RPT-UPDATE 2-Fitch unveils CDO overhaul, sees many affirmations

(Corrects dropped letter in word 'downgrades' in paragraph 16)

By Jane Baird

LONDON, April 30 (Reuters) - Fitch Ratings unveiled a new methodology on Wednesday for rating corporate collateralised debt obligations, which it said would lead to affirmations of many ratings and downgrades of some others by several notches.

In early February, following criticism that debt ratings agencies played a role in creating the credit crisis, Fitch announced an initial proposal for an overhaul, which it said would lead to an average downgrade of five notches of the $75 billion worth of synthetic, investment-grade CDOs it rates.

Investors expressed fears that the severity of the initial overhaul could kick the credit derivatives market into another tailspin, and at end-March, the ratings agency extended its review and said its new plans would lead to less severe downgrades than initially expected.

In contrast with their comments in February, Fitch executives on Wednesday declined to give any figures on how many CDOs would be affected and to what degree by the final version.

"While Fitch expects many ratings to be affirmed, downgrades are also expected, in some cases by several rating notches," it said in a statement.

Its review will cover about 500 existing CDOs, including 400 synthetic CDOs and 100 cash CDOs for a total value of $110 billion to $120 billion, Fitch executives said.

"Our approach is intended to create more stable and predictive ratings, especially for the highest ratings categories, and our aim is to restore investor confidence in ratings as an accurate and relative measure of risk," Ken Gill, Fitch managing director for structured credit, told Reuters.

SUBJECT TO COMMITTEE

"The quantitative approach is a starting point, and any final ratings decisions will be subject to committee, so those internal committees need to begin before we can communicate any more detail," Gill said.

"Some managers may come to us and may propose changing their portfolios, and obviously if we think those proposals are credible, we would not want to take action without assessing all that in the context of a committee," said Philip McDuell, Fitch head of structured credit for Europe and Asia.

Fitch in the coming weeks will identify those CDOs most likely to be downgraded by putting them on credit watch negative and affirm the ratings on those not likely to be downgraded, giving priority to the two extremes, McDuell said.

"The extent of manager flexibility and other relevant qualitative considerations are also expected to be factors in the rating review," said Roger Merritt, Fitch's chief credit officer for global structured credit, in the statement.

"If a manager shows willingness and ability to mitigate portfolio risk, we will take this into account," he added.

While Fitch has toned down some of its alterations, the final version is still probably the most conservative of the ratings agencies, keeping to the same tone as the initial proposal, said Priya Shah, a structured credit analyst at Dresdner Kleinwort.

"This should result in more strict yet more stable ratings for the new corporate CDOs which they rate," she said. "However, in the interim it will result in downgrades for existing deals, more so on synthetic, highly concentrated, investment-grade CDOs."

Synthetic CDOs are created from portfolios of credit default swaps (CDS) in which the investor sells protection against the risk that companies will default on their debts.

The market has feared that downgrades would force investors limited to triple-A or other ratings to dump their holdings of synthetic CDOs, driving CDS spreads wider.

Fitch in February cited four basic changes in its methodology, which Gill said were kept in the final version.

"The overall framework and the risks we are capturing has not changed (since the February proposal). What has changed is certain nuances of the application, and we believe it is a more refined approach," Gill said. "There has been no dilution of the analytical approach at all."

One issue is industry concentration. Many investment-grade CDOS have 25 to 30 percent of their portfolios in the banking and finance industry, for example.

"We expect the downgrades to be the most severe in those transactions with portfolio concentrations, or those with little or no cushion in their current level of credit support," Merritt said.

Another issue was vulnerability to ratings downgrades. Fitch said it would use screening tools to identify companies in CDO portfolios that have an above-average likelihood of downgrades.

The agency also said it would change its default risk assessment to take better account of peak default rates from 30 years worth of data and would adjust assumptions on recovery rates when companies do default.

"In the past year, we've learned a lot about how concentration, portfolio rating migration and correlation can impact a CDO rating performance," Gill said. (Editing by Will Waterman)