Continued downgrades of market value structures (MVS) - and subsequent restructurings in some cases - have called attention to their sensitivity to pricing dislocations.
As a result, rating methodologies have been re-evaluated to take into account unforeseen market pressures. Highlighting this effort is Fitch Ratings, which released revised criteria for rating MVS last week after a review that started in December 2007.
"Market prices have come under pressure even for assets that are not undergoing a credit stress," said Alan Dunetz, a managing director in Fitch's structured credit group.
Dunetz noted that the rating agency will normally re-examine its criteria when there is new data or information. Unprecedented stress on the liquidity and market value of credit instruments was the main driver behind the reevaluation, Fitch said.
Among the rating changes is a cap of BBB' for "knock-out" MVS. In these transactions, the unwind triggers are set back significantly from current market levels. But unlike traditional MVS, the rated notes will be undercollateralized if they are breached and recoveries will likely be minimal or none in the event of an unwind, Fitch said. These transactions include CPDOs, SIV capital notes, leveraged super-senior notes, and total-rate-of-return CLOs.
Other key changes are the explicit limits on ratings for most MV deals backed by less-liquid assets - which could include second-lien loans; emerging market debt; tranches of CDOs and alternative investments such as hedge fund investments; and private equity investments, Dunetz said.
MVS backed by less liquid asset types will, for the most part, be ineligible to be rated above A'. Since there are fewer investors in this asset class, the reference portfolios are more likely to see "erratic spread movements," Fitch said. MVS with illiquid assets will most likely be ineligible for investment-grade ratings and may not even be rated, Fitch said.
There will be a greater emphasis on qualitative factors in determining Fitch's view of advance rates - a percentage of collateral that determines the size of a loan that a lender is able to make.
While it is important to look at quantitative data like historic price changes, it is not adequate on its own, Dunetz said. Factors such as an assessment of the underlying risk of the asset, the nature of the market as well as any structural changes that have occurred in the market that might make the historical data less relevant will all be taken into account.
At the same time, ranges of advance rates have been established for a limited number of categories of assets. This differs from Fitch's prior approach where specific advance rates were established on an asset-by-asset basis.
The rating agency will also bring in sector-specific analysts to rate the deals, which should heighten the level of detail in their assessments. "Sector-specific analysts can bring detailed asset class knowledge to bear, which can help in the determination of risk factors that might affect market price and volatility," Dunetz said, noting that analysts would be consulted as needed.
While new MV deals are few and far between, all new transactions Fitch is asked to rate will apply these criteria. The rating agency said it has also started to review the impact on existing deals.
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