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April 11 (The following statement was released by the rating agency)
Fitch Ratings has published its criteria detailing how ratings of structured finance (SF) notes and covered bonds (CVB) are constrained by the credit quality of the sovereign to which the SF transaction or CVB programme is exposed. The methodology is consistent with the one presented in the exposure draft published on 22 January 2014.
The criteria provide details of Fitch's current approach to assigning SF and CVB ratings that are higher than the relevant sovereign local currency Issuer Default Rating (LC IDR), and outline how Fitch embeds sovereign default risk in its rating stresses. It also details methodology applicable to ratings of multi-jurisdictional SF notes or CVB. These criteria are applicable globally to international scale ratings, with the exception of those jurisdictions falling within the scope of the "Criteria for Rating Securitisations in Emerging Markets".
Fitch believes that it is not possible to completely de-link SF and CVB ratings from the credit quality of the relevant sovereign, as a high level of sovereign default risk raises the prospect of extreme events occurring in a country and reduces the certainty of performance projections for SF and CVB assets. CVB are also further affected by sovereign risk through its impact upon the issuing bank and liquidity of the cover pool.
These criteria are not expected to affect ratings assigned to SF notes or CVB whose securitised or cover pool assets are concentrated in a single jurisdiction, as it reflects Fitch current global analytical practices with respect to rating caps. Similarly, no major revision of the base case and stress assumptions currently applied by Fitch are expected. These are expected to incorporate sufficient cushion to withstand the risks discussed in these criteria, including the proposed sovereign distress scenario.
In contrast, however, a limited number of ratings assigned to multi-jurisdictional SF notes and CVB may be downgraded by one or two notches upon implementation of the criteria. Fitch will publish the consequent rating actions in the following weeks, if any.
As detailed in the criteria, the ratings of SF notes and CVB issued in foreign currency cannot exceed the Country Ceiling (CC) of the country of the assets, unless the transfer and convertibility (T&C) risk is mitigated. Where T&C risk is mitigated, ratings cannot be higher than four notches above the CC. In addition, Fitch SF and CVB ratings are capped at a maximum of six notches above the sovereign LC IDR. This cap is independent of the CC-related cap and represents an additional rating constraint reflecting the increased likelihood of extreme macroeconomic events and significant adverse events occurring (e.g. political interference in the economy), which Fitch associates with a high level of sovereign default risk.
In all cases where SF notes or CVB are rated above the sovereign LC IDR, Fitch expects the credit protection available to the notes or bonds to be sufficiently robust to withstand the stresses resulting from a sovereign default, such that they are not expected to default in such a scenario.
SF and CVB ratings in countries that are part of currency unions (most notably, the eurozone) would not exceed the country's CC, which captures the risk of the imposition of capital controls and/or an exit from the union. This is because Fitch expects that upon an exit from the union T&C risk may not be mitigated and/or event risks could be acute. Fitch's long standing view remains that the departure of any country from the eurozone is unlikely and is significantly lower than a sovereign default within it.
Due to their diversified country risk exposure, T&C risk can become a secondary rating driver for multi-jurisdictional structures. For this reason, Fitch applies a specific and less stringent approach where the exposure to sovereigns with a lower CC than the SF or CVB rating is below 20%. As in the case of single-jurisdiction SF transactions or CVB, exposure to macroeconomic and/or event risks is analysed separately and may lead to rating caps if material, regardless of the T&C risk assessment.
Market participants' feedback on the exposure draft report has been published concurrently with the criteria report in the special report entitled, entitled "Feedback Report: Criteria for Sovereign Risk in Developed Markets for Structured Finance and Covered Bonds" available at www.fitchratings.com. The "Criteria for Sovereign Risk in Developed Markets for Structured Finance and Covered Bonds" are available on www.fitchratings.com or by clicking on the link below.
Link to Fitch Ratings' Report: Criteria for Sovereign Risk in Developed Markets for Structured Finance and Covered Bonds