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
