Tuesday, February 17, 2009

Fitch Decision on Proposed Additional Structured Finance Rating Scales

Fitch Ratings launched its new Loss Severity Ratings for global structured finance [on February 17, 2009]. The latest in a series of steps by Fitch to enhance the quality and transparency of its credit ratings, Loss Severity (LS) ratings are designed to complement traditional debt ratings.

LS Ratings were first proposed by Fitch on 1 July 2008 as part of a wider consultation on three potential supplementary rating scales and indicators for structured finance. The other scales considered addressed rating transition probability and volatility, and collateral quality assessment.

In the case of a volatility or transition risk rating applied to structured finance securities, it remains Fitch's view that the analytical drivers to such a rating would overlap significantly with those already addressed by 'Rating Outlooks'.

"Rating Outlooks are intended to give a forward-looking opinion about the prospective direction of a tranche's rating over the next 12-24 months," says Stuart Jennings, structured finance risk officer for the EMEA region at Fitch Ratings. "Fitch believes that they give the market greater information about prospective future individual tranche performance than any potential explicit rating volatility indicator."

In addition, factors that would result in a security being assigned a high volatility rating would also typically be captured by the underlying credit rating. For example, assigning a high investment-grade rating, e.g. 'AAA', would in many cases be incompatible with the type of factors that might lead to a high volatility rating.

This would serve as a limit on any potential scale's application. Fitch's decision, therefore, was not to assign volatility ratings but instead to roll-out 'Rating Outlooks' globally across structured finance. The majority of market feedback supported Fitch's position on this point. Fitch remains the only agency to assign rating Outlooks to structured finance securities.

Fitch's third proposal concerned an explicit assessment/rating of underlying collateral quality. Feedback on this was mixed as to the value of supplementary information that would be provided. In addition, Fitch believes two new scales within a short space of time could create a degree of excess information. Instead, Fitch will enhance the transparency of its credit opinion in this respect through the provision of explicit commentary on collateral quality in its pre-sale and research reports.

The new Loss Severity rating methodology is detailed in a criteria paper published today, entitled "Criteria for Structured Finance Loss Severity Ratings". The original exposure draft for the three proposed ratings scales and indicators, "Fitch Proposals for Complementary Ratings and Indicators to Structured Finance Ratings", was published on 1 July 2008. Both reports are available on the agency's public website, www.fitchratings.com.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

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