Responding to investor gripes about lack of transparency and ratings instability for CDO transactions, Fitch Ratings unveiled new global rating criteria for corporate CDOs last week.
This marks a major step for the rating agency in regaining market confidence. As part of this announcement, Fitch will begin rating corporate CDOs again, a business it put on hold last November.
"We felt it was important to reflect upon and address what investors were asking for in terms of stable, predictive structured finance ratings," said Roger Merritt, managing director at Fitch.
Indeed, the rating agency engaged in a very extensive dialogue with the market, taking investor and manager feedback into account when making some of the changes. "There were areas where, even with the time we had spent, investors and managers were able to provide useful analytical points to consider," said John Olert, managing director at Fitch.
A key change to the ratings criteria is additional attention to risk elements within the portfolio - in particular, where there are concentrations by obligor or industry or where some of the portfolios have additional risks for adverse selection, Olert said. "We have now established ground rules that will do a better job at recognizing potential default and ultimately loss," he said, which will be reflected in the need for more credit enhancement in portfolios that have those heightened risk characteristics.
Historically, corporate CDOs have been evaluated based on average default statistics for the market as a whole. To the extent that an individual CDO has certain concentrations within its portfolio, it would not be reflected in such statistics. But as a result of the methodology overhaul, Fitch is better able to reflect that risk. "We think that is an important revision to the way CDOs have been modeled to date," Merritt said.
Similarly, Fitch has done benchmarking analysis to make sure that for higher-rated CDO liabilities, these transactions are able to withstand the peaks in defaults that have been observed over the past 30 years.
"We know that for corporate defaults, the averages may be one thing, but there is a lot of variation around the averages. So for higher-rated CDO liabilities, we think it is important that they are benchmarked against the observed peaks in defaults," Merritt said.
Also in the revised criteria, Fitch will continue to give credit to managers with the highest CDO asset manager (CAM) rating, though its basic approach to rating CDO managers has not changed. CAM ratings range from one to five, with one being the highest mark.
Fitch will review the entire portfolio of rated transactions under the new criteria, which will occur in stages. Initially, Fitch will focus on clarifying the new methodology and addressing questions. The rating agency will also be putting out additional information on the broader impact of the changes to existing CDOs in the coming weeks.
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