April 28 (Bloomberg) -- Standard & Poor's lowered its assumptions for how much money investors will recover after defaults of mortgage-tied collateralized debt obligations, a sign that the firm may be preparing to add to record downgrades.

Ratings cuts on top of the more than $351 billion from New York-based S&P in less than a year may push owners such as UBS AG and Citigroup Inc. to sell the debt rather than wait for CDO demand to rebound, said Brian James, a partner at Link Global Solutions, a New York-based structured-finance consulting and recruiting firm.

``Further rating-agency action will cause banks who hold the majority of AAA bonds to re-evaluate their strategy,'' James said. ``So far they have been more comfortable writing down their positions in the hopes of better recoveries.''

The CDOs covered by S&P's revision are at least 40 percent invested in some U.S. home-loan bonds created since Sept. 30, 2005 or pieces of other CDOs with such holdings, according to a statement today. The most-senior bonds from the CDOs originally rated AAA should recover 60 percent of principal owed, while securities rated A or lower will get nothing, S&P said.

While S&P's recovery expectations for a structured-finance security generally don't affect the ratings the firm assigns to that bond, the assumptions can influence whether the company believes a vehicle such as a CDO that itself holds the security deserves a certain rating.

Mortgage-linked CDOs, mainly classes once rated AAA by S&P or Aaa by Moody's Investors Service, have been the biggest source of the more than $320 billion of asset writedowns and credit losses reported by the world's largest banks and securities firms since the start of 2007. CDOs repackage assets such as mortgage bonds and buyout loans into new securities with varying risks.

Secondary Activity

The change announced today ``may have a negative impact on the ratings assigned to the affected CDOs because a reduction in expected recoveries typically necessitates more'' investor protection, S&P analysts led by Patrice Jordan, the head of its global CDO business, said in the statement.

More downgrades could also force banks, insurance companies and securities firms to raise more capital, cut dividends or reduce assets.

S&P so far has cut $351.6 billion of CDOs ``as a result of stress in the U.S. residential mortgage market and credit deterioration'' among home-loan bonds, the ratings company said April 25. Ratings on $16.3 billion more were under review by S&P with a ``a high likelihood of downgrade.''

Investors should recover 35 percent of principal after defaults on securities from the CDOs junior to their so-called super-senior classes but also originally rated AAA, S&P said today. Originally AA classes should recover 5 percent, it said.

James, a former co-head of fixed-income at Cohen & Co., a Philadelphia-based firm that manages and underwrites CDOs, said that ``as recovery value projections continue to deteriorate we are likely to see an increase in secondary market activity as holders are forced to entertain the bid side of the market.''

CDO Squareds

S&P's structured-finance ratings only reflect the odds that investors will receive timely interest payments and the return of their principal by the debt's maturity date, according to a May 29 statement from the company.

Ambac Financial Corp., the second-largest bond insurer, reported $940 million of new reserves last quarter because of expected losses on CDO ``squareds,'' which are made up solely of other CDOs, and ``high-grade'' CDOs, which hold asset-backed bonds with high ratings, including other CDOs, Chief Financial Officer Sean T. Leonard said on a April 23 conference call.

``We continue to closely monitor the high-grade CDO exposures in our book,'' Chief Risk Officer David W. Wallis said. The ``majority'' of the company's risks from mortgage-linked CDOs stem from high-grade deals, he said. The ``main issue'' for two of the three that the New York-based insurer now expects to lose money on is ``the CDO bucket'' of their holdings, he said.

Recovery Assumptions

In February, S&P updated its recovery assumptions for the types of mortgage bonds held by the CDOs that its announcement today affected.

Recoveries on the most-senior originally AAA rated securities backed by Alt-A, subprime, or home-equity loans or tax liens will likely be 80 percent, while for junior AAA securities they should be 65 percent, S&P said then. Alt A bonds initially rated A should recover 35 percent, while similar securities backed by the other types of loans will recover 10 percent, it said.

Lenders make Alt-A home loans to borrowers who want atypical terms such as proof-of-income waivers, delayed principal repayment or investment-property collateral, without having to offer sufficient compensating attributes. Borrowers with poor or limited credit records or high debt used subprime mortgages to buy properties or tap home equity by refinancing.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net.

Last Updated: April 28, 2008 16:56 EDT