Fitch Ratings: Synthetic CDOs Insulated from Ford & GM

LONDON & NEW YORK--May 1, 20056, 2005--Fitch Ratings, the international rating agency, says that negative rating migration in the automotive sector is unlikely to lead directly to collateralized debt obligation (CDO) downgrades. Fitch has already undertaken some sensitivity analysis of a cross section of synthetic CDOs, focusing particularly on CDO-squared structures with generally high exposure to the auto sector and specifically with high exposure to General Motors (GM). For all transactions sampled, the effect of bringing down GM by a whole rating category (from 'BBB-'('BBB minus') to 'BB-'('BB minus') had no effect to the ratings of the CDO. Only when the CDOs were stressed to the point that all autos referenced were downgraded did some CDO ratings come under pressure for downgrade. CDOs are typically structured to provide some resilience to relatively isolated negative ratings migration. Furthermore, Fitch's analytical assumptions for CDOs with respect to modelling correlation between, and within, industries provide some protection from contagion risk in the form of increased credit enhancement.

However the downward pressure on credit quality within this sector exposes synthetic CDOs to some level of event risk. These CDOs are exposed to credit risk via credit default swaps, which invariably allow for debt "restructuring," as well as "bankruptcy" or "failure to pay," to trigger the calling of a credit event by the protection buyer. Once a credit event is called, the valuation process begins in order to determine the loss severity for the CDO. In Fitch's opinion, the weaker credits such as the automotive parts suppliers rather than the automotive companies would be more vulnerable to credit events such as these.

"Ford and GM retain substantial amounts of liquidity, particularly at Ford, that provide the financial capacity to address their current situations. At Ford, liquidity may be further enhanced by the potential sales of Hertz, although the pending restructuring of Visteon will fall on Ford and is expected to require substantial outlays by Ford over the next several years," said Mark Oline, Fitch Managing Director and lead analyst on the U.S. automotive sector.

Fitch is anticipating a corporate restructuring between Ford and Visteon. It is unclear exactly to what extent it will be financial restructuring and if so, whether it would be sufficient to trigger a restructuring credit event. Fitch addresses this risk when assigning initial ratings to synthetic CDOs by increasing the default probability for all reference entities that allow restructuring to be called as a credit event. Fitch's CDO Performance Analytics team will continue to work with Fitch's corporate rating analysts to monitor this risk.

According to Fitch's synthetic index, which covers over 350 CDOs, exposure to the global automotive sector in synthetic CDOs has risen steadily to approximately 7.1% of 2005 vintage CDOs from a low of approximately 3.9% in 2002 vintage CDOs.

The largest single name exposure in Fitch's synthetic index is Ford Motor Co., which is referenced by 230 CDOs representing over 65% of the CDOs in Fitch's synthetic index. General Motors Corp. (GM) is the second most pervasive automotive company in the index, which is referenced in 217 CDOs or approximately 62% of the index. Other significant exposures include DaimlerChrysler AG, Delphi Corp., Visteon Corp. and Volkswagen AG, which are referenced in approximately 52%, 40%, 39% and 38% of CDOs in the index respectively. The top three automotive exposures in the index currently maintain investment-grade ratings by Fitch, though the Rating Outlook is Negative for Ford and GM, while DaimlerChrysler maintains a Positive Rating Outlook.