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Announcement:

Moody's puts all but senior-most CLO tranches on review for downgrade

04 Mar 2009

Approximately $100 billion of securities affected

New York, March 04, 2009 -- Moody's Investors Service announced today that it has placed nearly all rated tranches of U.S. and EMEA cash flow collateralized loan obligations (CLOs) on review for possible downgrade, except for the most senior Aaa CLO tranches. Included in today's rating actions are junior Aaa tranches and those tranches rated Aa and below. Most CLO combination notes are also included.

Today's rating actions, which affect approximately 3,600 tranches totaling $100 billion from 760 transactions, reflect the revision of certain key assumptions that the agency uses to rate and monitor CLOs. These revised assumptions incorporate Moody's expectation that corporate default rates are likely to greatly exceed their historical long-term averages and reflect the heightened interdependence of credit markets in the current global economic contraction.

In its February 4th announcement, "Moody's updates key assumptions for rating CLOs," Moody's stated that it had increased its default probability assumptions for corporate credits in the collateral pools of CLOs by a factor of 30% across all rating categories. In addition, Moody's stated that assets with negative outlooks or that are on review for possible downgrade would be treated as if they had already been downgraded by one or two notches, respectively. At the same time, Moody's changed its calculation of the primary measure of industry and issuer diversification in CLOs (the Diversity Score) to increase the estimate of correlation in most pools of corporate credits.

Moody's did not place any senior-most tranches of U.S. and EMEA CLOs on review for downgrade at this time because of their underlying credit support, the presence of cash flow diversion and de-levering structural mechanisms, and the diminished reinvestment opportunities. However, negative rating actions on these tranches may occur as Moody's conducts its CLO review.

Moody's break-even default analysis indicates that the Aaa-rated senior tranche of a typical CLO has enough protection to survive a 50% collateral default rate over the life of the transaction under a 40% recovery rate assumption for a pool of mostly senior secured loans. (See Moody's Special Report titled: CLOs: History, Structure, and Perspectives dated August 1, 2008.) Such levels have not been seen since the Great Depression. By way of comparison, Moody's default rate forecasting model currently projects the five-year cumulative default rate for all speculative-grade corporates at roughly 30% under a baseline scenario and 36% under a pessimistic scenario. (See Moody's Monthly Default Report -- January 2009, dated February 10, 2009.) Moody's does not anticipate changes in the Aaa rating of the senior-most tranches of a typical CLO unless corporate credit conditions deteriorate further and realization of the pessimistic scenario becomes more likely.

Two Stages of CLO Rating Review

Moody's will conduct its CLO ratings review in two stages. In Stage I, which will begin immediately, Moody's will use a parameter-based approach to calibrate the extent of downgrades to tranches currently rated single-A and below in the vast majority of cash flow CLOs. Any senior-most CLO tranches that appear to have significantly weaker than average structures and portfolios may be placed on watch for possible downgrade at that time as well. In Stage II, which is expected to begin at the end of March, Moody's will perform a more comprehensive analysis by modeling each CLO individually. At that time, additional rating actions will be taken as necessary for all rated liabilities, including tranches currently rated Aa and Aaa. Moody's expects to complete Stage II by the end of the second quarter of 2009.

The collateral portfolio characteristics that will be examined as part of Stage I include (1) the current rating, (2) the level of over-collateralization (O/C), (3) the Weighted Average Rating Factor (WARF) transition since mid-2008, (4) the absolute increase in percentage of Caa-rated assets since mid-2008, (5) whether a tranche is currently, or is expected on an upcoming payment date, to pay-in-kind (PIK), and (6) the concentration of structured finance securities, such as other CLOs, in the collateral pool.

Moody's adopted a parameter-based approach for Stage I for two main reasons. First, our sample testing shows that an overwhelming majority of tranches rated single-A or below are expected to experience at least a four-notch downgrade on average which, in the case of the single-A's, would put them on the boundary between investment grade and speculative grade. In particular, single-A's will be considered for downgrade by five to eight notches if a deal's single-A O/C is less than 110%, its WARF has increased by more than 10%, its Caa bucket has increased by more than 5%, the tranche is PIKing, or it has more than 5% structured finance assets. Second, certain parameters, as described above, could be used to identify potential performance differentiations across most CLO transactions, enabling us to make that distinction in advance of a more time-consuming credit analysis involving cash modeling.

Moody's emphasized that the parameters serve as guidelines for rating committees, which will individually assess each transaction by taking into account the CLO's own performance data, deal-specific document features, structural protections, and the collateral manager's track record.

The tranches rated Aa and Aaa in CLO transactions do not lend themselves to a parameterization approach, even as a first step in the credit process, as the unique portfolio characteristics and structural features of the CLOs tend to differentiate performance more at the top end of the capital structure. Most of these senior tranches currently rated Aa and Aaa will be reviewed during Stage II. During this Stage II review, it is expected that a number of junior Aaa-rated tranches and Aa-rated tranches will be downgraded by two to four notches on average, with a wide range of outcomes that depend on the specific transaction, and a small number of senior-most Aaa-rated tranches may also be downgraded. Because Stage II will involve modeling the entire capital structure of the CLO, it may also lead to further ratings actions on tranches currently rated below Aa.

Exclusions from Today's Actions

Other than senior most tranches, CLO tranches also excluded from today's action are those from transactions that have been reviewed since the beginning of 2009, principal protected notes, and certain tranches guaranteed by third parties. In addition, Moody's believes that CLO transactions with certain characteristics are not amenable to analysis using a parameter-based approach. These include older-vintage (pre-2003) transactions and others that have had considerable de-levering; CLOs with large (> 15%) structured finance concentrations; certain U.S. SME CLOs; SME CDOs outside the U.S., and deals that have odd structures, cash flow characteristics, or non-standard collateral pools that do not adapt appropriately to parameterization. These transactions are expected to be addressed in the coming months.

Moody's further emphasized that while most transactions will be analyzed according to the two-stage review process discussed in this announcement, there may be cases where transaction performance warrants a prioritization of the full analysis ahead of the time line set forth in the framework above.

Rating Methodology

The principal methodology used in rating and monitoring the transaction is the following publication, which can be found at www.moodys.com in the Credit Policy & Methodologies directory, in the Ratings Methodologies subdirectory:

Moody's Approach to Rating Collateralized Loan Obligations (December 31, 2008).

Other methodologies and factors that may have been considered in the process of rating this issue can also be found in the Credit Policy & Methodologies directory.

In addition to the quantitative factors that are explicitly modeled, qualitative factors are part of the rating committee considerations. These qualitative factors include the structural protections in each transaction, the legal environment, specific documentation features, the collateral manager's track record, and the potential for selection bias in the portfolio. All information available to rating committees, including macroeconomic forecasts, input from other Moody's analytical groups, market factors, and judgments regarding the nature and severity of credit stress on the transactions, may influence the final rating decision.

A list of the review actions associated with this announcement may be found at:

(Excel data)

http://www.moodys.com/cust/getdocumentByNotesDocId.asp?criteria=PBS_SF158157

New York
Jian Hu
Managing Director
Structured Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Paris
Guillaume Jolivet
Asst Vice President - Analyst
Structured Finance Group
Moody's France S.A.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's puts all but senior-most CLO tranches on review for downgrade
No Related Data.
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