Standard & Poor's Ratings Services recalibrated its ratings criteria for collateralized debt obligations, resulting in the ratings firm's putting about 4,790 CDO tranches totaling $578 billion on watch for downgrade.
The changes will make the CDO ratings more comparable to ratings in other sectors, S&P said.
The ratings agency will introduce tests - both quantitative and qualitative - to supplement its default-simulation model. S&P will also adjust its models to target AAA default rates it believes are commensurate with conditions of extreme macroeconomic stress, such as the Great Depression, as well as BBB default rates consistent with the highest actual corporate defaults over the past 28 years.
S&P said downgrades are likely to be multiple notches after reviewing the tranches over the coming months, with Chief Credit Officer Thomas Gillis estimating that outstanding synthetic CDOs will likely experience an average downgrade of four notches. Super senior AAA tranches will probably be affected less, with expected downgrades of two to three notches, while tranches rated AAA will likely be affected more, with an estimated downgrade of four to five notches.
Of the tranches on watch for downgrade, 1,626 tranches are from 623 European transactions and are $250.5 billion in size.
"We believe that adding quantitative and qualitative elements to our analysis - entirely apart from the Monte Carlo default simulations we run - will provide a more robust analysis than using only simulation models," Gillis said.
Ratings agencies have been criticized about being overly optimistic with their ratings earlier this decade when structured-finance securities were created by packaging loans into newly created investments. CDOs, which use sliced-and-diced assets such as subprime-mortgage bonds to create customized products offering various levels of risk, have been at the heart of steep write-downs at big banks and brokerage firms.
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Foreclosed California home |
A Treasury report showed 360,165 people had their monthly payments reduced through August, up from 235,247 through July, but a senior Treasury official conceded much more must be done to soften the impact of a severe and prolonged housing crisis.
Treasury has begun releasing monthly reports on the loan modification program, called the Home Affordable Modification Program or HAMP.
In July, it said that just 9 percent of the estimated number of homeowners eligible had had their loans modified, so Treasury's assistant secretary for financial institutions, Michael Barr, was able to claim modest progress in August.
He told a House Financial Services subcommittee that the program launched in February, which brings banks and loan servicers together with at-risk homeowners, was on target to help a half million Americans homeowners by Nov. 1.
But that is a small start on a huge problem at the heart of U.S. economic woes. Hoping for a Home "cash for clunkers" extension of the $8000 tax credit to first time home buyers could help move inventory as it is released on to the market.
Barr said that "even if HAMP is a total success, we should still expect millions of foreclosures" as administration and industry efforts continue to stabilize a crisis-stricken housing sector.
Barr said a strong housing market was "crucial" to a sustained U.S. economic recovery and described the slump in prices and demand in the housing sector as being "at the center of our financial crisis and economic downturn."
He noted that analysts anticipate more than six million Americans could lose their homes in the next three years as defaults continue to soar.
"Much more remains to be done and we will continue to work with other agencies, regulators and the private sector to reach as many families as possible," Barr said.
The Treasury report showed that some lenders had not helped any of their borrowers who were eligible for loan modifications. Others had helped varying numbers of those who were 60 or more days delinquent on their mortgages, ranging up to 100 percent for one bank that only had one eligible borrower.
The option ARMs in a higher price range are expected to start to show up if lenders can't refinance the borrowers.
