Fitch Explores SF Concentration Risk in Basel II Proposals

LONDON & NEW YORK--(Business Wire)--
Fitch Ratings explores the issue of concentration risk in a report that comments
on recent Basel II proposals responding to the financial crisis. While the
overall proposals provide meaningful enhancements that will further strengthen
the effectiveness and rigor of the Basel II capital framework, Fitch's analysis
indicates that specific aspects could have unintended effects on the
risk-sensitivity of capital requirements for structured finance exposures. Fitch
notes potential overlap between Fitch's tightened SF CDO rating criteria and
proposed increases in Basel II risk-weights on 're-securitization' exposures
held by banks, which could result in the 'double-counting' of risks within SF
CDO capital charges.

Addressing concentrations is an important element of measuring and managing
risks within securitization transactions, particularly re-securitizations such
as SF CDOs, or collateralized debt obligations backed by an underlying pool of
structured finance securities. Fitch recently developed revised rating criteria
for SF CDOs that apply a rigorous and robust treatment of potential risk
concentrations within these structures. As a result, the enhancement levels
needed to achieve investment-grade ratings have increased considerably,
particularly for collateral pools characterized by risk concentrations and
thinner tranches. However, as part of the proposed Basel II enhancements under
Pillar 1, which addresses minimum regulatory capital requirements for banks, the
risk weights for 're-securitizations' such as SF CDOs will be increased relative
to the risk-weights on other forms of securitization exposure.

"One of the main factors driving recent SF CDO credit deterioration has been
risk concentrations within the underlying pool of structured finance collateral
to the same asset classes, geographic areas, and, importantly, vintages, since
assets originated within the same time period are exposed to similar
underwriting risk factors," said John Olert, Group Managing Director, Fitch
Structured Finance group. "With both Fitch tightening its SF CDO rating criteria
and Basel II increasing the associated capital charges on re-securitizations, it
appears that there is a potential overlap in these efforts especially if other
agencies make similar changes to their criteria."

"In concept, similar risk exposures should face similar capital charges,
irrespective of the form that the exposure takes. When layering the higher
proposed Basel II re-securitization charges onto the additional conservatism of
Fitch's SF CDO criteria, our analysis indicates that the Basel II capital
charges on the full SF CDO capital structure could be several multiples higher
than the Basel II charges on the entire underlying pool of structured finance
collateral, even though the risk exposure is essentially the same," said Ian
Linnell, Group Managing Director, Fitch Structured Finance group.

The Basel II capital framework, currently being implemented globally, is a
significant regulation that Fitch believes will promote stronger risk management
practices and more informative measures of risk-based capital within the banking
industry. The proposed enhancements address each of the 'Pillars' of Basel II,
including Pillar 1, minimum regulatory capital requirements; Pillar 2, banks'
internal risk and capital assessments and the supervisory review process; and
Pillar 3, risk-based disclosure to promote market discipline. As emphasized by
the Basel Committee in releasing the proposals, Basel II is intended to be a
'living framework' that continues to adapt to evolution in financial markets and
the financial services industry, which Fitch notes will help to support its
relevance going forward.

The report 'Basel II's Proposed Enhancements: Focus on Concentration Risk' is
available on Fitch's website at www.fitchratings.com; Annex 2 of the report
illustrates the potential impact of Fitch's revised ratings criteria and the
Basel II re-securitization proposals on the capital charges for SF CDOs. The
website requires users to perform a simple log-on process. The report can be
found by linking to 'Credit Market Research' (under 'Market Focus') and then
clicking on 'Research'.

Fitch's rating definitions and the terms of use of such ratings are available on
the agency's public site, www.fitchratings.com. Published ratings, criteria and
methodologies are available from this site, at all times. Fitch's code of
conduct, confidentiality, conflicts of interest, affiliate firewall, compliance
and other relevant policies and procedures are also available from the 'Code of
Conduct' section of this site.

Fitch Ratings
Stuart Jennings, +1 44 20 7417 6271 (London)
Krishnan Ramadurai, +1 44 20 7417 3480 (London)
Ian Linnell, +1 44 20 7417 4344 (London)
Martin Hansen, +1-212-908-9190 (New York)
John Olert, +1-212-908-0663 (New York)
Media Relations
Julian Dennison, +44 020 7682 7480 (London)
julian.dennison@fitchratings.com
Sandro Scenga, +1-212-908-0278 (New York)
sandro.scenga@fitchratings.com

Copyright Business Wire 2009