Fitch considering splitting ratings assessments into two

New York, Feb. 15 - Fitch Ratings said it is considering a shake up of the way it assigns ratings that would split the current scale into two.

If the agency goes ahead, issuers would in future have a recovery rating and a probability of default rating.

Fitch said it is considering the change because of the increasing complexity of debt offerings, the emergence of credit derivatives, Basel II and the losses experienced during the last credit downturn.

It said these changes 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," said Roger Merritt, managing director at Fitch, in a news release. "This additional granularity, in turn, will add greater transparency to the ratings process."

Issuers and securities rated B or lower, including structured finance, will be rated on a new recovery scale ranging from R1 for a high recovery of 90% to 100% to R6 for a low recovery of 0% to 10%. The new assessment will be published in conjunction with traditional credit ratings.

Fitch said: "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 issuers, including investment-grade rated debt, a recovery assessment will not be explicitly assigned but will be reflected in the ratings based on average historical recovery levels plus specific factors for the issuer and its securities.

Issuers will also receive a new issuer default rating (IDR) that will take the place of the existing long-term rating and will be assigned to companies and sovereigns. The assessment will reflect the ability to meet financial commitments on a timely basis without regard to recovery prospects.

Fitch said the default rating will be the same as the existing senior long-term rating in many cases. 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.

Fitch's existing DDD to D rating for defaulted obligations will be eliminated and issuers will either be rated D or RD (Restricted Default), depending on whether they default on all or some of their debt. Distressed securities will be rated in the B or C range depending on their expected recovery.

As an example, Fitch gave a hypothetical issuer with an IDR at BB due to its default probability of 17.5% over 10 years and senior secured bank loans rated R1 and unsecured debt rated R4. The expected loss rate for the loans is 1.75%, calculated as 17.5% multiplied by 100% minus the 90% recovery rate. The expected loss rate for the bonds is 10.5%, calculated as 17.5% multiplied by 100% minus the 40% recovery rate. The secured bank debt would be rated three notches above the IDR at BBB. Fitch said that was a conservative level for the expected loss, reflecting the importance is places on timeliness of payment.

Fitch also gave as an example a hypothetical issuer with an IDR at CCC due to its default probability of 69% over 10 years and senior secured bank loans rated R2 and unsecured debt rated R4. The expected loss rate for the loans is 13.8%, calculated as 69.0% multiplied by 100% minus the 80% recovery rate. The expected loss rate for the bonds is 41.4%, calculated as 69.0% multiplied by 100% minus the 40% recovery rate. The secured bank debt would be rated two notches above the IDR at B-. Fitch again said that was a conservative level for the expected loss, reflecting the importance is places on timeliness of payment.

Fitch is inviting comments on the proposal for a month. Any changes are expected to be implemented this year following sector and individual company reviews.

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