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Fitch Unveils Recovery Ratings System

Fitch Ratings has introduced recovery ratings that quantify the level of recovery for bank debt and bond holders in the event of a default.

Fitch Ratings has introduced recovery ratings that quantify the level of recovery for bank debt and bond holders in the event of a default. The rating system, which covers $200 billion in loans, bonds and preferred shares, ranges from outstanding probability of recovery (R1) to poorest chance of recovery (R6), and will be applied to all companies in its North American Corporate Finance Group that are rated B+ and under. Fitch employs a recovery band to quantify the chance of recovery. Corporates rated R1 have a 91-100% chance of recovery, R2s have a 71-90% chance, R3s have a 51-70% chance, R4s have a 31-50% chance, R5s have a 11-30% chance and R6's have the lowest chance of recovery at 0-10%.

Roger Merritt, managing director at Fitch said, a confluence of events led Fitch to institute this system now. "We began the process by outlining the basic concept and gathering market info in February," he said. "We feel that defaults will continue to rise in the near future and recovery analysis will become very important," Merritt said. He noted the ratings should be helpful for banks using Basel II to manage capital and for investors looking for more significant ways to manage their risk.

Moody's Investors Services has plans to launch recovery ratings of its own in the near future, according to a spokesman. Standard & Poor's introduced recovery ratings for bank loans in December 2003. Steven Bavaria, v.p. and head of bank loans at S&P, said its ratings cover a broader scope of the market, noting that the Fitch ratings focus on credits rated B+ and below.

Among the names that landed R6 ratings from Fitch, the sector with the most was telecom/cable, with six (see chart). But John Olert, co-head of North American finance at Fitch, called attention to the airline sector. "The R6 rated sector that really stands out to me is the airlines," he said. The reason lies in the fact that many airlines have turned to more senior secured sources of financing and if they should fall into default, the recovery outlook is bleak for the unsecured debt in the chart. In the case of a default all the capital will go to secured debt holders, leaving nothing to those holding unsecured debt. Airlines rated R6 by Fitch include America West Airlines, Delta Air Lines, Continental Airlines and NorthWest Airlines.

Fitch almost used a seventh rating of R0 after getting market input in February. The R0 rating would be reserved for only the most secure debt, such as bank debt and utility mortgage bonds, according to Olert. Fitch decided against that rating because of concern that it might be misinterpreted. "Just because we might have rated a bond as R0, we didn't want people to think all bank loans are automatically R0. This is still a very subjective process," added Olert.

Portfolio managers seem to think that the new ratings are, for the most part, helpful. Gary Wolfer, portfolio manager at Univest Wealth Management and Trust, said that although he will not have much use for the new ratings, he sees this as a positive and a powerful tool going forward. "I only have a couple of things rated below B+ so it doesn't help me personally very much. But I really like the idea and think it's quite helpful." Andy Aran, portfolio manager at Alliance Capital Management, concurred. "I can only think that investors will welcome any new information that comes their way," he said.

Companies Rated R6 Under Fitch's New Recovery Rating Scheme
Sector Company Instrument Recovery Rating Rating
Telecom/Cable Intelsat senior unsecured note R6 CCC
Level 3 Communications inc subordinated debt R6 CC
Mediacom Communications Corp. senior unsecured debt R6 CCC+
Mediacom LLC senior unsecured debt R6 B-
Cincinnati Bell Inc. preferred stock R6 B-
Insight Communications Company Inc. senior unsecured debt R6 CCC+
A&D/Diversified Allied Waste preferred stock R6 CCC+
Allied Waste subordinated debt R6 CCC+
Owens-Illinois Inc. preffered stock R6 CCC
Transportation America West Airlines Inc. senior unsecured R6 CC
AMR Corporation senior unsecured R6 CC
NorthWest Airlines Corp. senior unsecured R6 CC
Continental Airlines Inc. senior unsecured R6 CC
Delta Air Lines senior unsecured R6 C
Energy/Metals& Mining Smurfit-Stone Container Corporation preferred stock R6 B-
Business Services Sungard Data Systems Inc. senior unsecured R6 B/B-
Sungard Data Systems Inc. subordinated R6 CCC+
Blockbuster Inc. subordinated claims R6 B-
Retail Toys 'R' Us Inc. senior notes R6 CCC
Building Technical Olympic USA Inc. senior subordinated R6 B-
Auto Parts Tenneco Automotive Inc. senior subordinated R6 B-
Delphi Corporation junior subordinated R6 CCC
Goodyear Tire & Rubber Co. unsecured notes R6 CCC+
Chemical/Healthcare Terra Industries Inc. convertible preferred R6 B-
Nalco Finance Holdings senior discount notes R6 CCC+
Technology Lucent Technolgies Inc. subordianted debt R6 CCC+
Food & Beverage Dole Holding Company senior secured R6 CCC+
Media Dex Media Inc. subordinated R6 CCC
Dex Media West Inc. subordinated debt R6 CCC+
HM Publishing Corp. senior subordianted R6 CCC-
Houghton Mifflin Co. subordinated debt R6 CCC


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