RMBS Rating Methodology

1
RMBS Rating Methodology
Clementine Kiang Oct. 16th, 2003
2
RMBS Rating Methodology

• Mortgage loan and property market research
• Determine market value decline under the worst
  case scenario
• Determine expected loss and required credit
  enhancement under the worst case scenario

3
Property Review

• Real estate historical trend
• Research on macroeconomic factors
• affecting housing
• - Housing market supply and demand
• - Economic growth
• - Unemployment rate
• - Mortgage interest rate

4
Costs and Risks of Residential Mortgages

• Loan market research
• - Residential loan market size
• - Underwriting process
• - Government subsidy program
• Property transaction process and costs
• Foreclosure process
• Mortgage loss experience
• Insurance

5
Credit Risk Analysis

• What is the likelihood that an obligor will
  default or not make payments in accordance with
  the terms of the related loan agreement?
• If the obligor does default, how much will be
  lost relative to the original amount of the loan
  with respect to the loan agreement?

6
Credit Risk

• Why do we need to quantify credit risk?
• To know how much credit support is required at
  particular rating categories

Required credit support
Default Frequency
Loss Severity
Expected losses
X

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Other Risks

• Credit risk is only one of the risks in a
  securitization structure
• The required credit support will also size other
  risks such as commingling risk, set-off risk, and
  servicer transition risk

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RMBS Rating Methodology-Expected Credit Loss
Assumption

• Start with a benchmark pool
• Determine loss severity under different rating
  levels
• Determine default frequency under different
  rating levels
• Adjust loss severity of the benchmark pool to
  reflect risks of the loan pools

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Benchmark Pool

• Pool size - minimum 300 loans
• Loan term - 25 years
• Max loan size - Taipei NT6 million others
  NT3.5million
• Loan to value - maximum 70
• Geographic dispersion (by postal code)
• - maximum Taipei 10 others 5
• Borrower status - salaried or professional
• Property features - less than 10 years or in
  prime location
• Loan record - no delinquent within the past 24
  months
• Use of funds - purchase home no equity take-out

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Determine Loss Severity -Market Value Decline
Assumption

• Based on loss experience, real estate status and
  macroeconomic conditions
• Determine the maximum market value decline in the
  worst case scenario of its rating level
• Categorize market value decline into four
  regions Taipei city, northern Taiwan, central
  Taiwan and south Taiwan

11
Determine Loss Severity

• Original property value
• Market value decline
• Auction discount
• Selling costs
• Legal costs
• Accrued interest

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Market Value Decline Assumption

• twAAA - twBBB
• Taipei City 30 - 18 Northern
  Taiwan 36 - 24 Central Taiwan 48 - 36
• South Taiwan 48 - 36
• the ratio applies the benchmark pool only

13
Loss Severity Assumption

• twAAA - twBBB
• Taipei City 55 - 32 Northern
  Taiwan 61 - 38 Central Taiwan 72 - 52
• South Taiwan 72 - 52
• the ratio is subject to change to reflect risks
  of the loan pools

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Credit Loss Assumption

• Default frequency x loss severity expected
  credit loss -----gt required credit support
• Default probability twAAA - twBBB
• 11 -
  5
• Expected credit loss
• twAAA
  - twBBB
• Taipei City
  6.1 - 1.6
• Northern Taiwan 6.7
  - 1.9
• Central and Southern Taiwan 7.9 - 2.6
• the ratio applies the benchmark pool only

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RMBS Case Study

• NT
  mil.
• Class A twAAA 4,200
• Class B twAA 250
• Class C twA 150
• Class D twBBB 125
• Class E non-rated 275
• 5,000

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Transaction Features

• Backed by NT5 billion residential mortgages
• Floating rate mortgage using one year time
  savings deposit rates
• Floating rate certificate using 90 day commercial
  paper rate
• The final legal maturity date is 24 months after
  the last scheduled payment of the loan

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Certificate Payment

• Interest payments of senior certificates will be
  made before subordinated certificates
• Principal payment of senior certificates will be
  made before subordinated certificates
• When default trigger is reached, the trust will
  accelerate repayment of principal to certificate
  holders

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Risks in the Structure

• Interest rate risk
• Prepayment risk
• Commingling risk
• Set-off risk
• Servicer transition risk

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Interest Rate Risk

• Basis risk exists because interest received from
  mortgages is based on one year savings deposit
  rate but interest paid to certificate holders is
  based on 90 day commercial paper rate
• Interest spike on savings deposit rate and
  commercial paper rate are simulated and tested in
  the cash flow analysis to ensure timely and full
  payment of interest and principal
• Basis risk can be mitigated through swap

20
Prepayment Risk

• Prepayment is not a credit risk. The likelihood
  of default is reduced if the borrower prepays
• If the borrower prepays, accrued interest on
  loans will be paid only up to the repayment date
• Interest received in the trust will be less than
  expected leading to insufficient funds to meet
  payment obligations to certificate holders
• The cash flow models simulate different
  prepayment assumptions to see impact on the cash
  flow

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Commingling Risk

• The servicer will remit monies collected to the
  trust one day after monies are received
• Commingling risk occurs if the servicer is
  insolvent and the monies belonging to the trust
  are not remitted to the trust
• Commingling risk is mitigated either by setting
  aside a reserve or by increasing the issuance
  weighting of the most junior class certificate to
  absorb losses

22
Set-off Risk

• If the originator is insolvent, borrowers can
  set-off their deposits against their loans with
  the originator if such deposits exist prior to
  the closing of the securitization transaction
• Set-off risk is sized according to obligors
  deposit amount as of the closing date
• No set-off risk will be sized if obligors do not
  have deposits with the originator before closing

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Servicer Transition Risks

• If the master servicer is not able to perform its
  duties, the rights and obligations of the master
  servicer will be terminated
• The back-up servicer will assume the obligations
  and duties of the master servicer
• Servicer transition risks exist during the
  transition period
• Certificate interest and senior fees are sized
  and kept as liquidity reserve during the life of
  the transaction

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Other Considerations

• True sale
• SPT bankruptcy remoteness
• Transfer of properties to the trust
• Foreclosure of properties
• Tax ruling/tax opinions

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What Ratings Do Not Address

• The early maturity of the certificates due to
  prepayment
• Total return of the certificates
• Likelihood of downgrade
• Fraud and mistakes on the part of the issuer