Fitch: Evaluating Guaranteed Collateralized Financings Issued by Financial Institutions

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has received a number of inquiries from financial institutions (FIs) regarding assigning ratings to collateralized financing facilities created through a separate subsidiary or special purpose vehicle (SPV) guaranteed by the FI. Such facilities, which may be issued on either a public or private basis, are intended to offer investors a secured investment alternative to traditional tri-party repurchase agreements (repo) or other unsecured funding instruments. Such debt issuances may be executed in the form of collateralized commercial paper (CCP), secured medium-term notes or global note programs. The purpose of the commentary is to outline Fitch's analytical approach to such instruments relative to existing ratings assigned to FIs and their liabilities.

FIs explain they are motivated to establish collateralized facilities for purposes of:

--Broadening the potential base of investors;

--Potentially expanding the maturity profile of the FI's current funding base;

--Conserving existing capacity or offsetting reduced capacity in the traditional repo or other short-term funding markets;

--Offering more customized terms;

--Potentially increasing existing investors' capacity to assume greater aggregate counterparty exposure to the issuing FI.

To date, FIs which have issued or considered issuing these products have predominantly been highly-rated global trading banks, and Fitch anticipates that such institutions will remain the primary issuers of these instruments going forward. Fitch's ratings on collateralized instruments will be determined by the structure of the obligation. For transactions rated to date, the ratings have been based on a guaranty provided by a rated FI sponsor and, therefore carry a rating equivalent to the sponsor's senior unsecured debt ratings determined by Fitch's 'Global Financial Institutions Rating Criteria' dated Aug. 16, 2010 and available at 'www.fitchratings.com'.

To date, Fitch has not considered the value of the eligible collateral providing security to these issues. Fitch notes that a rating uplift may be considered depending upon the legal structure, the segregation of assets, the type of assets used, the level of overcollateralization associated with such assets, the maturity profile, and the quality and frequency of reporting information associated with such assets provided to Fitch. In such instances, Fitch's FI group would work in coordination with its Funds and Asset Manager Rating and/or Structured Finance groups depending on the specific structure of the rated issue. Fitch's review and surveillance of the underlying collateral would be necessary in order to determine if ratings uplift were warranted and would also depend on the level of overcollateralization on a mark-to-market basis and an assessment of the eligible assets' price volatility under stress scenarios, particularly a default of the sponsoring FI. In addition, determination of a ratings uplift would depend on the legal appropriateness of the transaction, the separateness of the pledged collateral in the event of a bankruptcy or receivership of the FI, the repayment mechanics of the instruments given the potential delays in collateral liquidation, and the degree to which there is an alignment of interests between the FI and the noteholders.

Fitch is mindful that in the event of an insolvency or receivership of the FI, the regulators could seek to repudiate any contracts and gain possession of the segregated collateral for the benefit of all creditors. Fitch believes the FIs are cognizant of this risk and several have been attempting to create structures that would reduce or eliminate that risk.

From a broader ratings perspective, Fitch will continue to monitor the level of secured liabilities for a given FI relative to its overall funding mix. Fitch believes that a high dependence on secured sources of financings such as asset-backed securitizations, repurchase agreements, covered bonds, or secured bank loans could constrain ratings. Fitch also believes that an over-reliance on secured financing could encumber most assets on the company's balance sheet, reducing overall financial flexibility. In addition, a high concentration of secured financing increases the risk that unsecured creditors could be adversely affected as secured creditors may have priority claims to higher quality assets. If the industry shifts to a higher level of secured funding versus historical levels, Issuer Default Ratings (IDRs) could come under pressure and unsecured debt ratings could fall below the IDR due to lower recovery expectations.

Fitch will evaluate proposed collateralized structures on a case-by-case basis. As rating precedents are determined, Fitch will communicate those decisions through updated rating action commentaries and updates to our published criteria.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Global Financial Institutions Rating Criteria' (Aug. 16, 2010);

--'Rating Market Value Structures' (March 26, 2010);

--'Closed-End Fund Debt and Preferred Stock Rating Criteria' (Aug. 17, 2009).

Applicable Criteria and Related Research:

Global Financial Institutions Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=547685

Rating Market Value Structures

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=507187

Closed-End Fund Debt and Preferred Stock Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=462492

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