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Fitch Ratings warns investors about accounting practice

16 April 2009 10:20 (UTC +04:00)

Baku - APA-Economics. Fitch Ratings is warning investors in complex loan investment funds about the practice by their managers of accounting for loans at par, regardless of market value of the loan.
Managers of collateralised loan obligations - which pool leveraged loans and sell differently rated investment notes with varying risk profiles - have been looking for ways to improve the quality of their loan portfolios as defaults rise.
As the prices for riskier, so-called leveraged loans, has plummeted since the start of the credit crunch, managers have been looking to take advantage of the heavy discounts by selling unwanted loans and replacing them with other loans of a superior credit quality.
However, Fitch is concerned about the way managers are accounting for those loans, in particular those seeking permission from their investors to mark the discounted loans at par despite the market valuation of the loan, without adding further protection for investors.
"The change in the CLO landscape has created significant challenges for issuers to manage credit under structural terms that were established during a more benign time," said Elizabeth Nugent, senior director at Fitch. Today, CLO managers are seeking approval from noteholders and ratings agencies for changes to the structural terms of their transactions regarding discounted security thresholds in order to adapt to the current market environment. Fitch encourages investors to review amendments carefully to determine if changes are in their best interest before providing consent."
If a manager wants to replace loans in its portfolio, trading below 85 per cent of par, in many cases it would require the consent of investors to mark that new loan at par and avoid crystalising any loss. Over past six months, some managers have been seeking to have those restrictions waved.
The comments by Fitch come at a time when concern about the fate of CLOs is increasing. In early March, Moody’s put the vast majority of the market on review for ratings cuts in response to changes to some of its rating assumptions, including increasing the expectations of the default rate among leveraged loans.
Moreover Standard & Poor’s warned in February that investors in the EU80bn ($102bn) of debt issued by CLOs could be at greater risk of losses than they realise if only a few companies default on their debt. S&P found that the debt of just 35 different borrowers appears in nearly half of the 184 CLO portfolios that S&P rates.
For example the debt of Ineos, the UK chemicals group, which is trying to renegotiate its debts, is held by 84.2 per cent of CLOs. Debt of TÃ©lÃ©diffusion de France, the French broadcaster, is held by 87.5 per cent of CLOs. Amadeus, the travel distribution and software company, is held by 82.6 per cent. Source: Financial Times