CDOs: The Ratings-Agency Sham

It is a shame this can be aired out in public and nobody even so much as winces:

CDO watch: ratings shopping

Several CDOs are going into liquidation on Tuesday - a sign, perhaps, that senior noteholders are losing their nerve amid more signs of deterioration in MBS fundamentals, as reported by the rating agencies this week.

But something slightly more interesting is happening with a CDO called Palladium II. As filed today with the Irish Stock Exchange:

REQUEST FOR NOTEHOLDER CONSENT

26 May 2008
Omega Capital Investments II p.l.c.

…
Notice is hereby given that it is proposed to request that Fitch Ratings Limited withdraws the rating which it has assigned to each class of the Notes so that the Notes will be rated solely by Standard & Poor’s Ratings Services, a division of McGraw-Hill Companies, Inc.

The reason? Surely something to do with this announcement, issued on Friday:

Fitch Ratings-London-23 May 2008: Fitch Ratings has today placed Omega Capital Investment II Plc’s Palladium CDO II (Palladium II) secured floating- and fixed-rate notes due in December 2014 on Rating Watch Negative (RWN), as listed below. The RWN actions reflect Fitch’s view on the credit risk of the rated notes following the release of its new Corporate CDO rating criteria.

Fitch goes on to detail the likely downgrades to the various tranches of Palladium, with the triple-A seniors looking to be cut five notches to single A, and the subordinate tranches moving to BBB.

The reason, then, that Palladium’s managers, Omega Capital Investments [BNP Paribas], are so keen to get the Fitch ratings removed before the downgrades occur, is because downgrades could trigger a default. As FT Alphaville reported on Friday (from Total Securitisation), rating downgrades have been the primary cause of CDO defaults in almost all cases so far.

Palladium II, it appears, isn’t the only CDO withdrawing Fitch ratings. There’s also Taberna (Fitch ratings withdrawn Friday).

Ratings shopping in action? Certainly a clear sign that the market incentivizes looser rating standards. Unwelcome downgrades mean you lose your business.