In April, Fitch released its updated methodology for rating corporate CDOs, which primarily invest in assets with maturities of 10 years or less. A critical component of the revised corporate CDO methodology was access to robust data on corporate default rates for maturities of 10 years and less, and the benchmarking of CDO performance against these historical default rates. At that time, Fitch indicated it would continue to review other CDO sectors, as necessary, in order to refine existing assumptions and continue building on efforts to restore confidence across structured finance.

Now, Fitch says it is reviewing its corporate default rate assumptions for assets with terms of greater than 10 years. “Certain specialized CDO sectors may be exposed to underlying assets with default risk in excess of 10 years, making assumptions about the term structure of default probabilities for longer tenors a meaningful factor,” said John Olert, managing director and global head of structured credit for Fitch.

For assets with maturities beyond 10 years, however, historical default data may not be as readily available, it notes. Also, “While increased cumulative defaults over these extended maturies have been part of the analysis, further refinement may be appropriate,” it says. “In addition, prepayment risk arising from call features further complicates the analysis of default risk over a portfolio’s life, as well as assumptions about yields to maturity and excess spread.”

There are several options for making reasonable assumptions about the term structure of default for terms beyond 10 years, it explains. In some instances, Fitch may be able to rely on independent studies of default for a specialized sub-sector. In those cases where independent studies are not available or appropriate, other options are to rely on the limited corporate default data available related to observations beyond 10-years, apply a mathematical process to the 10-year data to extrapolate the curve beyond 10 years, or simply apply existing rating transition matrices to approximate the default propensity for terms beyond 10 years.