Fitch proposes changes to structured finance, covered bonds counterparty rating criteria

Fitch Ratings says it is proposing changes to its structured finance and covered bonds counterparty rating criteria and has invited feedback from market participants on the draft proposal.

Specifically, Fitch is proposing to make adjustments to the eligibility criteria it applies to collection account banks and collection account bank holders under a new commingling risk classification.

A commingling risk occurs when funds belonging to an issuer may get combined with the insolvency estate of a defaulted party in a structured finance transaction.

The agency is also updating how it sizes expected commingling losses for transactions that do not address commingling risk through documented minimum triggers or transfer periods.

These proposed changes apply to both structured finance (SF) as well as covered bond (CVB).

The proposed commingling risk classification will assess whether the commingling exposure is considered a key risk driver, secondary risk driver or immaterial depending on the potential commingling exposure as well as the ability of the transaction to maintain timely payments on the notes upon loss of the commingled funds.

“Commingling risk is expected to be a secondary rating driver for most transactions considering the most common protections in place in SF transactions. These changes result from Fitch’s review of recent bank failures as well as its analysis of materialised commingling risk.

“If the proposed changes become criteria at the conclusion of the exposure draft period, Fitch estimates that ratings of about 6.5% of outstanding RMBS tranches from Europe, the Middle East and Africa (EMEA) will in most cases be upgraded by one to two notches,” Fitch said.

It is also proposing to adjust the replacement period for issuer account banks to 60 days from 30 days, after becoming ineligible as well as considering changes in the bank regulatory environment, which support the view that banks are more likely to continue to operate as going concerns following a failure or be wound down in an orderly manner.

The 60-day period is also viewed as better as it reflects a realistic replacement period considering the practical steps that are needed to replace an account bank. No rating impact is expected due to this adjustment.

The changes equally include expansion in the use of case-by-case analysis to non-developed markets where rating caps and non-rated counterparties are in place.

“This section has been reworded and separated from commingling risk to improve its readability. Neither of the changes is expected to have a rating impact,” it stated, adding that it proposes to expand the Qualified Investments section for transactions issued in Canada by adding Canadian government obligations (guaranteed/backed or issued by the Canadian government) without specified rating limits, if the obligations are scheduled to mature before the next interest payment date.

Fitch seeks to expand the National Ratings section to increase transparency on how the criteria apply to national scale ratings, saying no rating impact is expected due to this addition.

The exposure draft has since been sent to market participants for their feedback.