Optimizing the Rating of Your
Securitisation
Yaron Ernst
SVP - Head of Business Development
Structured Finance Group
[email protected]
Agenda

Overview: Russian Securitisations

Moody’s Rating Methodology

Issues in New Markets

Outlook for Russian market
2
Overview: Russian
Securitisations
3
Russian/CIS Growth
Volume of CIS Securitisation by Year
$1,800
US Dollar (Million)
$1,600
Russia
Kazakhstan
$1,400
$1,200
$1,000
$800
$600
$400
$200
$0
2003*
2004
2005
2006
* Excludes Gazprom's $1.25B future flow deal
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2006 YTD Russian Securitisations by Asset Class
Russian Securitisations by Asset Class (2006)
RMBS
12%
Other
4%
Lease
Receivables
35%
Future Flow
22%
Consumer
Loans
27%
5
Growth of Housing Loans
6
Moody’s Rating
Methodology
7
Moody’s Global Rating Scale
Gilt edged
Aaa
Very high
Aa1
Aa2
Aa3
Upper-medium
A1
A2
A3
Medium grade
Baa1
Baa2
Baa3
Questionable
Ba1
Ba2
Ba3
Poor quality
B1
B2
B3
Very poor
Caa1
Caa2
Caa3
Ca
C
short term
Prime-1
Prime-2
Prime-3
Not Prime
Investment Grade
long term
Speculative Grade
Quality of credit
8
Moody’s Rating – Expected Loss



Ratings measure credit risk:

Probability of a default

Severity of a loss
Expected loss = Probability of default x Severity
Example:
– Prob. Def. = 5%
– Severity of Loss = 20% (recovery rate = 80%)
– EL = 5% x 20% = 1%
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Moody’s Idealised Expected Loss Table
R a ting
1
2
3
4
Ye a r
5
6
7
8
9
10
Aaa
0.00003% 0.00011% 0.00039% 0.00099% 0.00160% 0.00220% 0.00286% 0.00363% 0.00451% 0.00550%
Aa1
0.00031% 0.00165% 0.00550% 0.01155% 0.01705% 0.02310% 0.02970% 0.03685% 0.04510% 0.05500%
Aa2
0.00075% 0.00440% 0.01430% 0.02585% 0.03740% 0.04895% 0.06105% 0.07425% 0.09020% 0.11000%
Aa3
0.00166% 0.01045% 0.03245% 0.05555% 0.07810% 0.10065% 0.12485% 0.14960% 0.17985% 0.22000%
A1
0.00320% 0.02035% 0.06435% 0.10395% 0.14355% 0.18150% 0.22330% 0.26400% 0.31515% 0.38500%
A2
0.00598% 0.03850% 0.12210% 0.18975% 0.25685% 0.32065% 0.39050% 0.45595% 0.54010% 0.66000%
A3
0.02137% 0.08250% 0.19800% 0.29700% 0.40150% 0.50050% 0.61050% 0.71500% 0.83600% 0.99000%
Baa1
0.04950% 0.15400% 0.30800% 0.45650% 0.60500% 0.75350% 0.91850% 1.08350% 1.24850% 1.43000%
Baa2
0.09350% 0.25850% 0.45650% 0.66000% 0.86900% 1.08350% 1.32550% 1.56750% 1.78200% 1.98000%
Baa3
0.23100% 0.57750% 0.94050% 1.30900% 1.67750% 2.03500% 2.38150% 2.73350% 3.06350% 3.35500%
Ba1
0.47850% 1.11100% 1.72150% 2.31000% 2.90400% 3.43750% 3.88300% 4.33950% 4.77950% 5.17000%
Ba2
0.85800% 1.90850% 2.84900% 3.74000% 4.62550% 5.37350% 5.88500% 6.41300% 6.95750% 7.42500%
Ba3
1.54550% 3.03050% 4.32850% 5.38450% 6.52300% 7.41950% 8.04100% 8.64050%
B1
2.57400% 4.60900% 6.36900% 7.61750% 8.86600%
B2
3.93800% 6.41850% 8.55250%
B3
Caa
6.39100% 9.13550% 11.5665% 13.2220% 14.8775% 16.0600% 17.0500% 17.9190% 18.5790% 19.1950%
14.3000% 17.8750% 21.4500% 24.1340% 26.8125% 28.6000% 30.3875% 32.1750% 33.9625% 35.7500%
9.1905%
9.7130%
9.8395% 10.5215% 11.1265% 11.6820% 12.2100%
9.9715% 11.3905% 12.4575% 13.2055% 13.8325% 14.4210% 14.9600%
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Expected Loss Curve
Probability (interval of 0.1%)
10%
Expected Loss
8%
6%
4%
Standard Deviation
2%
Aaa expected
loss over WAL
0%
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
Cum. loss rate
11
Rating Process: Qualitative and Quantitative
a
u
Q
ive
t
lita
•Origination sources
•Underwriting quality
•Management level
•General risk factors
•Economic trends
Loan/Pool
Analysis
Qu
an
i ve
t
tita
•Loan-by-loan analysis
•Pool characteristics
•Statistical and
quantitative modeling
•Deal Structure
•Parties involved
•Legal/ tax issues
Deal and
Securities’
Structure Analysis
•Discussion of all factors
•Checking models’
•reasonableness
•sensitivity
•Benchmarking vs.
similar deals
•Final vote
Rating
Committee
•Pool cash flows
•Models review
•Default frequency and
•Tranching and
timing, loss severity
enhancement
•Payment priorities
•Spread analysis
•Performance/ cash triggers
•Tranching/ credit enhancement
12
Mortgage Backed Securities (RMBS) - 1
RMBS Asset analysis

Moody’s Individual Loan Analysis – “MILAN”

Is a Scoring Model,
– Each single loan compared to a benchmark loan
– Adjustments for deviations from benchmark
– The total portfolio to a benchmark portfolio

Result of in depth analysis and comparison of major
European RMBS markets

Standardised, but addresses country specific features

Able to analyse multi-seller/country pools
13
Mortgage Backed Securities (RMBS) - 2
RMBS Asset Analysis
Default
Definition
Benchmark Frequency
Benchmark
Loan
Loan
(Step 1)
(Step 2)
AdjustLoss
ments:
Severity
Benchmark single
Benchmark CE
loan
Loan
&
(Step 3)
(Step 4)
portfolio
MILAN
Aaa CE
(Step 11)
Total
Aaa CE
(Step 12)
Final
Aaa CE
(Step 13)
Qualitative and quantitative CE adjustments
CE adjustment due to replenishment, tranching, etc.
MILAN Inputs and Outputs are subject to
Rating Committee Decision
14
Mortgage Backed Securities (RMBS) - 3
“MILAN” Adjustments – Why?

Captures additional default, loss and volatility drivers
(deviation from benchmark and “no data“)
– For each single property
– Account for certain loan aspects
– Based on borrower characteristics
– Addressing seasoning and performance aspects
– For originator/servicer quality
– Diversification issues of the portfolio

Adjusting for structural aspects
– Revolving portfolio – future asset profile
15
Asset Backed Securities (ABS) - 1
Asset Analysis: Distribution Parameters

Mean & Standard Deviation

Based on historical originator data
– Static/dynamic
– Sub-Pools
– Consistency
– Extrapolation of short data series

Conservative view on Standard Deviation
– Stress for Recession scenario
16
Asset Backed Securities (ABS) - 2
Asset Analysis: Static Performance Data
Cumulative Losses
Months after origination
up to 12
up to 24
up to 36
up to 48
up to 60
up to 72
1996
1997
1998
1999
2000
2001
1.40%
0.80%
1.10%
0.90%
0.70%
1.00%
2.50%
1.80%
1.90%
1.90%
2.10%
3.20%
2.30%
2.60%
2.50%
3.50%
2.60%
2.90%
3.70%
2.70%
4.00%
Historical Cumulative Losses
5%
Cumulative Losses
4%
4%
3%
1996
1997
1998
1999
2000
2001
3%
2%
2%
1%
1%
0%
up to 12
up to 24
up to 36
up to 48
up to 60
up to 72
17
Asset Backed Securities (ABS) - 3
Asset Analysis: Extrapolated Performance Data
Months after origination
1996
1997
1998
1999
2000
2001
Average
Standard Deviation
Extrapolated Cumulative Losses
up to 12
up to 24
up to 36
up to 48
1.40%
0.80%
1.10%
0.90%
0.70%
1.00%
2.50%
1.80%
1.90%
1.90%
2.10%
2.30%
3.20%
2.30%
2.60%
2.50%
2.80%
3.00%
3.50%
2.60%
2.90%
2.80%
3.10%
3.40%
up to 60
up to 72
3.70%
2.70%
3.00%
2.90%
3.20%
3.50%
4.00%
3.00%
3.30%
3.20%
3.50%
3.80%
3.40%
0.38%
Extrapolated Cumulative Losses
Cumulative Losses
5%
4%
3%
2%
1%
0%
up to 12
up to 24
up to 36
up to 48
up to 60
up to 72
1996
1997
1998
1999
2000
2001
18
Asset Backed Securities (ABS) - 4
Asset Analysis: Adjustments to Distribution Parameters

Possible for both parameters
– Trends impact Mean
– Uncertainty impacts Standard Deviation

Pool dependent
– Composition (asset criteria, limits)
– Age of assets (“Seasoning“)

Originator/Servicer dependent
– Performance trend
– Change of credit policy (underwriting, servicing)
19
Asset Backed Securities (ABS) - 5
The Model: Links Assets and Liabilities

Standard model (“ABS ROM“) – technical frame
– Models deal specific features

Reflection of cash flow structure (“Waterfall“)

Beside distribution, other inputs:
– Timing of defaults/losses
– Recovery rates and time of recovery
– Amortisation profile, transaction expenses
– Triggers (variety possible, specific impact )
20
Issues in New
Markets
21
Issues to Watch: Securitisations In New markets

Legal and regulatory environment

Organisation of financial sector

Interest and currency exchange rate risk

Sovereign rating

Systemic risks - Local Currency Guidelines (LCG)

Objectives of issuers and investors

Extent of government support
Importance of Legal Environment

Bankruptcy laws – true sale, claw back, commingling,
set-off

Security interest and claim priorities

Enforceability

For future flow deals – isolation of cashflows abroad

Consumer protection laws/policy
– notification to borrowers
– data disclosure
– usury

Tax issues: corporate, transfer, withholding or other

Specific securitisation law
23
Two Main Elements That Could Reduce the Rating

Systemic risks
– Include financial stability, legal, regulatory, quality of
data, risk of fraud
– Affect ALL debt issued in the country, whether LC or FX

Transferability and Convertibility risk
– Address the potential impossibility of paying FX to
offshore investors in the event of moratorium coupled
with FX restrictions by the government
– Affect only FX debt
24
Risk Layers and Rating Scales
Political risk
Systemic risks
Legal
Structure
Assets
Origination
Serivicng
History
Currency
swap
IR swap
Liquidity
Back-up
servicing
-------------
Transferability
Convertibility
Expropriation
--------------------
Enforcement FXFraud risk
Global Scale
Payment
systems
Quality of
data/IT
LCNational Overall
stability
Scale
-----------(NSR)
LCGlobal Scale
25
Piercing the Sovereign “Ceiling” – How?
Aaa
A rating can exceed the LCG
only by an external guarantee
or insurance “wrap”
Sovereign ceiling may be pierced
based on: (1) highly rated local
currency obligation combined
with (2) liquidity facility or
political risk insurance
S
Y
S
Credit
T
Enhancement:
E
subordination,
M
reserve, excess
I
spread
C
Assets
Credit
Quality
R
I
S
K
S
L
E
G
A
L
R
I
S
K
S
Country’s local currency Guidelines
(LCG)
A1 for Russia
Country’s foreign
currency ceiling
A2 for Russia
26
Sovereign Ceilings and Local Currency Guidelines
27
Final Thoughts
28
Russia – Outlook for Securitisations



Tremendous growth of consumer and mortgage
lending will continue to generate future MBS/ABS
Improvements of laws/regulations to facilitate
securitisations should relieve existing uncertainties
Deal flow is expected to expand to other asset classes
– CDOs, leases, SMEs, infra-structure

Local securitisations are expected shortly (MBS)

Multi originators structures
29
Ten Commandments – Preparation For a Transaction
1.
Discuss legal issues EARLY with lawyers & rating agency
2.
Decide (and discuss with us) rating target
3.
Evaluate what enhancement/structure may be needed
4.
Prepare portfolio data, including data format
5.
Organise historical performance data
6.
Consider back-up servicer
7.
Determine structure
8.
Assess external support (PRI, wrap, guarantee)
9.
Plan deal timetable reasonably
10.
Prepare strategy for future transactions
30
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Contact: [email protected]
31