Nera readies for CDO ‘notching’ investigation

New York-based economic consulting firm National Economics Research Associates (Nera) has finalised its research plan for its structured finance ratings comparability study.

Rating agency Moody’s commissioned the study back in December 2001 and the results, which will rely on opinions from bankers, collateralised debt obligation (CDO) originators, CDO investors and rating agencies, should be available by the end of the third quarter.

Agencies that rate bundles of bonds for specific CDO structures may not have originally rated all the underlying debt. To receive an overall CDO rating confirmed in a timely manner, Moody’s and rival rating agency Standard & Poor’s may decide to use a bond rating provided by another agency, then lower the rating by up to four grades – a practice known as ‘notching’.

This has caused upheaval in the structured finance world. And the Moody’s-sponsored study follows a report commissioned by rival Fitch that showed three quarters of senior structured finance executives oppose notching.

Nera said its study is timely because rating agencies are being increasingly asked to rate CDOs and other programmes with underlying collateral pools that include securities rated by other rating agencies. Nera added that neither Moody's, nor any other market participant, will have editorial control or authority over the scope or methodology of the research.

“Companies are more likely to share their data and ideas with us if they can be assured that this study will be conducted independently, in accordance with the highest standards of scholarship, and that Nera will not give preference to the views of one market participant over any other,” said Andrew Carron, senior vice-president at Nera.

At the end of March, Fitch shocked the securitisation world by releasing a study accusing its rivals, Moody's and S&P, of suppressing competition in the rating of CDOs. Fitch has become so incensed that there is speculation it may even present the findings of its research to the US Department of Justice and the Securities and Exchange Commission.

John Bonfiglio, Fitch’s NewYork-based group managing director of structured finance, claimed notching traps CDO managers into either accepting a lowly rated CDO or paying for further credit assessments.

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