Friday, May 23, 2008

CDO defaults driven by downgrades

(FT Alphaville) Do ratings merely constitute a journalistic opinion, or are matters a little more complicated than that?

The tricky part comes, of course, because ratings are taken as more than simply journalistic opinions by participants in the market, in spite of rating agency insistence to the contrary. There’s risk weighting under Basel II, investment guidelines for pension funds and, of course, default triggers in complex structured debt products themselves:

From Aaron Johnson at Total Securitization:

Very few if any of the nearly 200 collateralized debt obligations in default have done so because of missed payments. At least 180 CDOs totaling about $200 billion have defaulted due to ratings downgrades as a result of failing overcollateralization tests, according to various CDO officials. “Even though a deal has technically defaulted, there is money coming in to the deal and payments are being made,” one CDO trust official said. “[Involved parties] are continuing to administer the deal in the same way as before it defaulted.”

That may not be the case later in the year, however, said one CDO researcher. “[Defaults] are all driven by ratings [right now],” she said. “In six to 12 months we’ll start to see some actual cash flow problems.”

No comments: