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 Posted: Mon Nov 12, 2007 4:13 pm |
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http://online.wsj.com/public/article/SB119340698261172889.html
CREDIT MARKETS
CDO Ratings
Are Whacked
By Moody's
AAA to Junk in a Day
Raises More Questions
About Credit Arbiters
By APARAJITA SAHA-BUBNA and CARRICK MOLLENKAMP
October 27, 2007; Page B1
Just days after Merrill Lynch & Co. rocked the markets with a $8.4
billion write-down tied mainly to problematic mortgage-related
investment holdings, Moody's Investors Service Inc. commenced a fresh
series of credit-rating downgrades of similar instruments.
The unit of Moody's Corp. expects more downgrades to continue in the
coming week, something that could hang over the market in the days
ahead.
The ratings firm cut, or said it was likely to cut, credit ratings on
scores of collateralized debt obligations, or CDOs, which are
financial instruments often tied to the fate of mortgage-backed
securities. Some of these CDOs were cut from the highest possible AAA
ratings to junk, an especially noteworthy step.
The rating firms have already downgraded more than $50 billion worth
of mortgage-backed securities in the past few months. Now, the fallout
is spreading to other instruments that are tied to these investments.
The subprime-mortgage market has seen soaring delinquencies after
years of aggressive bank lending. Lending standards became especially
lax in 2006 and early 2007, even though housing had already shown
signs of peaking. Subprime mortgages were the collateral in all of
these investments.
The latest actions began on Wednesday evening, the day Merrill
announced its write-down, and will continue until the end of October.
They included several CDOs that were underwritten by Merrill since
2006.
The actions by Moody's -- downgrades or a notice that the debt might
be downgraded -- are sure to bring new heat to the rating services
themselves. Many critics have argued that Moody's, McGraw-Hill Cos.
unit Standard & Poor's and other ratings services were too positive in
their initial ratings of these investments, and then too slow to
downgrade them once the housing market slowed. "When investors see a
bond go from AAA to junk in just over six months, the rating agency's
credibility suffers. It's clear their ratings methodology was
fundamentally flawed," said Derrick Wulf, portfolio manager at Dwight
Asset Management.
Moody's didn't total the dollar volume or number of CDOs that were
downgraded or put on review for possible downgrade. An initial count
put the number in the billions. On Oct. 11, Moody's downgraded
thousands of subprime mortgage-backed securities created in 2006,
which were originally worth $33.4 billion. At that time, Moody's said
502 CDOs had direct exposure to those subprime bonds.
CDOs are complex structured financial products. They bundle debt and
then issue new securities with differing amounts of risk and return,
and have been at the heart of broader credit concerns in recent
months. The most troubled CDOs bundled together only subprime bonds
that originally had low investment-grade ratings such as BBB. Many of
those bonds are now rated junk.
Some of the CDO downgrades on the week were severe, with ratings going
from investment-grade to junk in one fell swoop, a harsh assessment
that will affect the overall valuation of deals backed by these
instruments. This "shows that the collateral value is eroding faster"
than the rating firms expected, said Julian Mann, a portfolio manager
at First Pacific Advisors.
One $873 million CDO slice was rated AAA -- the highest of 10
investment-grade rankings. It was cut 10 notches to a junk rating of
Ba1 by Moody's. Ratings on another $229 million of AAA securities
within a CDO were slashed 14 notches to a junk rating of B2. In
addition, Moody's left the door open to further downgrades on both
these slices.
Although the move was widely anticipated, in light of the subprime
downturn, the scale and the severity of the downgrades and potential
downgrades could force some investors to sell their CDO holdings at
reduced prices. The fact that these CDOs are out of favor with
investors and not easily traded means the price cuts likely need to be
deep to attract willing buyers.
The CDO downgrades show there is "no quick fix for the subprime
problem," said Cynthia Cole, senior portfolio manager at Allegiant
Asset Management. "There won't be any pickup anytime soon, and it will
last at least until summer next year," she said, based on the
continuing housing slowdown.
--Serena Ng contributed to this article. |
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