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Fitch: Credit Quality Warning System Eroded by Disappearing Loan Covenants
New York, New York, USA 09 August 2006 -- In a new study released today, Fitch Ratings examines the role of loan amendments and the observed relationship between loan amendment activity, the general direction of credit quality, credit availability, and default patterns. The study finds that loan amendments offer a valuable view of broad corporate credit quality trends and provide investors with significant insight into individual company performance.

'Watching loan amendment activity for individual firms can provide an important warning of financial distress and in the extreme, default or bankruptcy,' said William May, senior director of Credit Market Research. 'Over the past decade, of those firms that defaulted with rated loans and bonds in their capital structure, one third had received a loan amendment within a few years of the bond default. In fact, 50% had received an amendment six months prior to the bond default and 75% one year prior to default.'

From a macro perspective, Fitch found that in the last credit downturn, rising loan amendments preceded rising defaults in the high yield bond market. Further, Fitch found that in six of the seven years examined in which loan amendment activity increased, bank lending standards tightened.

One of the key factors influencing the direction and severity of corporate default rates is credit availability, and, in particular, issuer access to funding in the loan market. High yield bond default rates have historically followed a pattern remarkably similar to credit availability trends in the loan market, with consistently low default rates accompanying periods of loose lending standards on commercial and industrial loans and high default rates accompanying periods of tight lending standards.

'The loan market's risk appetite and willingness to extend credit is clearly important, however anticipating changes in the loan market's behavior is challenging,' said Mariarosa Verde, Managing Director of Credit Market Research. 'Loan amendment patterns overall may offer clues about the likely direction of risk aversion in the loan market which in turn has consequences for defaults'.

The study also looks at covenant trends through the first half of 2006 and found that covenant packages continued to shrink in the first half of the year calling into question whether the information content provided by covenants and related amendments is also fading.

The report is titled 'Credit Quality Warning System Eroded by Disappearing Covenants, A Look at Loan Amendments' and is available on the Fitch Ratings web site 'www.fitchratings.com' under the Credit Market Research link.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 'www.fitchratings.com'. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Fitch Ratings


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