S&P publishes report on synthetic CDO surveillance process

In a report published today entitled ‘Surveillance primer – what drives synthetic CDO rating changes?’ Standard & Poor’s points out that surveillance of synthetic CDO ratings poses challenges unique among structured finance asset classes, partly because of the large number of outstanding tranches, partly because of product innovation, partly because some transactions are actively managed, and partly because portfolios are less granular than most ABS collateral pools.

Describing S&P’s approach to synthetic CDO surveillance, the report says these challenges are addressed through the use of CDS Accelerator – the analysis tool based on the CDO Evaluator rating model - combined with the CDS Express data feed.

This analysis is combined with qualitative assessment to produce an Sroc score for each tranche, which is central to S&P surveillance process. An Sroc of below 100% indicates that a tranche is a candidate for downgrade. However, where the Sroc falls below 100% S&P analysts assess what the Sroc would be after a further 90 days’ seasoning assuming no further portfolio ratings migration. If the “90-day forward” analysis would take the Sroc back above 100% the tranche is placed CreditWatch negative rather than being downgraded.

Tranches that are structured with ‘rating cushion’ are upgraded only if their rating cushion under a higher rating would be at least as large as their original rating cushion.

The report goes on to describe how S&P takes account of ratings migration, time decay and credit events in the portfolio, and points out that ultimate decisions on rating actions are made by a committee.

Source: Standard & Poor's