Wednesday, December 19, 2007

Fitch may set limits for debt product ratings

(FT) Fitch Ratings could set limits for the maximum credit ratings that can be awarded to complex debt products that are sensitive to changes in the market values of their underlying exposures, the agency said on Tuesday.

The move would affect some of the deals that have been particularly hard hit by the sudden withdrawal of liquidity from debt markets over the second half of this year, such as structured investment vehicles (SIVs) and constant proportion debt obligations (CPDOs).

Banks such as HSBC and Citigroup have been forced to step in and absorb tens of billions of dollars of SIV assets onto their balance sheets as funding difficulties and falling asset values have led to shaky credit ratings.

Meanwhile, a number of CPDOs, which essentially give investors a leveraged bet on a group of corporate debt exposures, have been forced to unwind, with investors losing up to 90 per cent of their initial stake in one deal from UBS. The CPDOs were hurt by volatility, particularly in the value of financial company debt in recent months.

“Structural changes in the credit markets and the dispersion of risk through leveraged structured vehicles have made it more difficult for investors to gauge volatility in times of stress and, therefore, Fitch is calling for greater transparency and revisiting its criteria in light of recent events,” said Roger Merritt, chief credit officer at Fitch.

“We believe this proposal is an important step toward meeting the needs of investors and bringing enhanced stability to the ratings on these securities.”

The growth of non-traditional credit investors, such as hedge funds, SIVs and other complex vehicles, has made it more difficult to gauge the collective market impact of simultaneous deleveraging of these vehicles whose holdings were opaque, Mr Merritt added in a market consultation paper.

Fitch is proposing revised liquidity stresses for most market value structures, which in turn would lead to higher credit enhancement levels, as well as ratings “caps” for certain less liquid assets and for most “knockout” structures.

Knockout structures include CPDOs and the junior debt issued by SIVs. The name highlights the way in which investors in such structures are the first to lose everything because they provide a protective cushion against losses for senior creditors in these deals.

CPDOs caused a flurry of excitement when they first emerged last year with many questioning how they could promise high returns and qualify for the safest AAA ratings from Standard & Poor’s and Moody’s. Fitch and rival agency DBRS both published papers saying they did not believe such structures deserved top ratings. Separately, Moody’s, a rival ratings agency, on Tuesday said its downgrades to collateralised debt obligations made up of pools of US mortgage-backed bonds and similar securities had totalled about $51bn over the month of November. This means almost 10 per cent of the entire market for such CDOs was downgraded in one month alone. At the end of November, $174.1bn worth of such deals remained on review for downgrade.

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