S&P could trigger CSO restructurings, says Morgan Stanley

In a new research report, Morgan Stanley says that Standard & Poor’s CDO methodology changes, which will lead to significant downgrades from AAA, are unlikely to force many CLO investors to unwind their holdings. It says that although the banks that hold the vast majority of senior CLO tranches would face higher capital charges if assets are downgraded, the increase in the capital charge is not drastic. For example, under Basel II, a bank’s capital charge for a CLO bond that was downgraded from AAA to A would go from 0.56% to 0.96%.

But in a separate piece, Morgan Stanley analysts say that the rating changes could prompt some holders to sell. S&P has said that CSO tranches are likely to be downgraded by an average of four notches each. The report says that the recent market rally, combined with the greater certainty over ratings methodology, could motivate investors to either sell or restructure. Many have been waiting for confirmation of final ratings changes before making a decision, says Morgan Stanley.