOLOGY
Moody's approach to modeling portfolio of Equity Default Swaps at
closing can be broadly summarized in three steps.
Moody's identified three stock market regimes that display significantly
different behaviors both in terms of likelihood of stock prices collapse
and correlation structure: these are the Normal, Stress or
Crash regimes, each with a related probability of occurrence.
Then for each EDS and in each market regime, Moody's inferred,
with the support of various statistical studies, a probability of
the threshold being hit based on: (i) the initial rating of the
reference entity, (ii) the maturity of the transaction and (iii)
the threshold level (between 10% and 40%).
Finally, the dependency structure (i.e., correlation)
between EDS was defined -- it is mainly driven by equity return correlation
and adjusted according to (i) the market regime, (ii) the industrial
sector and (iii) the geographical area.
The Monte Carlo method is the most suitable to rate synthetic CDO transactions,
including EDS, as it allows to take into account global and industry
correlations, and portfolio heterogeneity - in terms of triggers,
ratings or amounts. In each Monte Carlo trial, entities are
modeled separately - subject to the correlation structure determined
above -- while distressed Equity Events and recovery rate upon trigger
being hit are simulated. Cumulative losses are then computed on
the rated tranches.
The monitoring process is consistent with the rating methodology described
above. Among other components, the monitoring committee reviews
the result of two modeling approaches and three loss scenarios,
as detailed below.
For entities whose Barrier is above 40%, the two approaches
considered relate to the computation of the probability of hitting the
trigger and are the following:
- In the first one, this probability is derived from a statistical
analysis of world-wide indices;
- In the second one, it is derived from a stochastic simulation
whose primary driver is the implied volatility obtained from the option
market.
The three loss scenarios considered in the determination of the rating
are as follows:
- One central loss scenario estimates the loss for each tranche
based on the current share levels at maturity;
- Two alternative scenarios account respectively for a 20%
increase and a 20% decrease of all stock prices together.
Finally, the result of the monitoring model described above has
been floored to Caa1 (respectively Caa2, Caa3) for tranches for
which the central loss scenario predicts no loss (respectively partial
loss, wipe-out.) The floor is set one notch higher
for tranches for which the Equity Events observation period has not yet
started.
Moody's will continue to monitor the transaction on a regular basis.
New York
Jian Hu
Managing Director
Structured Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
London
Christophe Larpin
Analyst
Structured Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Moody's downgrades notes issued by Edelweiss Capital Plc.
