But Standard & Poor’s is aiming at a scientific approach, according to Mark Gaw, an analyst in S&P’s CDO group. Gaw said S&P is steadily moving toward offering more quantitative measures of CDO manager ability. One such measure would be assessing manager performance at the tranche level, which could allow different classes of CDO investor – equity, mezzanine and senior debt holders – to better anticipate how a manager will actively manage a portfolio in their interest. Senior note holders desire more highly rated assets in a portfolio, while mezzanine note and equity holders prefer higher yielding assets.
“It sounds like an interesting idea, but I’m not sure how they’re going to capture that,” said Noel Kirnon, managing director of structured finance at competitor agency Moody’s Investors Service. Gaw declined to say when the tranche performance measure would become public.
For now, Standard & Poor’s will assess CDO management teams and organisations, performance of existing deals, and managers’ operational, systems and compliance infrastructures. The reviews are largely textual and offer no judgements. Industry participants familiar with the first few management reviews on Standard & Poor’s website saw little new. One analyst suggested investors might prefer a grid-type presentation with 'good', 'fair' and 'poor' rankings instead of the lengthy text-based report Standard & Poor’s offers. Another analyst suggested the reviews could be a good first-level screen that investors could use to narrow down their investment choices before performing due diligence.
Standard & Poor’s said the new service was offered in response to demand by CDO investors. “We encourage investors to do their own due diligence as well,” said Gaw. “But let's say there's an investor in Japan or Europe who cannot come and see every manager they're investing in – this can help.” Neither Fitch Ibca, Duff & Phelps or Moody’s Investors Service – S&P’s main competitors – offer their own CDO management reviews to the public, nor have plans to do so, according to officials at the agencies.
No one believes evaluating CDO managers is easy. David Tesher, head of CDOs at Standard & Poor’s, believes that management is the most difficult aspect of CDO performance to predict. But it is important. Standard & Poor’s figures show that for CBO (collateralised bond obligation) transactions originated in 1999, the top 10 managers had an average of 1.99% of assets under management go into default, versus a 10.81% asset default rate for the bottom 10 managers, in the past year. And of those defaults, the top 10 managers recovered, either through sale or workout, 52.05% of the asset’s value, while the bottom 10 managers averaged only a 7.09% recovery. Although it is unclear how S&P ranked managers.
“It's definitely something that’s hard to do, and something the market is demanding. How they're going to standardise and quantify the evaluation is going to be an ongoing process,” said Anthony Thompson, managing director in securitisation research at Deutsche Bank in New York. “There is no easy answer, but the best defence is maintaining constant dialogue with the manager, and reviewing the trustee reports trade by trade to get a handle on the manager's style and expertise."
Arturo Cifuentes, co-head of structured finance at Triton Partners, a $1.4 billion structured investment fund manager in New York, likens the Standard & Poor’s reviews to a “check-list” approach that monoline insurance companies and pension fund investors often bring to CDO manager evaluation.
But the approach fails to pick up on very important but non-specific factors, said Cifuentes. “The most important thing is always the one that you don’t have in your form,” Cifuentes said, adding that he always recommends visiting a manager before investing.