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S&P plans synthetic CDO recovery tool
Standard & Poor’s has asked market participants for feedback on a new rating metric for synthetic CDOs. The rating agency plans to issue what it calls synthetic tranche recovery metrics, which will give investors an indication of the likely recovery of their investment. Standard & Poor’s ratings, like those of Fitch but unlike Moody’s, are first-dollar-of-loss ratings. That is, they assess the probability of investors suffering a loss but do not indicate how severe that loss is likely to be.
The new metric is therefore an attempt to give investors greater information on the riskiness of their investments. Recovery rates on synthetic CDOs can vary greatly depending, in particular, on the thickness of the tranche. See Standard & Poor’s 100713 S&P STRM (PDF, 597.3 kb) for details of the planned measures.
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Maybe S&P would be better off concentrating on the basics. It is quite obvious that they are no longer assessing many synthetic CDOs they already rate (as has been previously reported in Creditflux), but simply leaving them at CCC/CCC- despite short times to maturity and adequate credit support. When investors initially select S&P as a ratings agency, I think the implicit assumption is that they will stay the course and assess the CDO for its life. The fact that they have broken this trust is far more important to investors than any new features they are bringing out
Not to be overly picky, but S&P really employs a hybrid system of ratings. For corporate bonds of companies subject to the US bankruptcy code, a subordinate bond and a senior bond will very likely default at the exact same time due to the automatic stay. Thus in that case when S&P rates the subordinate bond lower than the senior bond, S&P's rating is mainly speaking to the difference in likely recovery upon default ("expected loss" approach) just as Moody's does for all its ratings.