Fitch Ratings has revised its ratings criteria for counterparty risk in connection with structured finance transactions. Fitch also published a related “Derivatives Addendum,” which detailed its counterparty criteria specific to derivatives contracts used in securitization.

Fitch’s criteria continue to require counterparties (including derivatives counterparties) to structured finance transactions to have minimum long-term issuer default ratings of at least “A” and minimum short-term issuer default ratings of “F1” (or, where the requisite collateral is posted from the time of the structured finance transaction closing, at least “BBB+” and “F2”) for Fitch to support note ratings of the “AA” category or higher. Among other changes, the revised criteria treats counterparties that are on Rating Watch Negative as one notch below their actual current rating for eligibility purposes to mitigate any potential short-term rating action; shortens the period in which remedial actions are expected to be taken where collateralization is possible from 30 days to 14 days; and increases collateral expectations as a counterparty’s credit profile deteriorates. However, Fitch chose not to pursue the primary item outlined in the exposure draft it released for comment in March 2009, i.e., its proposal to require the collateralization of derivatives from the time of the structured finance transaction closing. In electing not to pursue the change, Fitch acknowledged that this change would have restricted the universe of eligible counterparties, hence undermining the replaceability of counterparties, a critical assumption of the criteria.

In its revised criteria, Fitch also refers to ongoing litigation connected to the bankruptcies of the Lehman Brothers entities, particularly the validity of the subordination of derivatives termination payments. Specifically, Fitch’s Derivatives Addendum states that if pending litigation overturns the subordination of such payments, this “may result in substantial rating action on transactions in which the counterparty could be subject to bankruptcy proceedings that could overturn subordination.” It further states that, “[i]n the meantime, Fitch expects this aspect to be addressed by unqualified transaction legal opinions. If such opinions are not provided, the agency will determine the rating impact for a transaction on a case-by-case basis with the effect that note ratings above the rating of the counterparty may not be possible.”