Today, Fitch Ratings announced a new proposal designed to provide greater transparency into the interplay between default risk and loss given default than heretofore has been available to the market:
--New ratings scale designed to add greater transparency by combining probability of default measures with loss given default analysis.
--New methodology to be global in scope.
--Introduction of a benchmark measure of default probability, the Issuer Default Rating.
--New Recovery Rating Scale proposed, focusing on lower-rated speculative-grade securities.
The addition of more information on recovery prospects, in conjunction with the IDR, recognizes the market's need for bifurcated information on the two main elements of credit risk.
Fitch's enhanced methodology is being introduced to the market as an Exposure Draft for the purposes of soliciting feedback from investors, issuers and other market participants during a one-month comment period. Any ratings changes are expected to be implemented during the year, following sector and individual company reviews.
Proposed Recovery Scale
Fitch's new Recovery Scale ranks securities on scale of R1 (high recoveries) to R6 (low recoveries) in order to provide better estimates of potential recovery values in bankruptcy/liquidation. The proposed recovery scale will be applied globally to issuers and securities rated 'B' or lower, including structured finance securities, and will be published in conjunction with traditional credit ratings.
The explicit publication of a recovery rating for low speculative-grade securities recognizes that recoveries are more critical when default is imminent and recoveries can be estimated with higher accuracy. For higher rated securities including investment-grade issues, recovery assessments will not be explicitly assigned but will be reflected in the ratings on the basis of average recovery levels witnessed historically, as well as specific factors for the issuer and its securities.
Proposed Issuer Default Rating
In addition, a new Issuer Default Rating (IDR) will be assigned to issuers. The IDR, which will take the place of the existing long-term rating, will be assigned to companies and sovereigns and will reflect the ability to meet financial commitments on a timely basis, without regard to recovery prospects. In many instances, the IDR will be the same as the existing senior long-term rating, although in some cases they will differ. Securities in the issuer's capital structure will be rated higher, lower, or the same as the IDR on the basis of their recovery prospects.
Market Implications
The increasing complexity of debt offerings, the emergence of credit derivatives, Basel II and, finally, the losses experienced during the last credit downturn have heightened the market's interest in measures of loss given default as well as probability of default. "The addition of more descriptive information on recovery prospects will better allow investors to appreciate the main components of credit risk, says Roger Merritt, Managing Director. This additional granularity, in turn, will add greater transparency to the ratings process."
Additionally, the recovery scale will serve to promote greater global uniformity in how ratings are 'notched.' "This will be especially valuable as capital markets continue to develop across markets with dramatically different legal regimes and insolvency laws, according to Ian Linnell, Managing Director.
To provide feedback on the Exposure Draft, email 'roger.merritt@fitchratings.com' or 'ian.linnell@fitchratings.com'.