Fitch Ratings published its surveillance criteria for rating CDOs exposed to corporate debt.
The revised approach considers a number of important factors. Among which is that highly rated tranches be resistant to excessive rating volatility throughout normal credit cycles, while lower rated tranches might show a more significant level of volatility over the same cycles.
Fitch said that fundamental to this new approach is that the highly rated tranches' credit enhancement anticipates some level of portfolio deterioration over a base case before a rating action is required.
While the new approach is a lot similar to the agency's methodology for determining ratings for new issues, its revised surveillance criteria contain some notable differences. The surveillance methodology primarily considers that class ratings are able to tolerate explicit levels of portfolio migration throughout the deal's life.
Furthermore, Fitch’s criteria for new ratings considers analytical adjustments for certain portfolio factors, including obligor concentration and adverse selection, which might result in higher loss expectations when the ratings are first assigned. These adjustments are not necessarily applied over the monitoring process.
‘Accounting for future portfolio declines in our loss rates for higher rated tranches should better protect against a downward spiral that other methodologies may not capture,’ said John Olert, group managing director and head of global structured credit for Fitch.