Programwide credit enhancement (PWCE) is an essential component in the analysis of global ABCP programs, according to a new Fitch Ratings report.
The rating agency stressed the importance of the availability of PWCE for traditional ABCP programs, along with liquidity protection and sponsor quality. The rating agency believes that this level of credit enhancement has played a major role in the sector's relative resiliency in the current challenging credit and funding environment.
"Throughout the credit crisis, programs with PWCE were recognized for having an additional layer of credit protection and generally perceived as lower risk," said Michael Dean, managing director and U.S. ABCP group head. He also noted that many global ABCP programs have recently added or increased the size of existing PWCE facilities to further protect investors and reduce potential volatility.
Fitch said the availability of PWCE has always been a key consideration for the agency in its analysis of ABCP programs and its assignment of top short-term ratings, since it is difficult to achieve the highest short-term ratings of âF1+' without PWCE, absent other structural mechanisms or full support features.
The PWCE facilities are "available to absorb losses in the event individual conduit funded transaction losses exceed their dedicated transaction specific credit enhancement levels," said Fitch Managing Director Darryl Osojnak.
He said that they align the interests of the bank sponsor and ABCP investors, as a PWCE support facility would be written down and exhausted before ABCP investors take a hit.
Though the majority of the Fitch-rated ABCP programs globally are supported by PWCE, other structural protections are instituted to reduce the need for PWCE in cases where they do not benefit programs.
These include: fully enhanced underlying transactions; asset eligibility limited to âAAA' exposure only; springing PWCE requirements in the case of portfolio deterioration; or, asset ejection mechanisms, as in the case of many securities-backed vehicles, where assets are sold or put to liquidity providers in the event of downgrades.
Fitch's ABCP analysis consists of a review of the conduit's sponsor, program structure, legal documentation, investment guidelines, collateral composition and credit enhancement and liquidity facilities.
The agency focuses on the structure and characteristics of individual conduit transactions and may also apply a portfolio level analysis to quantify the credit risk on a program's overall portfolio.
For more granular pools, this portfolio approach utilizes a default simulation model to measure the conduit's PWCE amount, which simulates the default behavior of individual assets and allows for the modeling of the distribution of portfolio defaults and losses, taking into account default probabilities and recovery rates, as well as the correlation between assets in a given portfolio. The key inputs into this model include asset rating, notional amount and collateral type.
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