S&P Cuts Recovery Assumptions for Subprime-Backed CDOs
Collateralized debt obligation securities (CDOs) backed by US subprime mortgages are facing further downgrades after Standard & Poor’s cut its assumptions of how much might be recovered when mortgagees default on their loans.
S&P now expects zero recovery in the event of default for the affected CDOs rated A or lower. For CDOs rated AA, the expected recovery-on-default assumption is 5% , for Junior AAA it is 35% and for Senior AAA it is 60%.
The new assumptions apply to CDOs of asset-backed securities (ABS) tranches for which 40% or more of the collateral consists of the affected U.S. Residential Mortgage-Backed Securities, including Alternative-A (Alt-A), subprime, home equity loan, and tax-lien RMBS issued in the U.S. during and after the fourth quarter of 2005. Also affected are CDOs backed by tranches from other CDOs, which themselves are backed by the affected U.S. RMBS in a proportion of 40% or more of their respective asset balances.
Due to the potential variability surrounding the performance of the affected CDO collateral, Standard & Poor’s said it will no longer tier its expected recovery according to the rating of the CDO liability (tranche). Therefore, the recovery values outlined above are applicable to all CDO liability ratings.
The changes to our recovery-upon-default assumptions may have a negative impact on the ratings assigned to the affected CDOs because a reduction in expected recoveries typically necessitates more subordination to sustain the ratings on the tranches.
Full details are available in the report Criteria: Recovery Assumptions Revised For Certain CDOs Backed Predominantly By U.S. RMBS.
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