Th announcement by Fitch of tis intent to downgrade as much as $220 billion of CDOs is in keeping with an announcement by Standard & Poor’s of its plans to downgrade or put on review up to $534 billion of CDOs. Both are the result of new, more negative default assumptions in the underlying assets.
Fitch Ratings may downgrade $220 billion of collateralized debt obligations as mortgage-related losses increase.
The New York-based company may lower the securities by as much as five levels after failing to accurately assess the risk of debt that packages other assets. CDOs with AAA grades that are based on credit-default swaps and aren’t actively managed may face the steepest reductions, according to guidelines proposed by Fitch today.
Ratings firms are responding to criticism that they failed to react quickly enough as rising defaults on subprime mortgages in the U.S. caused a plunge in the value of CDOs. Fitch, a unit of Fimalac SA in Paris, lowered $67 billion of mortgage-linked CDOs in November, slashing some AAA debt to speculative grade, or junk.
“Fitch is acknowledging that it was overly optimistic in its default rate and other assumptions in its original CDO methodology,” said Christian Stracke, an analyst at bond research firm CreditSights Inc. in London.
Moody’s Investors Service last year downgraded $76 billion of CDOs and began this year with $185 billion of deals under review. The New York-based company said yesterday that it may overhaul its system for evaluating structured-finance securities, proposing options including a numerical scale and a designation of “.sf” to differentiate a structured-finance ranking from a corporate credit grade.
Reuters gives some additional detail:
Fitch said the change in methodology would probably hit synthetic CDOs the hardest, leading to an average downgrade of five notches for the $75 billion worth it rates. Synthetic CDOs are created from portfolios of credit derivatives, typically on investment-grade corporate borrowers….Synthetic CDOs are based on portfolios of credit default swaps, which are bets on whether a company will default.
And we have a new feedback loop:
Many investment-grade CDOs have large concentrations, 25 to 30 percent, of credits in the banking and finance industry, which included some of the most liquid names in the derivatives market, he said.
“We are taking a harsher view of that industry concentration in our new approach,” he [Ken Gill, managing director for structured credit] said.