Recovery Ratings Reveal Diverse Expectations for Loss in the Event of Default

by William May of Fitch Ratings,
Charlotte Needham of Fitch Ratings, and
Mariarosa Verde of Fitch Ratings

December 14, 2006

Introduction: The record losses that accompanied corporate defaults during the credit cycle downturn of 2001 and 2002 did much to focus the fixed-income market's attention on the estimation of recovery values as a critical component of credit risk analysis. More recently, the recognition that heated competition among lenders and investors is causing structural protections to weaken, especially in the syndicated loan market, the tremendous interest in credit derivatives, including loan-only credit default swaps (LCDS), and the need to quantify loss severity for Basel II have further elevated recovery analysis in many investors' minds. The estimation of post-default recovery values, however, is a complex task, one that combines knowledge of an individual issue's characteristics, its place in a firm's capital structure, the finances of the issuing firm and the ability to model a chain of events that could lead a firm to declare bankruptcy.

Taking all of these factors into account, in 2005 Fitch introduced recovery ratings, creating a new rating framework that clearly separates the two primary components of credit risk: default risk and recovery risk. Since that time, Fitch's assignment of recovery ratings to corporate finance issues has grown and now covers more than 250 entities rated ‘B+' or lower with about 1,800 individual issues totaling more than $500 billion in notional value, spanning 26 industries, in 27 countries. This new report, the first in a series of reports describing the performance of Fitch recovery ratings, examines Fitch's current recovery ratings, differences in their distribution, and upgrade and downgrade activity based on position in the capital structure, industry, issuer risk and geography.

Download paper (114K PDF) 11 pages

Related Reading:
Recovery Ratings: Exposing the Components of Credit Risk
Recovery Ratings: Developing an Effective Methodology for Banks
Recovery Ratings Home Page

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