Moody's Investors Service has assigned definitive ratings to four tranches of an unfunded credit default swaps (CDS) pursuant to Trade Finance Transaction #11, where Standard Chartered Bank ("SCB") is the credit protection buyer, and Standard Chartered Bank (Hong Kong) Limited is the credit protection provider:
- Us$40 million A Tranche in relation to the 16.18% to 17.18% tranche, definitive rating assigned Aaa (sf)
- Us$40 million B Tranche in relation to the 15.18% to 16.18% tranche, definitive rating assigned A1 (sf)
- Us$261.2 million C Tranche in relation to the 8.65% to 15.18% tranche, definitive rating assigned A3 (sf)
- Us$80 million D Tranche in relation to the 6.65% to 8.65% tranche, definitive rating assigned Baa3 (sf)
The ratings measure the risk, on an expected loss basis, that the credit protection provider will be required to make payments in respect of credit events under the terms of the transaction.
The ratings also address any premiums due but not paid by the credit protection buyer, up until an early termination date, if any.
The ratings do not address the potential losses resulting from an early termination of the transaction, nor any market risk associated with the transaction.
Moody's ratings address only the credit risks associated with the transaction. Non-credit risks have not been addressed, but these may have a significant effect on the yields to investors.
Trade Finance Transaction #11 is a synthetic balance-sheet collateralized loan obligation (CLO) transaction. It aims to transfer the mezzanine credit risk (from 6.65% to 17.18%) of a USD4 billion reference portfolio to the credit protection provider.
The transaction's legal maturity date is in 5 years, and is scheduled to terminate 2 years after the closing date, if all credit events (if any) are settled, subject to any early termination events.
The reference portfolio consists of corporate trade financing obligations that meet certain criteria with respect to creditworthiness and diversity. These obligations are initially originated by SCB and its affiliates, mostly in Asia and other emerging market countries.
The credit protection buyer and provider had not executed the CDS contract, which deems the transaction as non-enforceable.
However, Moody's has considered the presence of a parallel enforceable transaction, which is expected to share the same reference portfolio throughout the entire transaction term, but references the lower part of capital structure -- the detachment point of the parallel transaction equals the attachment point (6.65%) of the bottom tranche of the rated transaction.
Moody's has evaluated the legal integrity of the parallel transaction, as well as the presence of substantially similar terms and conditions and other features, including the identical portfolio shared by this transaction and the parallel transaction.
Moody's will receive periodic reference portfolio reports and other transaction reports to monitor the credit risk of the portfolio. The parallel transaction is not rated by Moody's.
The credit protection provider will provide credit protection against the occurrence of credit events in the reference portfolio. Credit events in the transaction are defined as bankruptcy, failure to pay, and restructuring.
The occurrence of a credit event, the compliance to the eligibility criteria and replenishment conditions, as well as the computation of any losses, would be verified by the accountant of the transaction.
SCB can replenish loans or other exposures that have been paid or reduced with new exposures by adding new reference obligations, or increasing the notional amount of existing reference obligations within the first 21 months from the closing date ("replenishment period").
This process is subject to the satisfaction of eligibility criteria and replenishment conditions including (but are not limited to):
- Reference obligations with low internal credit ratings not exceeding certain limits
- Weighted average life of the portfolio is less than 91 days
- Tenor of any reference obligation not exceeding 366 days
- Concentration in each of the countries not exceeding the specified amounts
- Concentration in each of the industries not exceeding the specified amounts
- Reference entity not being recorded on SCB's early alert review system
- H -Score (a measurement of obligor concentration) not being lower than 200
For each defaulting obligation, the actual recovery will be received through the loan workout process in accordance with SCB's standard procedures. SCB will continue the workout process until it is formally concluded or the defaulted obligation is sold.
If the workout process is completed before 60 business days prior to the legal maturity date, the loss amount for the defaulted obligation will be based on the actual recovery.
Otherwise, it will be calculated based on the loan loss provision per SCB standard provisioning policy and/or the loss determined through the market value quotation process.
The main drivers of Moody's analysis of this transaction are:
- 3.78% annualized weighted average default rate assumption of the hypothetical reference portfolio -- Moody's has constructed a distressed hypothetical portfolio based on the eligibility criteria and replenishment conditions. The default rate assumption is primarily determined by credit mapping and stresses that Moody's applies as part of its rating methodology.
- 30% weighted average recovery rate assumption of the hypothetical portfolio.
- 4.31% weighted-average pair-wise asset correlation assumption of the hypothetical portfolio for simulating the default distribution.
- Exposure limits to each country based on country ceilings and available credit enhancement to each tranche.
- Attachment point and the detachment point for each of the four tranches.
- Structure of the transaction, including the replenishment guidelines, cumulative default triggers, and the legal documentation.
The initial portfolio comprises 14,721 reference obligations of 1,679 corporate reference entities. Most of the reference obligations are short-term senior unsecured loans.
Only a small portion of the reference portfolio will have Moody's public ratings. For the remaining portfolio, the credit quality of each of the reference entities is assessed based on a credit mapping between SCB's internal rating scale and Moody's public rating scale, which was last updated in February 2014. The initial reference portfolio has a weighted-average credit quality corresponding to a Ba3 rating based almost entirely on credit mapping.
In terms of geographical diversification, approximately 54% of the initial portfolio is concentrated in Asia, and most of the remainder in the Middle East and North Africa (16%), the Indian Subcontinent (16%), and Europe (7%).
The top five countries are Hong Kong (16%), India (14%), United Arab Emirates (13%), China (12%), and Singapore (11%).
The top four industries in the initial reference portfolio were wholesale (16%), energy: oil and gas (9%), consumer goods: durable (8%), and consumer goods: non-durable (7%).
The principal methodology used in this rating was Moody's Approach to Rating Corporate Synthetic Collateralized Debt Obligations published in November 2013.
Loss and Cash Flow Analysis:
Moody's CDOROM model was used in conjunction with a separate cash flow model, Moody's ABSROM model, to measure the potential expected loss incurred by the credit protection provider in this transaction.
The CDOROM model performs a Monte Carlo simulation that uses Moody's default probability assumption as input. Each obligor is modeled individually, with a standard multi-factor model incorporating intra-and inter-industry correlations.
The correlation structure is based on the Gaussian copula. In each Monte Carlo scenario, defaults are simulated.
The CDOROM model will generate the default distribution of the hypothetical portfolio. The default distribution generated by CDOROM will serve as input in the ABSROM.
The ABSROM can model: (1) the revolving nature of the portfolio, (2) the assumed loss for each default, (3) the loss allocation in accordance with the documented order of priorities, and (4) the effect of the cumulative default trigger to end the replenishment period before its scheduled date.
As such, the ABSROM model calculates the loss incurred by the credit protection seller under each default scenario, which, combined with the probability assigned by the CDOROM model to that default scenario happening, allows for the computation of the expected loss of each tranche.
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