Fitch pushes for more competitive bidding after CDO credit events

The rating agency’s structured finance group said future transactions should be structured with valuation methods with a minimum of five firm bids or more, “excluding any involved parties to the CDO”. In addition, Fitch said it preferred valuation methods involving multiple bidding rounds.

Jill Zelter - New York-based analyst at Fitch Ratings, and co-author of the agency’s latest credit products special report on credit events in synthetic CDOs – told RiskNews: “The number of bids in our sample ranged from two to five - many included five bids. A greater number of bids tended to bring a higher recovery rate.” Fitch also found that recoveries tend to be higher for valuation processes that last between 30 and 50 days, and 90 and 180 days.

In current market practice, once a credit event is called on a reference entity within a synthetic deal, the reference assets under the CDS are bid for by a handful of parties. Typically, there are up to three such bidding rounds and either the highest of those three bidding rounds, or the average of the highest bids is used to determine expected loss, and effectively the payment that has to be made by the CDO investors.

Fitch’s study sample included 115 of the 280 global synthetic CDOs that it rated between 2000 and the beginning of 2003. Of the credit events included within the study, 94.5% were triggered by bankruptcy or failure to pay. Though it’s a perennial bone of contention between dealers and investors, restructuring only accounted for 3.3% of the total. The remaining 2.2% was due to moratoria and repudiations – temporary cessations and cancellations, respectively, of liabilities by a debtor.

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