Fitch Ratings:
Link to Fitch Ratings' Report: Rating Derivative Product Companies: Exposure Draft
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681116
Today, Fitch Ratings issued an exposure draft outlining the agency's latest views on rating Derivative Product Companies (DPCs). Certain legal and structural aspects of DPCs did not perform as expected during the financial crisis and many DPC programs had been winding down. Lately, there has been a resurgent interest in DPCs as bank ratings have come under pressure, prompting Fitch to take a fresh look at rating DPCs.
RATINGS APPROACH
There are two primary types of DPCs - termination vehicles and continuation vehicles - both of which historically were rated 'AAA' on a standalone basis. Under its revised criteria, Fitch proposes to place greater emphasis on the credit strength and operational integration with the sponsor of the DPC as well as its standalone financial strength and operating profile. Specifically, it is proposed that a DPC's final rating may be modestly above the Issuer Default Rating (IDR) of the sponsor, with maximum achievable ratings likely to be in the 'AA' category.
However, rating floors would be also be assigned to the DPCs, reflecting their standalone structure, capitalization, and operational separateness from their sponsors. Fitch proposes a floor rating of 'A' for continuation DPCs if the vehicle is well-capitalized and appropriately structured, while a standalone rating floor for termination DPCs may be as high as 'AA'.
The lower rating floor set for continuation vehicles reflects the long-tailed exposure to the sponsor and the reliance on a contingent manager to re-hedge the portfolio, potentially at a time of acute market stress. The contingent manager's resources, skills, market access, and ability to monitor the DPC's activities are essential for a continuation DPC.
RATINGS DE-LINKAGE POSSIBLE
Fitch is also proposing to 'de-link' the ratings of DPCs from the ratings of their sponsors at the level of the rating floor, if the DPC is appropriately structured and capitalized. Therefore, the DPC's rating will migrate with the sponsor's rating until the rating floor is reached. In assigning the rating floor to a DPC, Fitch will consider the following risk factors: legal risk and governance, counterparty credit risk, market risk, liquidity, capital modeling risk, collateral and capital, and operational risk.
DPCs AS STRUCTURED FINANCE COUNTERPARTIES
Demand for higher rated structured finance (SF) counterparties is one impetus for the renewed interest in DPCs. In Fitch's view, continuation DPCs may be better suited as SF counterparties than termination DPCs, if appropriately structured with a rating floor of 'A.'
The full report is entitled 'Rating Derivative Product Companies: Exposure Draft' and can be found at www.fitchratings.com. Please send your comments on this exposure draft to 'DPC.Feedback@fitchratings.com' by July 13th.
Additional information is available at 'www.fitchratings.com'.
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Fitch Ratings
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or
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sandro.scenga@fitchratings.com