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Moody's Tweaks Semantics For U.S. Cash-Flow CDOs

10 Jun 2004

Moody's Investors Service has revised its rating terminology to more accurately reflect the appropriate subordination levels in U.S. collateralized debt obligations.

Moody's Investors Service has revised its rating terminology to more accurately reflect the appropriate subordination levels in U.S. collateralized debt obligations. The rating agency was prompted to replace its 'Moody's Rating' term with 'Moody's Default Probability Rating' and 'Moody's Obligation Rating' because it has noticed different recovery rates on different obligations from the same issuer. These terms mean the rating agency can differentiate more accurately between obligations in an issuer's capital structure, such as senior-secured loans and a second-lien, according to Rick Michalek, v.p./senior analyst in New York. This is important because recovery rate assumptions are frequently different for these two assets, since the traditional senior-secured loan is higher in the capital structure. Some second-lien loans, however, can achieve a senior secured loan recovery rate.

In CDOs, "A pool of assets with a large proportion of second-lien loans could require more enhancement than a pool of assets with just senior-secured loans," Michalek said. The rating agency recently came out with a report describing the reason for these new definitions, CDO RatingFactors No. 4.

Scott McMunn, senior portfolio manager at Winchester Capital Principal Finance in London, has noticed deterioration in the underlying collateral in some deals, such as collateralized loan obligations. He added that distressed loans, payment in kind and unsecured credit is now being put into some senior secured CLOs.

"These two terms are only for use inside the CDO documentation when trying to assign ratings for the CDO," Michalek stressed, noting that these terms are not new types of ratings and these new semantics are strictly for the structuring of cash-flow CDOs. "When bankers are assembling pools they will be able to be a bit more efficient to obtain the same rating," he said, explaining why Moody's has tweaked the definitions.

10 Jun 2004