OREANDA-NEWS. March 10, 2015. Fitch Ratings has updated its global rating criteria for collateralised debt obligations backed by loans to small- and medium-sized enterprises (SMEs). The report replaces the existing "Criteria for Rating Granular Corporate Balance-Sheet Securitisations (SME CLOs)", dated 5 March 2014. The updated assumptions are not expected to have an impact on existing SME CLOs.

In the latest criteria Fitch has decreased the average annual default rate expectation for Spain to 5% from 6.25%. The revised benchmark results from a reduction in Fitch's expected annual default rate for the real estate and construction sector to 8% from 10% and a reduction in the proportion of debt assumed in this sector to 30% from 44%. These changes reflect that surviving SMEs operating in Spain's real estate and construction sector are now less prone to default in an improving economic environment and the sector's falling contribution to the overall economy.

Fitch will use this updated country benchmark in conjunction with the bank data and originator review to derive Spanish SME CLO portfolio expected default rate. However, for vintage SME CLOs the overall default probability assumption is largely determined by observed default rates.

Fitch has also updated the default probability term structure assumption for SMEs. The amendment consists of a lower default probability in the first years while keeping the five- year cumulative default probability unchanged. The adjustment in the first year probability of default is more pronounced for higher average annual default rates. For example for a 5% average annual default rate the first year default probability has decreased to 7.5% from 9.2% while for a 3% average annual default rate the first year default probability has only decreased to 4.1% from 4.2%. The change in the term structure better reflects peak default rates observed by banks on their loan book and the receding risks of a severe downturn returning next year in the European peripheral economies. Only portfolios with a large proportion of short-dated assets and fairly high annual default rate expectation will benefit from this change.

The criteria report now details how Fitch assesses portfolios with revolving credit lines. Fitch will only give credit to debt with a stated maturity.

Revolving credit lines are subject to heightened refinancing risk when the originator has become insolvent. When assigning ratings de-linked to the originator Fitch will assume that with limited refinancing options credit lines will likely be amended and extended or restructured as term loans. The agency will extend the maturity of the credit lines by a minimum of two years.

In addition given the revolving nature of credit lines Fitch will also assess whether the issuer is liable for future advances. This depends on jurisdiction and the agency expects transaction legal opinions to assess the obligations and rights of the SPV with respect to revolving credit lines. When the securitisation vehicle is liable for further advances Fitch will assess whether the SME CLO structure has sufficient cash available at all times to cover additional advances to borrower.

Finally Fitch will assess the servicer's operational capabilities to monitor, distinguish and allocate credit lines interest and principal proceeds owed to the bank and the securitisation vehicle when relevant.

The updated criteria report is available at www.fitchratings.com and describes Fitch's methodology for analysing collateralised loan obligations backed by loans to corporates that generates revenues from operating businesses rather than investments. The criteria report is applicable to all securitisations backed by secured and unsecured SME loans. Fitch may also apply the criteria to analyse portfolios of corporate loans and leases.