Bankers Puzzled Over Brief S&P Watch List

Industry participants no longer see a major threat in efforts by S&P to determine whether stricter swap-counterparty requirements might lead to downgrades of asset- and mortgage-backed bonds — but they may not be completely out of the woods.

The agency created alarm among bankers when it suggested in December that a wide swath of deals could be affected by the swap adjustments, which raise the rating thresholds at which counterparties in interest-rate and currency contracts are considered able to meet their obligations. A Jan. 18 list of securitizations placed on watch for downgrades as part of the process turned out much smaller than expected, however.

S&P's action encompasses $115.8 billion of bonds: $85.5 billion of home-loan paper; $17.9 billion of collateralized debt obligations; $6.4 billion of asset-backed bonds; and $5.9 billion of commercial mortgage securities. The agency has said it has no plans to place more bonds on watch because of the redefinition.

One banker said he expected the total to be tens of billons of dollars higher. In that sense, the outcome is a relief. With no clear way to explain the discrepancy, however, he and other market participants remain on edge. “I don't think people are 100% certain why [the list is] so much smaller,” the banker said. “There's a fear that there could be another shoe to drop here.”

In part, the narrower-than-expected field reflects the fact that S&P isn't considering downgrades for bonds whose ratings already are lower than those of their swap counterparties or for issues with safeguards that would withstand the collapse of those players. The agency also isn't threatening cuts for deals whose issuers promised to address concerns about their counterparty exposures — but could add those transactions to its watch list if the changes fail to materialize.

Still, another banker said he knew of deals that by all measures should have been on S&P's list, but weren't.

S&P's new swap requirements were sparked in part by the 2008 collapse of Lehman Brothers, whose widespread activities as a counterparty raised questions about how similar players might be deemed suitable to honor their contracts. For the most part, the upshot is that senior securitized products employing interest-rate or currency swaps can only maintain their grades if the counterparties either carry a rating of single-A or higher, or are graded single-A-minus to triple-B-plus and post collateral. Any counterparties with a rating of triple-B or below must be replaced.

The previous threshold to avoid the collateral-posting requirement was a short-term “A-1” rating, which in some cases is equivalent to a long-term grade of single-A-minus. Those designated triple-B-minus or below had to be replaced.

Going forward, issuers whose deals are on watch for downgrades will likely switch to higher-rated counterparties or pay more for existing swaps so the shops supplying those contracts can post collateral. Even for issuers whose transactions aren't under review, costs could rise as a result of S&P's new standards.

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