Fitch Places Bank TruPS CDOs on Watch Negative on Increased Default & Deferral Activity

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has placed certain notes issued across 59 collateralized debt obligations (CDOs) on Rating Watch Negative. The rating actions relate to CDOs backed all or in part by trust preferred securities (TruPS) or subordinated debt primarily issued by banks, with particular focus on those transactions with underlying defaulted and/or deferring collateral.

Further supporting Fitch's rating analysis, certain transactions also have exposure to deferring, defaulted or underperforming TruPS or subordinated debt issued by insurance companies, real estate investment trusts (REITs), homebuilders or financial institutions specializing in residential mortgage lending. The rating actions primarily affect junior classes of notes rated in the 'BB', 'BBB' and 'A' categories. No securities rated 'AAA' affected by this rating action and only 5.4% of securities rated in the 'AA' category affected by this rating action.

As detailed in its May 2 special report ('Emerging Credit Concerns Facing U.S. Bank TruPS CDOs'), Fitch revised its ratings and asset performance Outlook with respect to U.S. bank TruPS CDOs to Negative from Stable, citing a significant increase in observed TruPS defaults and deferrals as well as overall deterioration in the credit quality of banks underlying TruPS CDOs. Since the publication of the report, Fitch has been notified of five additional bank TruPS deferrals, with $468.8 million in aggregate TruPS financed through TruPS CDOs. Observed deferrals continue to be driven by factors similar to those outlined in Fitch's special report - namely residential construction loan exposure, residential mortgage production and lack of a core deposit franchise.

Taking into account these additional deferrals, the aggregate amount of bank TruPS defaults and deferrals observed by Fitch since September 2007 is $1.1 billion. This is in comparison to $268.5 million of bank TruPS deferrals observed by Fitch over the seven years prior to September 2007. Fitch believes further bank default and deferral activity is likely, as banks face liquidity pressures and potential deterioration of residential construction loan portfolios over the near term, as well as broader based economic pressures over the intermediate term. Many large banks are having success raising additional capital, and Fitch is aware of certain banks which have issued TruPS through CDOs that are pursuing similar capital raising efforts. That said, the timing will likely be slower and the success rate will likely be lower for such banks than what has been observed with respect to large, publicly traded banks.

In identifying transactions and individual classes of notes to be placed on Rating Watch Negative, observed default and deferral activity was evaluated in the context of transactions-specific characteristics such as available credit enhancement, prepayments and credit risk sales observed to date, obligor concentration, cash flow redirection mechanisms, and other structural enhancements. Consistent with the expectations outlined in Fitch's special report, today's rating actions are largely focused on classes rated in the 'A' category or below. The instances of securities rated in the 'AA' category being placed on Rating Watch Negative are limited to those transactions with outsized obligor concentration (as a result of prepayments) or other high risk exposure such as TruPS or subordinated debt issued by REITs, homebuilders or financial institutions specializing in residential mortgage lending.

In focusing on deferrals as well as defaults, Fitch recognizes that the ability to defer payments for up to five years is core feature of TruPS. Nonetheless, Fitch views deferrals as indicator of increased risk of default and recognizes there may also be certain terms and conditions of the TruPS financing which, if breached, result in a technical default prior to the conclusion of the five-year deferral period. These may include failure by such entity to provide on-going financial statements, the regulatory seizure of such entity, or the filing for bankruptcy protection by the holding company of such entity, among others. As a result of the occurrence of such technical defaults, $59 million of TruPS previously classified as deferring are now deemed by Fitch to be in default.

Fitch's TruPS CDO rating criteria assumes a level of deferral and default activity as a function of the rating assigned to a given liability, and is designed to address the repayment of the notes pursuant to their stated terms. In taking these rating actions, Fitch's primary concern is not of an imminent risk of principal loss to rated noteholders, but rather, an adverse change in the credit risk profile of the notes, particularly in light of current pressures facing U.S. banks, and the significant remaining risk horizons of the transactions (ranging from 22-to-30 years, absent collateral prepayments). As evidenced by Fitch's rating actions, these concerns are more pronounced with respect to junior classes of notes.

Fitch is in the process of updating its analysis of the credit quality of performing bank collateral underlying TruPS CDOs, based on the release of fourth-quarter 2007 (4Q'07) and 1Q'08 financial statements. This analysis is expected to result in additional default probability adjustments for certain banks. Upon the conclusion of this collateral analysis, transactions not included as part of this rating action commentary may be exposed to negative rating actions including placement on Rating Watch Negative or downgrade. Additional classes of transactions included as part of this rating action commentary may also be exposed to negative rating actions including placement on Rating Watch Negative or downgrade.

Fitch does not expect to resolve the status of transactions placed on Rating Watch Negative until its bank-specific credit analysis is completed. With respect to defaulted or deferring collateral, Fitch will seek to undertake an issuer-specific analysis in order to determine the likelihood of resumption of payment and the potential recovery prospects in the event of default. Given that Fitch's analysis of performing and non-performing bank collateral remains ongoing, the magnitude of potential rating changes on bank TruPS CDOs cannot yet be quantified.

A spreadsheet detailing Fitch's rating actions with respect to publicly rated notes, as well as certain transaction-specific portfolio information relevant to Fitch's analysis, is available on the Fitch Ratings web site at www.fitchratings.com under the following headers:

Structured Finance then Structured Credit then Special Reports

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.