The current crisis has drawn into sharp focus concerns that structural features in some securitization transactions may need to be re-assessed to ensure they are adequate in mitigating the impact arising from possible failures of servicers or other transaction parties. Moody's believes that the performance of a securitization transaction depends not only on the underlying collateral performance but also on the effective performance by such transaction parties of their responsibilities. Our November 2009 publication on this topic, Operational Risks in Securitizations to be Revisited, cites several occurrences where nonperformance of a transaction party may have detrimental effects on a transaction's performance regardless of the underlying pool's performance. We refer to this risk as "operational risk,"
In light of this, Moody's published a special report in May 2010, Global Structured Finance Operational Risk Request for Comment, presenting our proposed methodological approach to evaluating the de-linkage of the rating of a structured transaction and the credit quality of important securitization parties. More importantly, the report outlines our fundamental considerations when analysing (i) servicing arrangements (back-up servicer, master servicer, third-party servicer) for 'Aaa'-rated securitizations which feature a true sale of the collateral to an issuing entity, (ii) cash manager/calculation agents when this responsibility is assumed by a third party unrelated to the servicer and (iii) liquidity standards necessary to achieve 'Aaa' ratings. We invite participants in the structured finance market to review and comment on our proposals on operational risk. Comments are welcome through June 15 and should be sent to email@example.com. The final report is scheduled to be released in July 2010.
We recognize that there are regional differences in the role and availability of certain transaction parties and therefore our proposed global framework addresses how operational risk in transactions may also vary as a result. For example, U.S. assets (such as RMBS and prime auto) are characterised by a history of servicing transfers, the availability of a number of third-party servicers able to quickly take over servicing and trustees who are responsible for finding a successor servicer or servicing the portfolio if the servicer defaults. The relative abundance of replacement servicers is also observed in the Asia Pacific region for most asset types, although there have been limited servicing transfers to date. On the contrary, EMEA may be more vulnerable to successor servicer risk given a more fragmented servicing market with fewer available potential replacement servicers and less history of servicing transfers. In addition, trustees in most EMEA securitizations do not have the contractual responsibility for servicing or facilitating a transfer.
The differences also extend to the role of cash manager/calculation agents responsible for managing cash belonging to the issuer on behalf of the issuer. Cash managers are also responsible for tracking the performance of the receivables and calculating the distribution of transaction cash flows. In most U.S. securitizations, the servicer fills the role of cash manager/calculation agent while in Japan, the trustee generally assumes this function. In EMEA, the cash manager/calculation agent responsibility is often assumed by a third-party unrelated to the servicer.
The trustee in U.S. transactions plays a wider role than its counterparts in EMEA and would also, in general, hold cash on behalf of the issuer and act as successor servicer or managing servicing transfers if the original servicer is no longer able to function as servicer. In Japan and Australia, the trustee is the owner of the receivables and delegates servicing operations to the servicer. This important difference in roles between trustees in U.S./Asia -Pacific and EMEA highlights the need for committed back-up arrangements in EMEA securitizations.
In general, our proposed approach on servicing arrangements considers thresholds to achieving 'Aaa' ratings based on the ease of potential servicing transfers (see tables).
On Cash Management/Calculation Agents
Given the responsibility of the cash manager (CM) in managing, amongst other things, cash belonging to the issuer on behalf of the issuer, third-parties performing this role are expected to be rated or credit assessed to be investment grade. We expect that a back-up CM would be appointed if the third party is not assessed to be investment grade either at closing or during the course of the transaction.
We recognize, however, that certain third parties may provide services expected of a CM to securitizations as their primary business model and these entities may not be rated nor credit assessed to be investment grade. In some situations, a third party rated at least 'Ba3'/'B1' (or equivalent) may perform the role of a CM provided it satisfies certain other criteria regarding governance, business model, financial stability, size and ownership.
A third-party CM may rely on information on the underlying collateral periodically provided by the servicer in order to calculate the amounts due and make distributions of transaction cash flows. To mitigate this risk, we expect the obligations of the CM to be performed even where information is not available through use of appropriate alternative means of calculations.
Given that the temporary non-performance of responsibilities by transaction parties or a stay arising in a bankruptcy of a transaction party may give rise to cash disruptions, we believe that adequate liquidity in a transaction should be available to support interest payments on the notes during the interruption period. Whilst the form of liquidity may differ across asset classes and regions, the sizing of sufficient liquidity should be dictated by the event potentially causing the longest period of interruption.
We believe that appropriate transaction liquidity depends on a range of factors, including (but not limited to) the rating of the sponsor, the type of assets securitized and the presence of a back-up servicer(s) in the market. In CMBS, the jurisdiction of the borrower and/or the underlying properties securing the loans in the portfolio would also be a relevant consideration.
All transactions should have a reliable source of liquidity in an appropriate amount. In ABS transactions, for example, liquidity is typically sized to cover not less than three to six months of interest payments whereas liquidity may cover up to 18 to 36 months for EMEA CMBS transactions.
The proposed approach is not intended to be immutable but subject to potential adjustment based on transaction specific characteristics. In some situations, a transaction may still achieve 'Aaa' ratings without the full range of operational risk mitigants considered by Moody's. However, the rating on such transactions will be more linked to the rating of the relevant transaction party and therefore may have a higher risk of downgrade.
Investment Grade Sponsors or Third Party Servicers
Low risk: assets serviceable by third parties, such third parties exist, servicing transfer is straightforward, good history of transfers and market rate for servicing is known and sized.
* In general, a back-up servicer ("BUS") facilitator is expected at loss of 'A3' (or from closing if servicer is rated lower).
Medium risk: assets serviceable by third parties but market for 3rd parties does not exist, third parties limited, transfers may be difficult, limited history of transfers and/or market rate is unclear.
* In general, a "warm" BUS is expected upon loss of Baa3 and the transaction has sufficient liquidity and credit enhancement.
High risk: assets are literally or effectively not serviceable by or transferable to third parties or transferable/serviceable with great difficulty.
If servicing is not transferable, the servicer is expected to be rated 'Aa3' or above. Where servicing is transferable but with great difficulty, a warm BUS is expected at closing if the servicer is rated below 'A3'.
Non-Investment Grade Sponsors
Medium risk: assets serviceable by 3rd parties and the servicer is rated 'Ba3'/'B1' and above.
* In general, a BUS is expected at closing and if arrangements are "cold", the transaction should have sufficient liquidity and credit enhancement. A short-term 'P-1' rating may be achievable in the U.S., but in no other regions.
High risk: assets serviceable by third parties and servicer is rated below 'B2' or unrated and satisfies certain other criteria regarding governance, business model, financial stability, size and ownership.
* In general, a "warm" BUS is expected at closing provided the transaction has sufficient liquidity and credit enhancement. A short-term 'P-1' rating is not achievable in any region.
The exception: assets serviceable by 3rd parties and either (i) the servicing platform/franchise value is likely to remain intact during bankruptcy or (ii) the servicer is a deposit-taking institution of sufficient size assumed to have strong government support so that servicing functions will continue.
* If the servicer is a "mega-platform", generally a BUS facilitator is required at closing.
* If the servicer is a large issuer but not "mega-platform", generally a "warm" BUS is expected at closing.
* Non-standard assets would be considered on case-by-case basis and a short-term 'P-1' rating may be achieveable on a case-by-case basis.