Standard & Poor's has upgraded its collateralized debt obligation modeling tool, CDO Evaluator Version 3, and it will affect 18 rated synthetic CDO tranches totaling around $490 million. CDO Evaluator Version 3 is being used in connection with version 2.4.3 for the first quarter. Version 3 will become the only S&P modeling tool on April 1.
"Over the past three to five years, we have acquired a large amount of new historical corporate transaction and default data and have seen significant innovations in the synthetic CDO market," explained Kai Gilkes, managing director and head of the structured finance quantitative group at S&P. "The changes being made to create E3.0 are more significant than those undertaken in previous releases."
One of the major changes is the updated probabilities of default. "For the corporate names in the CDOs' underlying reference portfolio, investment grade probabilities of default have been reduced and non-investment grade probabilities of default have been increased. For underlying asset-backed securities and CDOs, new maturity dependant default dates have been created," Gilkes said.
Given the new information about possible defaults, some of the ratings placed on transactions need to be revised. S&P does not plan to "grandfather in" these ratings. Because the new default data may lead to a substantially different outcome, the ratings will be changed soon after discovery. "The impact is broadly neutral for the vast majority of existing transactions. However, in some cases the impact is either positive or negative depending on the composition of the existing portfolio or the structure of the CDO," Gilkes said. He states as an example that a CDO containing a large amount of high-yield assets may have a negative impact on the rating of the CDO.
S&P has placed the ratings of 18 United States CDO transactions on CreditWatch with negative implications as a result of the new evaluation model. The CDOs that are affected are Archstone I PLC, Barton Springs CDO SPC Series 2005-1, Blue Point Series 2005-1 and 2005-2, Morgan Stanley ACES SPC Series 2005-14, 2005-18 and 2005-22, SALS 2004-A, Salt Creek High Yield CSO 2005-1, Signum Finance II PLC Series 2005-5, 2005-7 and 2005-12, Strata 2004-8, Strata 2005-19 Floating Rate Notes, Sunset Park CDO Series 2004-4, Sunset Park CDO SPC Series 2005-5 and 2005-3. S&P's CDO Evaluator Version 3 will not be ready to process cash flow CDOs until early in 2006.