Fitch nears end of global CDO review

The London- and New York-based agency stopped rating new corporate CDO transactions in November 2007 and set about reviewing its methodology for rating new deals. Having completed the process in April this year, it has since been applying the new, more conservative criteria to its stock of 483 deals.

In many cases, this is expected to lead to downgrades.

The agency said so far it has affirmed ratings on around 50% of the corporate CDOs it rates and placed the rest on watch for a downgrade, giving an indication of the direction and magnitude of any future rating action. The deals were left until the end of the review to give managers or arrangers a chance to modify portfolios where possible.

The agency is now resolving these, according to Phil McDuell, Fitch’s London-based head of structured credit for Europe, the Middle East, Africa and Asia-Pacific. “Out of the roughly half of transactions that weren’t affirmed, we’re working our way through those,” he said.

In Asia, this process of resolution is nearing completion, while in the US and Europe the agency is about halfway and a third of the way through its review, respectively. “I suspect we will be finished with the corporate CDO review in the next couple of months,” he said. The agency plans to release a report on the effect of the changes once the process is finished.

McDuell said the outcome of the review was broadly in line with an impact study released by Fitch on May 20. Back then, it predicted the 394 synthetic investment-grade transactions it rates would experience the most variable impact from the new methodology.

In a sample of 164 single-tranche synthetic deals, just 54% of AAA tranches saw their ratings affirmed, with 46% downgraded – and 13% falling all the way to BBB. Among deals rated AA, 73% were predicted to drop to BBB.

From the outset of its consultation on the new methodology, the agency suffered widespread criticism both from dealers and investors. Items of particular contention included the more subjective nature of the criteria, as well as the use of implied ratings gleaned from the credit default swap market.

The latter was meant to address cases of so-called ratings arbitrage, where credits chosen for a CDO are trading unusually widely for their ratings. This increases the spread on the overall portfolio, but destabilises it if the credit is due for a downgrade. Some analysts also worried that a mass downgrade of Fitch-rated deals would have a palpable destabilising effect on the wider credit derivatives market.

“It did cause a bit of shock and people were alarmed at what might happen to the ratings,” said McDuell. “But as the year’s gone on, people have seen how the market’s developed; we’ve got more credibility as every day has gone by. And I don’t think there are many people out there who think we’re going in the wrong direction with the approach for corporate CDOs.”

Nonetheless, Fitch had received requests from arrangers and investors to withdraw its ratings in a "handful of cases", he admitted.

Rating agencies have been under close regulatory scrutiny over the past year, after discontent with the scale and severity of downgrades emanating from the US subprime mortgage market. Out of the three main rating agencies, Fitch is as yet the only one to embark on a full overhaul of its rating methodology for corporate CDOs.

See also: Fitch unveils new structured product ratings
Restoring ratings
A matter of trust
Surprise over "severe" Fitch CDO cuts