Fitch to Add 'Recovery Ratings' Analysis into CLO Ratings.

NEW YORK -- Today, Fitch Ratings has published an exposure draft on its new methodology to incorporate its Recovery Ratings into the ratings of Collateralized Loan Obligations (CLOs) thereby capturing a more fundamental, granular view of the underlying assets to more accurately determine the credit loss profile of the CLO collateral portfolio.

As leveraged loan issuance continues its record pace the ability to better distinguish relative risk across complex organizations and/or capital structures and the components of that risk have become increasingly important. To further transparency in this market, last year Fitch introduced Recovery Ratings for all corporate and financial issuers rated 'B' and below, affecting nearly $375 billion of securities issued by highly speculative companies.

Fitch's Recovery Ratings (RRs), on a scale of 'RR1' (outstanding) to 'RR6' (poor), are established using a bespoke analysis comparing distressed enterprise values against a given security's position in the capital structure. Fitch focuses primarily on ultimate recoveries, although the recovery analysis uses stressed cash flow scenarios and realistic enterprise valuations.

Incorporating RRs into the analysis of CLOs will allow Fitch to capture a more fundamental and granular credit view of the underlying loans of a CLO. In addition to providing differentiation between senior secured leveraged loans, this initiative is well-timed to better differentiate second-lien, mezzanine and middle-market loans which are increasing in allocation in many new CLO portfolios. These types of loans may exhibit wider recovery characteristics versus the more typical senior secured leveraged loans. The homogenous asset class and seniority based assumptions that have been previously used do not recognize issue-specific strengths and weaknesses, and in the case of newer types of loan collateral, these assumptions may carry greater risks. In addition, it enables managers and investors to more accurately determine the credit loss profile of the CLO collateral portfolio.

Overall Fitch expects modest positive rating changes within CLOs as a result of the new methodology. However, the agency stresses that CLO specific asset allocation will be the determinate factor as higher RRs ('RR1' and 'RR2') and lower RRs ('RR4' to 'RR6') will drive recovery estimates that are substantially higher and lower, respectively, than current VECTOR loan recovery estimates.

Fitch will solicit comments on this exposure draft for a period of 30 days from the date of publication. Following consideration of comments received, Fitch will publish final criteria changes. Fitch will continue to develop similar applications thereafter for other CDO asset types such as emerging market CDOs and structured finance CDOs.

In the upcoming weeks, Fitch will be publishing an exposure draft outlining enhancements to VECTOR, the agency's proprietary CDO rating model. In addition to several proposed enhancements to VECTOR, the final version will incorporate the new Recovery Rating analysis.

The exposure draft, 'Use of Recovery Ratings in Collateralized Loan Obligation Rating Criteria' is available at 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.