Synthetic collateralized debt obligation issuers are grumbling that ratings agencies are failing to take account of substantial short-credit buckets in CDOs.
Dealers are under pressure to get these short buckets fully rated because a large swathe of investors will not buy into the deals without a full analysis of the short bucket from a rating agency.
Including large short credit buckets has become increasingly popular in the tight spread environment as a way for managers to differentiate their deals. The issue applies particularly to sophisticated asset-backed CDOs that are making a play on spread movements in addition to credit quality.
Officials at Standard & Poor's, Fitch Ratings and Moody's Investors Service defended their methodologies and said that as the market has developed new structures they have adapted and have looked to start including short ratings. "To say that we have not given any credit for short buckets is not true," said one rating agency official, who declined to be identified. He said additional cushion may be granted to a deal's rating following the analysis of short buckets and the manager's strength. Other rating agency officials declined comment or did not return calls.
CDO issuers, however, want ratings agencies to establish separate ratings that analyze a manager's ability to actively trade and short credit. Firms have been working with agencies on a deal-by-deal basis to ensure short buckets are acknowledged in the rating process. Adding a short bucket--and finding a manager capable of managing short credit positions--jacks up the cost of a CDO's fees, so investors are also looking for short buckets to be duly rated.
Market participants pointed to Halyard, managed by Solent Capital, as an example of a deal that has not gotten full credit for including a large short bucket. At any time in the life of the deal the short reserve can cover a drop in market value of 50% of the collateral, according to dealers, but those familiar with the deal said this has not been taken into account by ratings agencies. Credit Suisse is underwriting the deal, which it is now marketing (see related story page 6).
Most firms, including Citigroup said they have spent time explaining their own correlation models for actively managing CDO collateral to rating agencies, but they are dissatisfied that the agencies have yet to come up with a short-bucket rating methodology that is standard. As a result, issuers have questioned whether including a short bucket as opposed to issuing a constant proportion debt obligation is valid. Fees for a CPDO are higher, but the ratings agencies are more prepared to rate the greater manager flexibility in these structures.