Dec 19 - Fitch Ratings has updated its criteria assumptions for European Collateralised Loan Obligations (CLOs) with respect to partial exposure to peripheral eurozone countries where rating caps have been applied (Spain, Ireland, Portugal and Greece). The average exposure to assets in these four countries across all Fitch-rated CLOs is 10%, with an overall range between 3% and 20%. Most of this exposure originates from Spanish and Irish assets. The exposure to Portuguese and Greek assets across Fitch-rated CLOs is negligible with only one issuer in both countries.
Fitch has analysed the impact on its rated portfolio and the agency does not expect any material rating changes as a result of this change, owing to the currently limited exposure to these countries. The update will be applied to transactions when they next face a rating review.
Fitch applies country caps lower than 'AAAsf' for European structured finance (SF) transactions in eurozone countries where the sovereign rating has fallen below the 'A' category. For example the highest possible rating for Spanish SME CLOs is currently 'AA-'. These country rating caps are applied to portfolios with 100% concentration within a single country. The rating cap reflects the agency's concerns that the weakening sovereign increases the likelihood of extreme macro-economic events that could undermine the performance of the securitisations. Such risks become more extreme where the divergence becomes greater between the rating of the affected SF notes and the lower sovereign rating, to the point where SF ratings can no longer be supported at the highest end of the rating scale.
For portfolios with partial exposure to such countries, Fitch will apply rating caps on a case by case basis depending on the size of the exposure. For all Fitch-rated CLOs, the agency has determined that the exposure is currently sufficiently small not to warrant a rating cap. It remains possible that this may change over time, especially if more CLO assets from 'core' eurozone countries successfully repay or refinance than those in capped peripheral eurozone countries, leaving rising concentration to adversely selected assets from capped peripherals.
To factor in the expected increase in performance volatility, especially at the highest rating level, Fitch has increased its correlation assumption and reduced recovery rates for assets within these countries. The updated correlation and recovery assumptions were calibrated to match the expected loss at the country rating cap level to the current 'AAA' level. For example, the current 'AAA' recovery assumption for a senior secured loan with a recovery rating of 'RR2' is 45% while the current 'AA' recovery rate is 55% under Fitch's criteria. If the loan was granted to a corporate located in Spain, the new recovery at the 'AA' and 'AAA' levels will be 45% and 35% respectively.
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