April 1999

Structured Finance
Australia & New Zealand

Mortgage-Backed Securities

Asset-Backed Commercial Paper

Trade Receivables

Equipment Finance

Auto Loans

Credit Cards

Commercial Real Estate

 Structured Finance Australia & New Zealand ¨ April 1999

Structured Finance Contacts

STRUCTURED FINANCE LATIN AMERICA
Vickie Tillman, Executive Managing Director, Rosario Buendia, Director, ph: (1) 212-208-1195
ph: (1) 212-202-1854
EUROPE
CRITERIA AND CHIEF QUALITY OFFICER London
Thomas G Gillis, Managing Director, Kurt Sampson, Managing Director, ph: (44) 171-826-3535
ph: (1) 212-208-1573
Paris
STRATEGIC PLANNING/NEW PRODUCTS/ Alain Carron, Director, ph: (33) 1-4420-6664
BUSINESS PLANNING
ASIA-PACIFIC
Christopher Dalton, Managing Director,
ph: (1) 212-208-6007 Hong Kong
Calvin Wong, Managing Director,
NORTH AMERICA—RESIDENTIAL MORTGAGE ph: (852) 2533-3501
Frank Raiter, Managing Director, ph: (1) 212-208-8610 Melbourne
Edward Burbage, Director, ph: (61) 3-9631-2050
REAL ESTATE FINANCE David Bleakley, Rating Analyst, ph: (61) 3-9631-2057
Gale Scott, Managing Director, ph: (1) 212-208-8014 Mei Lee Da Silva, Director, ph: (61) 3-9631-2053
Fiona De Cata, Research Assistant, ph: (61) 3-9631-2060
GLOBAL ASSET-BACKED SECURITIES Luke Elder, Associate, ph: (61) 3-9631-2056
Pat Jordan, Managing Director, ph: (1) 212-208-1884 Jacqueline Fox, Rating Specialist, ph: (61) 3-9631-2028
Vera Ha, Associate, ph: (61) 3-9631-2058
NEW ASSETS Kate Leatham, Administrative Assistant, ph: (61) 3-9631-2051
Richard Gugliada, Managing Director, Corwin Leung, Director, ph: (61) 3-9631-2062
ph: (1) 212-208-5534 Roy Majoe, Associate, ph: (61) 3-9631-2052
Fabienne Michaux, Director, ph: (61) 3-9631-2054
NORTH AMERICA—ASSET-BACKED SECURITIES Ashley Reed, Associate Director, ph: (61) 3-9631-2061
Joseph F Sheridan, Managing Director, Fiona Steel, Associate, ph: (61) 3-9631-2059
ph: (1) 212-208-1975
Tokyo
Yu-Tsung Chang, Director, ph: (81) 3-3593-8724

Standard & Poor’s Asia-Pacific Offices

ASIA-PACIFIC MANAGING DIRECTOR MELBOURNE
Cecile Saavedra, Managing Director Graeme Lee, Managing Director
30 Cecil Street Level 37, 120 Collins Street
Prudential Tower #17-01/08 Melbourne 3000 Australia
Singapore 049712 ph: (61) 3-9631-2000, fax: (61) 3-9650-6349
ph: (65) 438-2881, fax: (65) 438-2320
SINGAPORE
HONG KONG Surinder Kathpalia, Director and General Manager
Lincoln Chan, Director and General Manager 30 Cecil Street, Prudential Tower #17-01/08
Suite 3601, 36/F Singapore 049712
Edinburgh Tower ph: (65) 438-2881, fax: (65) 438-2320
The Landmark
15 Queens Road TOKYO
Central, Hong Kong Thomas Schiller, Managing Director
ph: (852) 2533-3500, fax: (852) 2533-3599 Yamato Seimei Bldg. 19F,
1-1-7 Uchisaiwaicho
Chiyoda-ku, Tokyo 100-0011 Japan
ph: (81) 3-3593-8700, fax: (81) 3-3593-8691

www.standardandpoors.com/ratings
 Structured Finance Australia & New Zealand ¨ April 1999

Table Of Contents
Market Review .................................................. 5 Ratings Index ................................................. 108
Record Year For Australasian Structured Finance ................... 5
Capital Considerations In The Australian Rating Rationales .......................................... 120
Securitisation Market ..................................................... 12 Abel Funding Pty. Ltd. .......................................................... 120
ACE Overseas Ltd. ............................................................... 120
The Rating Process ......................................... 17 ACE Overseas Corp. ............................................................. 120
The Structured Finance Rating Process ................................. 17 Asset Based Financing Trust ............................................... 121
Asset Collateralised Entity Ltd. ........................................... 121
Mortgage-Backed Criteria ............................ 23 Australian Barley Board ....................................................... 122
Australian Residential MBS .................................................. 23 Australian Mortgage Securities Ltd. AMS
New Zealand Residential MBS ............................................. 44 —ARMS II Fund I and Fund II ...................................... 122
Asset-Backed Criteria ............................................................ 46 Australian Securitisation Corp. No. 1 .................................. 122
Auto Receivable-Backed Securities ...................................... 46 Banksia Series 1 Trust ......................................................... 122
CBO/CLO Transactions ........................................................... 50 Brentwood (Australis) Ltd. ................................................... 123
Credit Card Receivable-Backed Securities ............................ 54 BSF Bonds No. 1 Ltd. and BSF Bonds No. 2 Ltd. ................. 123
Equipment Finance-Backed Securities .................................. 57 Burnie Hospital Ltd. ............................................................. 123
Export Receivable-Backed And Future Construction and Development Co. Ltd. .............................. 123
Flow Transactions ........................................................... 62 Corporate Asset Securitisation Australia Ltd. Inc. .............. 124
Real Estate-Backed Securities .............................................. 66 Corporate Australasian
Trade Receivable-Backed Securities ..................................... 69 Securitisation Transactions Pty. Ltd. ............................ 124
Structural Issues And Legal Criteria ...................................... 73 Crusade CP No. 1 Pty. Ltd. ................................................... 125
Australian Interest Rate Criteria For Crusade Euro Trust No. 1 of 1998 ........................................ 125
Structured Finance Ratings ............................................ 73 Crusade Euro Trust No. 2 of 1998 ........................................ 125
Commingling Risk .................................................................. 75 Crusade Trust No. 1 of 1997 ................................................ 126
Criteria For Australian Issuers Of Diners Club Master Trust ..................................................... 126
Segregated Series Of Debt ............................................. 76 Eden Park Trust #1 ............................................................... 126
Due Diligence Review ........................................................... 83 Endeavour Mortgage Trust Funds ........................................ 127
Eligible Deposit Accounts ...................................................... 84 FANMAC Premier Trusts ...................................................... 127
Eligible Investments .............................................................. 85 FATO Ltd. .............................................................................. 127
Guarantee Criteria ................................................................. 86 Financial Assets Specialised Trust No. 1 ............................ 127
Legal Opinions—Overview Of Rating Requirements ............ 87 Financial Assets Specialised Trust No. 2 ............................ 128
Liquidity Facilities In Structured Deals ................................. 90 Financial Assets Specialised Trust No. 3 ............................ 128
Probabilistic Approach To Joint Support ............................... 92 Ford Credit Receivables Trust 1998-1 .................................. 128
Special-Purpose Entities— Generic Loan Asset Securitisation Structures Ltd. ............. 128
Creating A Bankruptcy-Remote Issuer ........................... 94 Home Owner Mortgage Enhanced Securities Ltd. .............. 129
Swaps And Structured Finance ............................................. 97 Home Owner Mortgage Enhanced Securities Ltd.
New Interest Rate And Currency Swap —MTN Program ........................................................... 129
Criteria Broaden Allowable Counterparties ................. 100 Initial Corporate Obligation Notes Pty. Ltd. ......................... 129
Currency Swap Providers Absorb Initial Corporate Obligation Notes Trust ............................. 130
Currency Convertability And Transfer Risks ................. 102 Interstar Securities MBS Program ....................................... 130
‘AAAt’ Swaps Approved In Interstar RD25 Master Trust ................................................ 130
Structured Finance Transactions .................................. 104 Jem Bonds Ltd. .................................................................... 131
Uniform Consumer Credit Code— JEMstone Fund .................................................................... 131
Implications For The Rating Process ............................ 105 JEM Warehouse Bonds Pty. Ltd. ......................................... 132

About This Publication...

Structured Finance Australia and NewZealand features commentary and rating criteria relevant to the
Australian and New Zealand market. If you or your colleagues would like to be added to our circulation
list, or if you require additional copies, please complete and send the tear-out page in this publication, or
contact Kate Leatham on (61) 3-9631-2051 or by facsimile on (61) 3-9650-6027.

Standard & Poor’s 3

 Structured Finance Australia & New Zealand ¨ April 1999

Keystart Bonds Ltd. .............................................................. 132 Rock Trust ............................................................................ 146

Longreach CP Ltd. ................................................................ 132 SABRE New Zealand Ltd. .................................................... 146
MBS New Zealand No. 1. Ltd. ............................................. 133 SABRE Securitisation Ltd. ................................................... 146
MBS New Zealand No. 2 Ltd. .............................................. 133 SBC Warburg Australia Securities Trust No. 1 .................... 147
Medical Mortgages Ltd. ...................................................... 134 Schooner Capital Pty. Ltd. .................................................... 147
MI Trust ................................................................................ 134 SECURE Australia Ltd. ......................................................... 147
Mortgage Corp. of New Zealand No. 2 Ltd. ........................ 134 Secured Asset Funding Entity No. 1 Ltd. ............................. 147
Mount Gambier Hospital Ltd. .............................................. 135 Securitised Australian Mortgage Trust
MTF Securities Ltd. .............................................................. 135 1995-1 and 1996-1 ........................................................ 148
Mustang No. 1 Trust ............................................................ 135 Securitised Australian Mortgage Trust
National Mutual Home Loans Securitisation 1997-1, 1997-2, and 1998-1 ......................................... 148
Funds No. 1 and No. 2 .................................................. 136 Series 1996-1 Torrens Trust ................................................. 148
National Mutual Home Loans Securitisation Series 1998-1 Torrens Trust ................................................. 149
Fund No. 3 .................................................................... 136 Series 1998-2 Torrens Trust ................................................. 149
NSW (Jersey) Ltd. ................................................................ 136 Series 1997-1 CATS Trust .................................................... 149
New Zealand Receivables Corp. Ltd. .................................. 136 Series 1998-1 CATS Trust .................................................... 150
Orion Funding Pty. Ltd. ......................................................... 137 Series 1997-1 Medallion Trust ............................................ 150
Pacific Retail Securities Ltd. ............................................... 137 Series 1998-1 Medallion Trust ............................................ 150
Paper Bond Ltd. .................................................................... 137 Series 1998-1 Medallion Trust ............................................ 151
PAV Hospital Funding Ltd. ................................................... 137 Series 1997-2 and Series 1997-3 WST Trusts ..................... 151
Port Augusta Hospital Ltd. ................................................... 137 Series 1997-4E WST Trust ................................................... 151
POLAR Finance Ltd. .............................................................. 138 Series 1998-1G WST Trust .................................................. 152
Prime Asset Vehicle Ltd. ...................................................... 138 Series 1998-1 REDS Trust .................................................... 152
Prime Asset Vehicle No. 2 Ltd. ............................................ 138 Speirs Securities Ltd. ........................................................... 153
Prime Investment Entity Ltd. ................................................ 139 Structured Prime Asset Receivables No. 2 Ltd. .................. 153
Progress 1997-1 Trust .......................................................... 139 Superannuation Members’ Home Loans
Property Income Investment Trust ....................................... 140 Securitisation Funds No. 1, 2, 3, 4, 5, 6 and 7 ............. 153
PUMA Finance Ltd. .............................................................. 140 SWORD Securitisation Ltd. ................................................. 154
PUMA Masterfund P-5 ........................................................ 140 Symphony Trust No. 1 .......................................................... 154
PUMA Masterfund P-6 ........................................................ 141 Sydney Capital Corp. Inc. ..................................................... 154
PUMA Masterfund E-1 ........................................................ 141 Tasman Funding Inc. ............................................................ 154
PUMA Masterfund E-2 ........................................................ 142 Titan Securitisation Ltd. ....................................................... 155
PUMA Sub-Fund No. 2 ......................................................... 142 Transferable Investment Certificates .................................. 155
PUMA Sub-Funds P-1 and P-2 ............................................. 142 Universal Mirror Trust .......................................................... 156
PUMA Sub-Funds P-3 and P-4 ............................................. 143 Waratah Securities Australia Ltd. ....................................... 156
RAMS Mortgage Corp. Ltd. Series 1, 2, 3 and 4 ................. 143 WB Trust .............................................................................. 157
RAMS Mortgage Corp. Ltd.—Euro Issue ............................ 143 WB Trust - 1998 ................................................................... 157
RAMS Net Interest Margin Ltd. .......................................... 144 WISDOM Prime Asset Trust No. 1 ...................................... 157
Registered Australian Mortgage Securities WST Funding Trust New Zealand Sub-Series 1 .................. 158
Trust No. 4 .................................................................... 144 WST-NZ Series 1998-1 Trust ............................................... 158
Resimac Series 1998-1 Fund ............................................... 144 Zenith Funding Pty. Ltd. ....................................................... 158
Retail Financial Services Ltd. .............................................. 144
RMT Securitisation Trusts No. 1 and No. 2 ......................... 145 Rating Definitions .......................................... 159
RMT Securitisation Trust No. 3 ........................................... 145

Published by Standard & Poor’s, a Division of The McGraw-Hill Companies, Inc. Executive offices: 1221 Avenue of the
Americas, New York N.Y. 10020. Editorial offices: 25 Broadway, New York, N.Y. 10004. Subscriber services:
(61) 3-9631-2000. Copyright 1999 by The McGraw-Hill Companies, Inc. Reproduction in whole or part prohibited
except by permission. All rights reserved. Officers of The McGraw-Hill Companies, Inc.: Joseph L. Dionne, Chairman;
Harold W. McGraw, III, President and Chief Executive Officer; Kenneth M. Vittor, Senior Vice President and General
Counsel; Frank Penglase, Senior Vice President, Treasury Operations. Information has been obtained by Structured
Finance—Australia & New Zealand from sources believed to be reliable. However, because of the possibility of human or
mechanical error by our sources, Structured Finance—Australia & New Zealand, or others, Structured Finance—Australia
& New Zealand does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for
any errors or omissions or for the results obtained from the use of such information.

Standard & Poor’s 4

 Structured Finance Australia & New Zealand ¨ April 1999

Market Review
Record Year For Australasian Structured Finance

Contact: Although the market is showing signs of maturing,

Edward Burbage, Melbourne (61) 3-9631-2050, the general outlook for Australasian structured
David Bleakley, Melbourne (61) 3-9631-2057. finance remains positive. Several key developments
in 1998 should contribute to a healthy market in the
future. A number of new asset types were securitised
during the year, an increased number of first time
AUSTRALASIA 1998 MARKET WRAP/1999 OUTLOOK issuers entered the market, and a few Australian
Ratings of structured finance securities backed by issuers successfully sold securities into offshore
Australasian assets hit another record in the year markets.
ended Dec. 31, 1998. The structured finance group Despite these achievements, in 1999, Standard &
assigned ratings to a record A$21.9 billion of rated Poor’s expects total volume of new ratings on global
mortgage-backed securities (MBS), asset-backed securities backed by Australasian assets to be level
securities (ABS) and asset-backed commercial paper with 1998. This is due to:
(ABCP) programs, supported mainly by Australian
♦ the large increase in asset-backed commercial
and New Zealand assets. Of the amount rated,
paper program commitments which will be
A$16.1 billion was actually issued, representing a
difficult to replicate;
20% increase in new issuance, but down consider-
♦ the shift to major banks in the MBS market, who
ably from the large gains of 70% and 75% for the
are traditionally more selective and will issue only
years ended Dec. 31, 1996 and 1997 respectively
if the pricing is competitive; and
(see chart 1).
♦ the relatively smaller size of transactions backed
The expected slowdown in the growth rate was due
by new asset classes.
in part to the financial turmoil in emerging markets,
which initiated a flight to quality by investors. This Australia
caused significantly wider credit spreads, and Issuance of rated mortgage-backed securities in the
increased the cost to issue structured finance Australian securitisation market remained flat for
securities. the year ended Dec. 31, 1998, falling to A$10.2

Chart 1

Newly Rated Securitisation Transactions For Year Ended Dec. 31*

New issues by securities issued

(bil. A$) New issues by program size
25

20

15

10

0
1995 1996 1997 1998
*Newly rated securitisation transactions as rated by Standard & Poor’s.

Standard & Poor’s 5

 Structured Finance Australia & New Zealand ¨ April 1999

Chart 2

Standard & Poor’s Mortgage Performance Index

4.0 22,000

3.5 20,000
18,000
3.0

(mil. A$ total loans on issue)

(% loan balance in arrears)

16,000
2.5 14,000
2.0 12,000

1.5 10,000
8,000
1.0
6,000
0.5 4,000
0 2,000
Jan-1996 Jul-1996 Jan-1997 Jul-1997 Jan-1998 Jul-1998

90+ days 60-90 days 30-60 days Current loan balance

million in 1998 from A$10.3 million in 1997, after the fourth quarter in 1998. After being the most
several consecutive years of record issuance. How- active participant in 1997, issuing A$3.3 billion of
ever in purely domestic market terms, Australian rated MBS, PUMA followed up with A$725 million
MBS declined sharply from A$8.1 billion in 1997 to of issuance in 1998, representing a decrease of
A$4.7 billion in 1998. The decrease was due to the 432%. The increase in MBS issuance by the regional
sharp increase in offshore issuance which rose banks, and the shift from nonbank to bank issuers,
72.2% to US$3.1 million in 1998. Westpac Banking was a major trend during 1998. Standard & Poor’s
Corp., PUMA Management Ltd., St. George Bank expects this to continue into 1999 as the regional
Ltd., and RAMS Home Loans Pty. Ltd. all sold MBS banks become repeat issuers, and first-time regional
into offshore markets during 1998. Westpac’s WST and major trading banks enter the market if the
1998-1G was the first Australian issuer to sell into pricing is attractive.
the U.S. market. Offshore issuance will no doubt On the credit side, MBS performance remained
continue into 1999, as issuers who can offer larger strong, a trend that is expected to continue. Arrears
deals will seek to tap the larger and more liquid U.S. levels remained stable, as indicated in Standard &
and European capital markets. Also, potential Poor’s Australian Mortgage Performance Index
changes in interest withholding tax legislation will (SPIN) (see chart 2). The strong credit quality
provide more favorable conditions for offshore reflects continued high affordability with historically
investors wishing to purchase Australian securities. low interest rate levels. To access Standard & Poor’s
Although issuance of MBS was down in dollar ABS Performance Newsletter, which contains the
terms, mortgages still represented the largest asset SPIN Index, contact Kate Leatham on (61) 3-9631-
class in the securitisation market, making up about 2051.
56% of all securities outstanding. Regional bank
Asset-Backed Commercial Paper Sector
participation was a significant reason for maintain-
ing the high percentage, with St. George Bank Ltd., ABCP programs were popular in 1998, as the sector
Colonial State Bank, Adelaide Bank Ltd., Bank of added 12 new programs, and A$9.7 billion in new
Queensland Ltd. and Bendigo Bank Ltd. increasing commitments to the Australasian securitisation
issuance by A$1.8 billion. This offset a large decline market. The sector has grown 164% over the past
in issuance by PUMA, which was engaged in two years, increasing ABCP outstandings to A$16.9
discussions to sell off its mortgage book for much of billion from A$6.4 billion, as the number of

Standard & Poor’s 6

 Structured Finance Australia & New Zealand ¨ April 1999

programs in the region has ballooned to 43. The Asset-Backed Securities Sector
increase made ABCP the fastest growing sector of Another positive development during 1998 was the
the Australasian securitisation market in 1998, as emergence of the ABS sector. Retail auto receivables
financial assets, mortgage warehouse programs and and commercial equipment receivables were either
trade receivables were all financed through ABCP directly or indirectly financed through securitisation.
(see chart 3). In total, A$903 million of ABS was issued in 1998,
One of the driving forces behind the growth in the up from A$694 million in 1997, when ABS issuance
ABCP sector has been the increasing popularity of had been dominated by Citibank’s A$510 million
sponsors setting up multi-seller conduit structures in Initial Corporate Obligation Notes Trust
order to purchase rated ABS. By setting up these transaction. The number of ABS transactions rated
types of programs, sponsors are able to take by Standard & Poor’s rose to six in 1998, up from
advantage of the difference between the interest paid two the previous year. In 1998, Symphony Trust No.
on the commercial paper and the interest received 1 sold A$144 million of ‘AAA’ rated and A$6
from the ABS notes. These types of programs, million of ‘BBB’ rated, floating-rate notes backed by
known as arbitrage vehicles, now make up approxi- Sanwa Australia Finance Ltd.’s equipment commer-
mately 54% of the entire ABCP sector. The popular- cial hire purchase agreements. A similar A$200
ity of these financing vehicles is gaining momentum, million transaction was completed later in the year
not just in Australasia, but around the world. by Orix Australia Corp. Ltd., through Eden Park
Widening spreads and investor flight to quality were Trust #1. Also in 1998, Ford Credit Receivables
other reasons behind the growth in the ABCP sector. Trust 1998-1 sold A$130.5 million of ‘AAA’ rated,
While spreads on commercial paper widened with fixed-rate, asset-backed bonds backed by fully
term spreads and liquidity becoming more costly, amortising, fixed-rate, retail, nonlease motor vehicle
many conduits still were able to offer attractive all- loans.
in pricing for ABS and MBS issuers. In 1999, A key feature of this sector is that the transactions
Standard & Poor’s expects the volume of new utilised internal sources of credit enhancement, such
program commitments to drop compared to 1998, as overcollateralisation, and excess spread, to
however outstandings under existing programs are support the high investment-grade ratings. Also, to
expected to increase as short-term investments will broaden investor appeal, various maturities and
continue to remain attractive for investors. Also, like managed amortisation schedules were structured
the term market, it is expected that more ABCP into the transactions.
conduits will issue into the deeper and more liquid
U.S. market.

Chart 3

ABCP Market Growth 1995-1998: Australian/New Zealand

ABCP outstanding at year end

ABCP program limits at year end
(bil. A$) Number of programs
40 45
35 40
Number of programs

30 35
30
25
25
20
20
15
15
10 10
5 5
0 0
1995 1996 1997 1998

Note: All data based on ABCP programs rated by Standard & Poor’s.

Standard & Poor’s 7

 Structured Finance Australia & New Zealand ¨ April 1999

New Zealand Standard & Poor’s does not expect a significant

Despite the New Zealand recession, domestic increase in New Zealand structured transactions in
securitisation issuance rose by 50% during 1998. 1999.
Five transactions were brought to market, represent-
AUSTRALASIAN SECURITISATION AT THE CLOSE
ing approximately NZ$1.3 billion of securitisation.
OF 1998
Total issuance was comprised of two MBS transac-
tions and three asset-backed commercial paper At Dec. 31, 1998, a total of A$46.8 billion of rated
programs. securities backed by Australian and N.Z. assets
remained outstanding. This represented a 46%
A significant portion of the growth came from the
increase to the volume of securities outstanding at
ABCP sector, where two new multi-seller programs,
year end Dec. 31, 1997. Most of the year’s issuance
and one new single-seller program, were established.
occurred in the first half, as many issuers were
Waratah Securities Australia Ltd., an existing
chased from the market due to widening spreads in
Australian commercial paper issuer sponsored by
the second half.
Westpac Banking Corp., was restructured into a
segregated issuer in March 1998. This allows for the Two aspects characterised Australasian securitisation
issue of limited recourse, Australian commercial in 1998: Residential mortgages continued to be the
paper secured by Australian assets, and the issue of dominant class of securitised assets in the local
limited recourse New Zealand dollar commercial markets, with 56% of securities outstanding backed
paper, backed by New Zealand assets through by residential mortgage loans. Australia and N.Z.
Waratah’s New Zealand branch. continued to be dominated by highly rated issues,
with 88.1% of issues outstanding rated ‘AAA’ or
By segregating the program, Westpac is able to sell
‘A-1+’.
various rated securities, backed by segregated pools
of assets. By creating the legal segregation between Tables 1 and 2 on the following pages represent the
the assets, the ratings on the securities can be newly rated transactions for 1998 and each issuer’s
independent of one another, unlike a traditional market share at Dec. 31, 1998.
ABCP conduit.

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 Structured Finance Australia & New Zealand ¨ April 1999

Table 1 Structured Finance Programs Rated 1998

Program New
Issuer size issues Origin
Issuer domicile (mil. A$) (%) Securitised asset asset Rating
Banksia Series 1 Trust Aust. 122.0 0.6 Residential mortgages Aust. AAA
Crusade CP No. 1 Pty. Ltd. Aust. 500.0 2.4 Financial securities Aust. A-1
Crusade Euro Trust No. 1 of 1998* Aust. 741.0 3.5 Residential mortgages Aust. AAA/AA+
Crusade Euro Trust No. 2 of 1998* Aust. 519.6 2.5 Residential mortgages Aust. AAA/AA-
Diners Club Master Trust Aust. 120.0 0.6 Credit card receivables Aust. AAA
Eden Park Trust #1 Aust. 200.0 1.0 Equipment Aust. AAA/A
Ford Credit Receivables Trust 1998-1 Aust. 131.0 0.6 Auto Aust. AAA
Home Owner Mortgage Enhanced
Securities Ltd. Aust. 564.0 2.7 Residential mortgages Aust. AA
Home Owner Mortgage Enhanced
Securities Ltd. Aust. 260.0 1.2 Residential mortgages Aust. AAA
Interstar RD 25 Master Trust Aust. 800.0 3.8 Residential mortgages Aust. AAA/AA-
JEMstone Fund Aust. 169.0 0.8 Residential mortgages/ Aust. AAA/AA/
commercial property BBB
JEM Warehouse Bonds Pty. Ltd. Aust. 58.3 0.3 Commercial property Aust. A-
Keystart Bonds Ltd. Aust. 1,000.0 4.8 Residential mortgages Aust. AA+
Longreach CP Ltd. Aust. 500.0 2.4 Financial securities Aust. A-1+
MBS New Zealand No. 2 Ltd. N.Z. 176.8 0.8 Residential mortgages Aust. AAA/AA-
Medical Mortgages Ltd. N.Z. 68.0 0.3 Residential mortgages Aust. A-1+
Mustang No. 1 Trust Aust. 1,000.0 4.8 Residential mortgages Aust. A-1+
NMHL Securitisation Fund No. 3 Aust. 110.0 0.5 Residential mortgages Aust. AAA
Orion Funding Pty. Ltd. Aust. 500.0 2.4 Financial securities Aust. A-2
POLAR Finance Ltd. Aust. 1,000.0 4.8 Financial securities Aust. A-1+
Prime Asset Vehicle No. 2 Ltd.
(Loy Yang B) Aust. 150.0 0.7 Corporate loan Aust. A-1+
Property Income Investment Trust Aust. 81.0 0.4 Commercial property Aust. AA
PUMA Masterfund E2 Series 2* Aust. 725.8 3.4 Residential mortgages Aust. AAA
RAMS Mortgage Corp. Ltd. Series 4 Aust. 200.0 1.0 Residential mortgages Aust. AAA/AA-
RAMS Mortgage Corp. Ltd. Series 5E* Aust. 639.5 3.0 Residential mortgages Aust. AAA/AA-
RESIMAC Series 1998-1 Fund Aust. 202.0 1.0 Residential mortgages Aust. AAA/AA-
RMT Securitisation Trust No. 3 Aust. 194.0 0.9 Residential mortgages Aust. AAA/AA-
Rock Trust Aust. 50.5 0.2 Residential mortgages Aust. AAA/AA-
SAM Trust 1998-1 Aust. 217.2 1.0 Residential mortgages Aust. AAA/AA-
Schooner Capital Pty. Ltd. Aust. 1,000.0 4.8 Financial securities Aust. A-1
Secured Asset Funding Entity No.1 Ltd. Aust. 1,000.0 4.8 Financial securities Aust. A-1
Series 1998-1 CATS Trust Aust. 500.0 2.4 Residential mortgages Aust. AAA
Series 1998-1 Medallion Trust Aust. 303.0 1.4 Residential mortgages Aust. AAA/AA+
Series 1998-1 REDS Trust Aust. 200.0 1.0 Residential mortgages Aust. AAA/AA-
Series 1998-1 Torrens Trust Aust. 246.7 1.2 Residential mortgages Aust. AAA/AA-
Series 1998-1G WST Trust* Aust. 2,390.2 11.4 Residential mortgages Aust. AAA/AA-
Series 1998-2 Torrens Trust Aust. 200.3 1.0 Residential mortgages Aust. AAA/AA-
SMHL Fund No. 7 Aust. 180.0 0.9 Residential mortgages Aust. AAA
Spiers Securities Ltd. Aust. 170.0 0.8 Financial securities Aust. A-1+
Sword Securitisation Ltd. Aust. 1,000.0 4.8 Financial securities Aust. A-1+
Symphony Trust No. 1 Aust. 150.0 0.7 Equipment Aust. AAA/BBB
Titan Securitisation Ltd. Aust. 1,000.0 4.8 Financial securities Aust. A-1+
Waratah Securities Australia Ltd. (NZ) Aust. 340.0 1.6 Financial securities Aust. A-1+
WB 1998 Trust Aust. 100.0 0.5 Residential mortgages Aust. AA
WST-NZ Funding Trust New Zealand
Sub-Series 1 N.Z. 260.6 1.2 Financial securities Aust. AAA/AA
WST-NZ Series 1998-1 Trust N.Z. 385.8 1.8 Residential mortgages Aust. AAA/AA
21,048.5 100
*Euro/U.S. issuance.

Standard & Poor’s 9

 Structured Finance Australia & New Zealand ¨ April 1999

Table 2 Australasian Securitisation Programs Market Share

Market share Market share
Rank Issuer (%) (mil. A$)
1 PUMA Sub-Funds 20.92 9,549.7
2 Series WST Trusts 7.54 3,443.0
3 Waratah Securities Australia Ltd. and Sydney Capital Corp. Inc. 5.96 2,718.2
4 ACE Overseas Ltd. 5.80 2,648.9
5 RAMS Mortgage Corp. Ltd. 5.76 2,630.4
6 Home Owner Mortgage Enhanced Securities Ltd. (HOMES) 3.85 1,755.9
7 Asset Collateralised Entity Ltd. 3.76 1,717.5
8 Crusade Trusts 3.57 1,629.9
9 Interstar Securities 2.60 1,189.0
10 Polar Finance Ltd. 2.01 918.5
11 Abel Funding Ltd. 1.91 869.8
12 Keystart Bonds Ltd. 1.71 782.6
13 ICON 1.64 750.8
14 Sword Securitisation 1.57 717.6
15 SMHL Funds 1-7 1.49 679.1
16 Securised Australian Mortgage Trust 1995-1, 1996-1, 1997-1, 1997-2 and 1998-1 1.42 647.7
17 Series 1997-1 CATS Trust and Series 1998-1 CATS Trust 1.27 579.6
18 RMT Securitisation Fund 1.21 551.4
19 Secured Asset Funding Entity No. 1 Ltd. 1.19 545.3
20 Schooner Capital Pty. Ltd. 1.19 541.8
21 Torrens Trusts 1.11 505.0
22 Progress 1997-1 Trust 1.10 500.0
23 AMS Ltd. - ARMS II Funds I and II 1.08 493.0
24 Series 1997-1 Medallion Trust and Series 1998-1 Medallion Trust 1.06 485.9
25 Longreach CP Ltd. 0.99 453.4
26 FANMAC Ltd. 0.95 432.6
27 WST NZ Funding & WST NZ Series 0.91 417.5
28 Transferable Investment Certificates 0.83 379.2
29 Corporate Asset Securitisation Australia Ltd. Inc. 0.74 337.6
30 Diners Club Master Trust 0.73 334.1
31 CAST 0.64 291.0
32 Wisdom Master Trust 0.62 281.6
33 MTF Securities Ltd. 0.61 279.4
34 Mustang Trust 0.61 276.8
35 SABRE Securitisation Ltd. 0.59 270.1
36 MBS New Zealand Ltd. 0.56 256.4
37 Prime Asset Vehicle Ltd. No. 2 0.55 250.0
38 Retail Financial Services Ltd. 0.52 235.9
39 National Mutual Home Loans Securitisation Funds 0.51 234.5
40 Structured Prime Asset Receivables No. 2 Ltd. 0.50 228.5
41 Eden Park Trust 0.44 200.0
42 Property Income Investment Trusts 0.44 200.0
43 Prime Asset Vehicle Ltd. 0.43 198.0
44 Construction and Development Co. Ltd. 0.42 189.9
45 RESIMAC 0.38 171.4
46 Series 1998-1 REDS Trust 0.35 161.9
47 MI Trust 0.35 160.7
48 Jem Bonds Ltd. 0.33 150.0
49 Generic Loan Asset Securitisation Structures Ltd. 0.33 149.1
50 Financial Assets Specialised Trusts 0.32 145.3
51 Universal Mirror Trust 0.31 141.7
52 JEMstone Fund Ltd. 0.31 141.0
53 WB Trust 0.30 135.1
54 New Zealand Receivables Corp. Ltd. 0.29 132.5
55 Ford Credit Receivables 0.29 130.5

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 Structured Finance Australia & New Zealand ¨ April 1999

Table 2 Australasian Securitisation Programs Market Share (continued)

Market share Market share
Rank Issuer (%) (mil. A$)
56 Symphony Trust No. 1 0.27 122.9
57 Pacific Retail Ltd. 0.21 97.6
58 Paper Bonds Ltd. 0.21 97.2
59 NSW Jersey 0.20 90.1
60 Banksia Series 1 Trust 0.20 89.8
61 Prime Investment Entity Ltd. 0.19 86.9
62 SABRE New Zealand Ltd. 0.17 76.9
63 SBC Warburg Aust Securities Trust No. 1 0.17 76.7
64 Secure Australia Ltd. 0.16 74.7
65 Brentwood (Australis) Ltd. 0.13 61.5
66 Mortgage Corp. of New Zealand Ltd. 0.13 59.8
67 JEM Warehouse Bonds Pty. Ltd. 0.13 58.3
68 BSF Bonds No. 1 and 2 Ltd. 0.13 58.0
69 Zenith Funding Pty. Ltd. 0.11 51.0
70 Rock Trust 0.11 50.5
71 Australian Securitisation Corp. No. 1 Ltd. 0.11 50.0
72 Medical Mortgages Ltd. 0.10 44.9
73 Speirs Securities Ltd. 0.08 35.7
74 Burnie Hospital Ltd. 0.07 31.3
75 FATO Ltd. 0.07 30.1
76 Mount Gambier Hospital Ltd. 0.06 29.4
77 Port Augusta Hospital Ltd. 0.06 26.1
78 PAV Hospital Funding Ltd. 0.02 11.0
79 RAMS Net Interest Margin Ltd. 0.02 8.4
80 Endeavour Mortgage Trust Funds 0.02 8.0
81 Titan Securitisation 0.00 —
82 Orion Funding 0.00 —

Standard & Poor’s 11

 Structured Finance Australia & New Zealand ¨ April 1999

Capital Considerations In The Australian Securitisation Market

Banks also often expect that, by removing risky
Contact:
assets from the balance sheet, the capital required to
Alison Murray, Melbourne (61) 3-9631-2093,
maintain them will also be freed up—an attractive
Ken McLay, Melbourne (61) 3-9631-2090,
prospect to those financial institutions aggressively
Edward Burbage, Melbourne (61) 3-9631-2050.
managing their capital. The inevitable corollary of
the “capital relief” argument is the expectation that
higher capital ratios may lead to stronger credit
Australian banks have been successful in transferring ratings.
asset risks in the residential mortgage securitisations
Standard & Poor’s approach to capital is conserva-
undertaken in recent times. The major incentives for
tive but broadly based and does not focus solely on
such securitisation programs are the development of
capital ratios. Rating methodology and criteria
additional sources of funding and the freeing up of
contemplate a range of financial and business-risk
capital resources.
factors in the evaluation of the appropriateness of
While Standard & Poor’s acknowledges the benefits
an institution’s capital structure. Capital is more
of securitisation, the retention of residual risks and
than simply a buffer against losses that fall within
the potential moral hazard often associated with
the expected range of credit risks in a bank’s balance
more complex structures may result in capital being
sheet. Standard & Poor’s regards capital as a buffer
freed up only to a limited extent. Thus, while some
against risks in future asset accumulation and other
capital usually is released in an asset securitisation,
unexpected events or losses that are likely to result
the amount of capital relief is a function of the
from a bank’s day-to-day business activities, both
structure of each individual transaction, rather than
on- and off-balance sheet.
the application of rigid guidelines for capital
In addition to the question of equity relief,
allocations.
securitisation raises a number of other capital
The key analytical issues considered in reviewing
considerations. To the extent that low-risk mortgage
asset securitisations of banks are:
assets are taken off-balance sheet, or commercial
♦ Credit risk credit assets are “cherry picked”, for example, the
♦ Liquidity risk risk profile of remaining on-balance-sheet assets
♦ Business risk increases, with clear implications for both the bank’s
debt holders and its capital requirements. Depending
MARKET TRENDS AND CAPITAL on the program’s structure and the underlying assets,
CONSIDERATIONS the asset originator may retain the risk of volatility
While the Australian market probably has yet to in residual earnings, which can be almost as signifi-
reach the level of maturity where transactions such cant as if the assets had remained on-balance-sheet.
as the securitisation of rock musician David Bowie’s The risks borne by both debt and equity holders can
song-writing royalties are a realistic option, it has, in be significantly altered by the application of the
a relatively short time, developed to the point that it proceeds of assets sold (for example, if the proceeds
is ready to progress beyond the realm of mortgage- are used to make new loans with a different risk
backed securities (MBS). profile). Further, the asset originator usually main-
With about 10 year’s experience in mortgage tains the client relationship, providing other prod-
securitisations, financial institutions are now testing ucts and services which, even at a very basic level,
the Australian market’s appetite for securities that involves some degree of operational or
are backed by credit card receivables, unsecured procedural risk.
consumer loan receivables, and commercial and While some capital usually is released in an asset
corporate loans. The trend is not surprising, given securitisation, the extent of any relief is very much a
that banks and financial institutions can achieve function of the structure of the individual
attractive pricing; funding diversification; improved transaction. To date, Australian banks largely have
liquidity management; and the ability to off-load restricted securitisation activities to residential
credit risks to credit enhancement providers and, in mortgage assets and have been careful to comply
some cases, investors. with the Australian Prudential Regulation Authority

Standard & Poor’s 12

 Structured Finance Australia & New Zealand ¨ April 1999

(APRA) clear policy prescriptions on the minimisa- a third party, or even retained contractually in whole
tion or elimination of residual risks and the separa- or in part—as is common in revolving transactions
tion of originators and their securitisation vehicles. such as credit card receivables—depending on the
These directives are aimed at affording the originat- structure in question. Standard & Poor’s criteria on
ing bank some protection in the event that a scheme capital requirements for off-balance-sheet activities
with which it is associated comes under pressure. To first identifies the risks associated with a transaction,
the extent that the Australian banks have been able and then seeks to prioritise such risks according to
to satisfy the APRA’s requirements, they are permit- severity and probability. The analysis also includes
ted to treat their programs as off-balance-sheet for an evaluation of the methods by which risks might
the purposes of calculating regulatory capital. By be moderated; for example, through transfer to
and large, Standard & Poor’s similarly considers the other parties (such as mortgage insurers in the case
risks in such mortgage assets to have been effectively of MBS programs).
transferred. Customised structures, variation in the composition
More recently, however, APRA’s position on separa- and performance of underlying asset pools, and
tion appears to have been tested, with some banks diversity of accounting methodology across different
retaining an element of brand-name association markets results in a unique set of characteristics for
while being accorded full off-balance-sheet treat- each different securitisation transaction, arguing
ment for regulatory capital purposes. This raises the against the application of rigid guidelines for capital
spectre of ‘moral hazard’. The transfer of risk assets allocation. Standard & Poor’s adopts a more
where the originator maintains some direct involve- discriminative approach, with case-by-case evalua-
ment—particularly in its own name—begs the tion focusing on major risk categories and the extent
question of the extent to which residual risk is to which the issuer retains risk.
retained. In Standard & Poor’s view, name-associ- The key risk categories are:
ated branding and a high degree of operational
involvement increase the incentives for an originat- Credit Risk
ing bank to support a program with which it is ♦ Asset value and excess servicing income;
associated, rather than suffer the embarrassment of ♦ Spread account and deposits due from trusts; and
a failed instrument. These incentives impose a cost ♦ Subordinated interest and guarantees by third
in the form of economic, if not regulatory, capital. parties.
As the Australian banks begin evaluating the Liquidity Risk
securitisation of riskier asset classes and as credit
♦ Funding and cash flow.
enhancement becomes more costly, it is increasingly
likely that some residual risks may be retained on- Business Risk
balance-sheet. In a worst case scenario, the charac- ♦ Servicing; and
teristics of the asset sale agreement—such as the ♦ Legal issues/representations and warranties.
retention of some rights or obligations by the seller
of the assets—may lead to the legal interpretation of VALUATION OF SERVICING INCOME
the transaction as a collateralised borrowing, Excess servicing income is the income stream from
resulting in little or no capital relief at all. This is the securitisation vehicle after principal and interest
likely to result in still higher moral risks and clear obligations have been met and credit charge-offs
economic capital requirements. made. This surplus usually is similar to the income
The introduction of accounting standards for that might have been realised if the assets had
securitisations in the domestic market, particularly if remained on-balance-sheet, but is taken to the
they are along the lines of the U.S. market’s FASB income account as a net fee, rather than as net
125 directive on the valuation of future cash flows, interest income. Under normal circumstances, credit
also may carry capital implications for Australian costs will result in variability in excess servicing
banks. income to the same extent that charge-offs for on-
balance-sheet receivables affect net earnings. Other
IDENTIFICATION OF RISKS factors can introduce volatility to the excess servic-
While the senior component of a securitisation may ing. For example, competitive pressure on interest
well be highly rated, an issuer’s risk may not be rates can result in a decline in the yield of the pool.
entirely eliminated. Instead, risk may be concen-
trated in subordinated tranches that may be sold to

Standard & Poor’s 13

 Structured Finance Australia & New Zealand ¨ April 1999

In addition, surplus funds also might be diverted to accounts or “deposits due from trust”—are
pay senior investors if the cash flows of the vehicle regarded as higher-risk assets because of their “first
are insufficient. loss” nature within the securitisation structure.
The accounting treatment of this cash flow differs Credit losses in the asset pool are charged against
across markets, resulting in divergent balance-sheet the spread account to the extent sufficient to absorb
outcomes and capital implications. In the Australian the losses. Typically, the spread account represents
MBS market, surplus cash flow is taken to the 3%-5% of total pool assets, although this depends
income statement upon receipt. When excess on the performance and loss characteristics of the
servicing income is treated in this way, much like an underlying assets. Usually, the spread account in
annuity payment, minimal additional risk is created mortgage transactions is lower than that for struc-
and therefore no capital allocation is required. tures in which the underlying assets are higher-risk
Under the FASB 125 requirement, however, which commercial loan obligations. The spread account
applies in the U.S. market, the (discounted) present can be funded by an initial deposit either from the
value of this future earnings stream is recognised as originating entity (commonly shown as “amount
an up-front gain on sale of assets. A capitalised on- due from trust” in the accounts of that entity) or a
balance-sheet risk asset is thus created. FASB third party, or it can accumulate from excess
requires that this potentially quite volatile risk asset servicing income.
be marked-to-market and amortised over the life of The spread account represents a concentration of
the transaction. credit risk and therefore is a highly-volatile risk asset
Clearly the valuation of the excess servicing cash if retained on the balance sheet of the asset origina-
flow is predicated on assumptions regarding tor. Because of differing default behaviour across
duration and expected credit losses in the asset pool. various asset classes in underlying pools, the
These assumptions can vary significantly across application of a standard capital allocation require-
different asset classes, transactions, and markets. ment for the spread account can be problematic. By
The significant write-downs in excess servicing and large, however, to the extent that it is in place to
receivables made by a number of home equity absorb first losses, Standard & Poor’s assesses the
lenders in the U.S. sub-prime market in the latter spread account as a 100% capital need because of
part of 1997 highlight the volatility that can be its high risk concentration characteristics and
introduced by inaccurate assumptions about pool volatility. This treatment acknowledges the fact that
behaviour. Accordingly, Standard & Poor’s under- the asset originator has retained the same level of
takes its assessment of the risk of the excess servic- risk as if the assets had remained on the balance
ing income and requisite capital support on a sheet. While the views of Standard & Poor’s and the
case-by-case basis. By reviewing actual pool per- Australian regulators in this regard are consistent,
formance and assessing credit and prepayment the same is not necessarily true in other markets. In
characteristics relative to both expectations and on- Japan, for example, some banks have provided loss
balance-sheet assets, Standard & Poor’s is able to protection to investors to the extent of 2% of the
evaluate the level of conservatism in underlying total portfolio and have still been permitted to avail
assumptions and therefore the appropriate level of from full off-balance-sheet treatment for regulatory
capital support. Higher levels of capital support capital purposes.
might be required where underlying assumptions are In the case of the Australian MBS market, the first-
particularly aggressive, asset quality is poor, default loss role generally is assumed by a mortgage insurer,
history is limited, or credit-loss buffers are low. who receives a fee in the form of premium income.
The insurance provider does not have recourse to
FIRST LOSS POSITIONS AND CREDIT the originating bank for any losses incurred. As a
ENHANCEMENTS result, banks originating MBS in the Australian
Typically, credit enhancement mechanisms provided market retain very little first loss risk, and the
either by the originating party or an independent capital required to support such off-balance-sheet
third party insulate investors in securitised assets structures similarly is modest. Typically, an appro-
against credit risk. These enhancements usually priate level of capital is in the order of about 10%
consist of one or more tranches of subordinated of the on-balance-sheet requirement, although this is
debt protecting the senior portion, and a first loss considered in the broader context of the risk profile
account to absorb credit losses. Such credit and diversity of the institution’s activities.
enhancements—commonly known as spread

Standard & Poor’s 14

 Structured Finance Australia & New Zealand ¨ April 1999

ADDITIONAL CREDIT ENHANCEMENTS In the event that securitised receivables flow back to
The subordinated interest represents an additional the balance sheet, any equity relief that may have
credit enhancement in a securitisation structure, the been delivered through securitisation is, of course,
size of which depends on a number of factors, eliminated, and appropriate levels of capital support
including the frequency and severity of losses in the are required. Regulatory requirements notwithstand-
underlying asset pool. Subordinated interests ing, an issuer generally will have a number of
represent a concentration of credit risk that is options that possibly will rectify the position, and
secondary to the spread account. In the event that the acceleration might be avoided temporarily or
the spread account is insufficient to accommodate indefinitely. The allocation of capital is, therefore, a
credit losses, the loss is borne by the subordinated function of the severity versus the probability of an
debt holders. In those structures in which there is no acceleration event occurring.
subordinated position, the asset originator or issuer Insofar as severity is concerned, the range obviously
usually is exposed to some level of recourse that is can be between zero and 100% of the capital
similar in terms of credit loss absorption. required if the assets had remained on-balance-sheet.
Accordingly, the amount of capital allocated against While history would argue that the probability of
the subordinated or recourse position is determined occurrence is relatively remote, a period of distress
in a fashion similar to that of the spread account. that results in an acceleration is unlikely to be
Once again, however, differences in asset type, limited to off-balance-sheet activities, and therefore
structures, and the quantum of the first loss posi- would be a time when equity is most needed as a
tion, together with incomplete or insufficient default cushion against risk in both on- and off-balance-
histories, make the application of standardised sheet activities. Given the presence of such trigger
capital requirements inappropriate. Analytical events, the transferral of risks in revolving transac-
judgments based on the characteristics of individual tions is indefinite and substantial equity support is
transactions usually are necessary. Generally, required. As a practical matter, only about 20%-
however, the capital allocation requirement will 30% of risks are transferred under most programs
represent multiple historic pool credit losses, or and, accordingly, Standard and Poor’s allocates
losses experienced by seasoned pools of similar asset capital in the order of 70%-80% of the on-balance-
composition. Where the first loss buffer is consid- sheet equivalent.
ered insufficient to absorb credit losses, a higher
MANAGEMENT AND SERVICING RISKS
capital allocation might apply, potentially to the full
extent of the subordinated tranche. In the event of Servicing risk refers to the various risks involved in
future material differences between actual and the provision of management services to the
expected performance, subsequent adjustment in portfolio; that is, to effect collections, maintain
allocated capital may be made. records, and manage cash flows. Typically, the
originating bank provides management services to
LIQUIDITY the asset pool, although this is not always the case.
Liquidity risk is most significant in revolving The ability to provide these services is a function of
transactions such as credit card receivables, rather the operating efficiency of the originator/issuer, and
than amortising MBS-type structures. Traditionally, is one of the many business risk factors assessed by
revolving structures incorporate provisions that Standard & Poor’s in its standard counterparty
accelerate repayment of principal to investors. These credit rating methodology. To the extent that
provisions usually are instigated by events such as a Standard & Poor’s assesses the servicing bank’s
decline in the excess spread through an interest- operating efficiency and management capacity in
margin squeeze or higher than expected charge-offs. determining its counterparty credit rating, an
Acceleration clauses are structural forms of credit additional explicit capital allocation for assets in a
enhancement that provide significant protection to securitised pool would, in many cases, appear
investors. When acceleration provisions are trig- inappropriate. Noting the concentration risks
gered, the underlying asset may flow back to the inherent in a bank that specialises in the origination
originator’s balance sheet, resulting in a funding and servicing of securitised financial assets, a
need and potential cash flow pressures. This is relatively higher capital base would be more appro-
particularly problematic for lower-rated issuers, priate compared with that for a diversified financial
where funding diversity, cash flow, and leverage institution. Nevertheless, if the assets in the pool are
considerations may be rating sensitivities. noncore or the originator has no particular expertise

Standard & Poor’s 15

 Structured Finance Australia & New Zealand ¨ April 1999

in managing them (for example if they were ac- normally required. In the event that an issuer exits a
quired in a merger), Standard & Poor’s would particular market segment, problems may arise if an
review the capacity of the bank to service and asset is deemed ineligible for the asset pool and the
manage the pool and assess the extent to which issuer does not have the capacity or market presence
these involved additional risks. to originate a replacement.

LEGAL RISKS AND OBLIGATIONS CONCLUSION

Representations and warranties inevitably are a part The packaging of higher-risk assets in more complex
of the legal documentation associated with structures is an inevitable development for the
securitisation and the transfer of assets and credit Australian market. With diversified assets and good-
risks. Principally at issue is the possibility of an asset quality portfolios, the domestic banks are well
or receivable being considered ineligible for inclu- placed to provide a range of investment products for
sion in the pool—for example, through the discov- an increasingly sophisticated investor market. While
ery of prior charges or imperfect ability to enforce Standard & Poor’s acknowledges the benefits of
against collateral—and thus being returned to the securitisation, the retention of residual risks and the
issuer’s balance sheet. Generally, the risk is relatively potential moral hazard often associated with more
remote, particularly for experienced market partici- complex structures may result in capital being freed
pants, and, accordingly, capital allocation is not up only to a limited extent.

Standard & Poor’s 16

 Structured Finance Australia & New Zealand ¨ April 1999

The Rating Process

The Structured Finance Rating before ratings are assigned) consist of analysts and
senior management from Standard & Poor’s offices
Process throughout the world. The primary focus and
Structured financings, or securitisation, has evolved responsibility of the committee forum is to ensure
as a method to more efficiently raise capital in the consistency and compatibility of criteria globally,
financial markets. Securitisation results in securities which is essential to the value of credit ratings, and
being issued in the public or private debt markets without which a rating could not be seen to imply
that are secured by, or represent undivided interests the same qualitative judgment wherever it was
in, a cash flow, or by the collateral value of a specific applied.
asset or pool of assets that has been sold or trans-
WHAT DOES A RATING REFLECT?
ferred, hence the name asset-backed securities.
A credit rating assigned by Standard & Poor’s,
In an asset-backed transaction, Standard & Poor’s
independent of asset type, assesses the ability of an
rates the securities that are issued by a special-
issue to pay principal and interest on the rated
purpose entity (SPE). Standard & Poor’s SPE criteria
securities in full and on time on or before maturity,
is discussed in more detail on page 94.
according to the terms of the issue. A structured
The assets to be securitised are sold to a SPE that finance rating, therefore, ultimately addresses the
finances the purchase through the issuance of credit quality of the bonds being rated for their
securities. The assets bought by the SPE are kept whole term and implicitly addresses liquidity levels
separate from the asset originator’s general funds within structures while rated bonds remain out-
and other assets, and are the primary source of standing.
protection for the investors in the asset-backed
Ratings give a basis to compare credit quality in the
securities. The unique characteristics of a Standard
market. The figure below sets out the rating scale
& Poor’s structured finance rating, compared with a
adopted by the Standard & Poor’s Ratings Group.
Standard & Poor’s corporate, financial institution,
or public finance rating, is that the performance of Standard & Poor’s traditionally has used letter
the securitised assets is completely removed from the symbols to rank debt from the greatest certainty of
ongoing operating, management, and potential repayment, designated by the letter rating ‘AAA’; to
insolvency risk of the originator of the assets. There the lowest, designated by the letter rating ‘D’ for
is no assumption of an operating history or previous
activity. The separation of the assets from the asset
originator is key in a structured finance rating, RATINGS CORRELATIONS
because the assigned rating can be fixed directly to Standard correlations of short-term ratings with long-term
the ability of a specified asset or pool of assets to ratings is shown below.
service payment obligations to investors. This makes AAA
it possible to achieve a higher rating on the debt
than the rating of the asset originator. AA +
Standard & Poor’s rating approach to structured AA A-1+
financings is country specific, deal specific, and
AA -
collateral specific, although the underlying principles
and approach to ratings are globally consistent. A+ A-1
Rating criteria often needs to be modified to reflect
A
the inclusion of new or unusual assets, in addition to
recognising that different markets may require a A-
different approach from that previously adopted
BBB + A-2
elsewhere. Standard & Poor’s is always willing to
review structural proposals in the light of changing BBB
market conditions and the advent of innovative BBB - A-3
financing techniques. Rating committees (the forum
in which transactions and ratings are discussed BB + B

Standard & Poor’s 17

 Structured Finance Australia & New Zealand ¨ April 1999

bonds in default. Plus or minus signs show relative These three cornerstones of structured finance rating
standing within the major rating categories, with the criteria are described below.
exception of ‘AAA’. Ratings on short-term debt with
Bankruptcy-Remote Criteria
a maturity of up to 12 months are rated on a scale
of ‘A-1+’ to ‘D’. Ratings of ‘BBB-’ or ‘A-3’ and The company that is to issue the securities to be
above are regarded as investment grade. rated must be established as a SPE. The SPE should
be bankruptcy- (or insolvency) remote so that it is
The rating of an asset-backed security evaluates
unlikely that interruption to cash flows to the
credit, legal, and structural risk. These rates repre-
investors will occur. The structure should be able to
sent only part of the investment decision-making
demonstrate that in the event that the originator of
process, which also includes factors such as market
the assets becomes insolvent, the pool of assets
price and risk preference. The rating does not mean
supporting the issue would not be available to
that an audit has been performed, nor does it attest
creditors of the originator, and thereby interrupt
to the authenticity of the information provided by
cash flows to the SPE because of such insolvency
the issuer, on which the rating is based. Importantly,
proceedings. The general aim of the SPE bank-
a credit rating is not a recommendation to buy or
ruptcy-remote criteria is to limit the SPE’s exposure
sell a security, and gives no indication of the aptness
to creditors other than the asset-backed security
of a given security for any investor’s portfolio.
investors.
A rating requested can be either public or private,
where a private rating is between Standard & Poor’s Ownership Criteria
and the issuer only, and a public rating is for general It is important that the assignment or sale of assets
release into the capital markets. and cash flow generated by those assets to the SPE is
A Standard & Poor’s rating is of importance for all effective. The SPE’s interest in the assets must be
the parties involved in a structured financing by perfected or capable of being perfected and have
making the credit risks involved in investing in such priority over other claims. The consequence of this is
securities more transparent. A rating may facilitate that the SPE has the right to control the assets.
the sale of securities if investors value the rating In general, Standard & Poor’s requires that all
assigned and the supporting information provided transfers of assets to the SPE from entities that are
by Standard & Poor’s. not bankruptcy-remote be structured as sales and
not as pledges of collateral. A pledge of collateral
RATINGS CRITERIA generally exposes the SPE to delay because enforce-
To achieve high standards and consistency in the ment of such pledge in an insolvency of the
ratings assigned, Standard & Poor’s develops its transferor may be subject to restrictions. Standard &
ratings criteria. This criteria is important to the Poor’s relies on an opinion of counsel to the effect
rating process and is used as a benchmark by which that transfers of assets to the SPE would be viewed
ratings are assigned. as sales and not as pledges of collateral in a bank-
Although structured finance criteria are not neces- ruptcy of the transferor.
sarily the same across jurisdictions, they will be Supporting Ratings
comparable, as the emphasis globally is on rating
A structured transaction may depend on the mon-
consistency. Investors need to be able to compare
etary support provided by third parties. This has
ratings given by Standard & Poor’s all over the
important implications when considering not only
world at any point in time. In other words, an
the overall integrity of a structure, but also the many
investor in a ‘AAA’ rated U.S. trade receivables
parties involved and the functions and responsibili-
asset-backed security should have the same degree of
ties they undertake. The inability of an institution to
confidence as an investor investing in an asset-
fulfill its role in a rated asset-backed transaction
backed security backed by equipment leases in
could cause the payment chain to collapse. There-
Australia, as Standard & Poor’s rates bonds at the
fore, it is important to identify the credit strengths
same rating level.
of all the third parties that play a monetary role in a
In structured financings, it is fundamental firstly to structured financing. Traditionally, this has been
establish a bankruptcy-remote SPE; secondly, to be done by looking at the ratings assigned by Standard
certain that the SPE has the legal rights to the assets; & Poor’s to the third parties, which are subse-
and thirdly, that all third parties that play a quently called supporting ratings. The requisite level
monetary role in the structure are of the required for a supporting rating is dictated by the rating
level of creditworthiness, given the desired rating.

Standard & Poor’s 18

 Structured Finance Australia & New Zealand ¨ April 1999

sought for the transaction and the nature of the THE RATING PROCESS
function, which that party fulfills. The issue gener-
ally cannot achieve a rating that is higher than any 1. ESTABLISHING CONTACT WITH STANDARD &
supporting rating. We refer to this as the ‘weak link’ POOR’S
approach. However, there are instances where the Standard & Poor’s would prefer to be contacted
rating of the structured transaction may not be early in a transaction’s proceedings once a term sheet
constrained by the rating of the lowest supporting (summary of the proposed structure and assets)
rating. For instance, Standard & Poor’s has adopted exists, so evaluation of the credit risks involved can
a probabilistic approach to certain jointly supported begin at an early stage. Standard & Poor’s is happy
obligations where two or more supporting ratings of to review the term sheet, identifying strengths and
a lower rating category can support more highly- weaknesses of the structure, and then discussing
rated debt. The joint probabilistic approach criteria these with the investment banker or issuer. Such
is discussed more fully on page 92. feedback, which is typically free of charge, is
In structured financings, nonrated third parties particularly valuable in first-time transactions,
cannot be relied on to perform their functions. The because it helps facilitate the understanding of both
structure should be such that the rated securities are parties. Specifically, the investment bankers can gain
expected to perform irrespective of the solvency of insight into the rating process and criteria: Standard
any unrated party in the structure. However, unrated & Poor’s criteria often impacts on transactions, and
parties can be included in transactions if they have a Standard & Poor’s can shed light on its own
form of credit support available to them to reassure processes and methodology. However, Standard &
Standard & Poor’s that the overall strength of the Poor’s does not act in any advisory or structuring
structure is not impaired. capacity to the transaction.
Once both parties have a good understanding of the
When Ratings Are Not Needed
transaction, a formal agreement between the two
The most important exception to the supporting parties is signed. The content of such an agreement
rating requirement is that the collateral backing a is basically an obligation from the investment
secured issue does not necessarily have to be rated. banker or issuer to officially engage Standard &
Standard & Poor’s evaluates the collateral itself as Poor’s to evaluate the credit risks involved in the
an integral part of the rating process to determine transaction and to assign a rating. Typically, a
that the collateral meets Standard & Poor’s stand- ratings fee (generally based on the amount of the
ards for inclusion in the transaction. Assets are asset-backed bond balance to be rated) and an
eligible collateral if they can be analysed as having annual surveillance fee is paid to Standard & Poor’s.
either reliable streams of income or secondary
Upon initial contact between the investment banker
market liquidation values.
and Standard & Poor’s, Standard & Poor’s assigns
Likewise, the servicer or administrator does not have an analyst to the transaction. The particular analyst,
to be rated. However, Standard & Poor’s undertakes who will be the investment banker’s primary contact
a review to ensure that the entity can fulfill the at Standard & Poor’s, will outline what is expected,
transaction’s procedural requirements. At the same going forward, for Standard & Poor’s to be able to
time, an explicit rating on an institution does not assign a rating to the transaction. From this point,
necessarily indicate its acceptability as a servicer. the relationship between the parties develops
Trustees, issuing, and paying agents also do not need quickly, information is transferred, and the formal
to have credit ratings. Standard & Poor’s discusses rating process begins.
with trustees their systems for providing services
before the trustees undertake to act on behalf of the 2. THE FORMAL RATING PROCESS
issue’s noteholders. Clearing systems do not need The formal rating process commences once Standard
explicit ratings, where Standard & Poor’s is satisfied & Poor’s has been formally engaged to assign a
with the system’s performance. rating. Structured transactions often have a strict
Standard & Poor’s undertakes the surveillance of all completion deadline. To streamline the process,
parties to the transaction for the life of the issue. Standard & Poor’s recommends that the issuer and
The issuer should have the right to terminate any investment banker outline the timetable for the
party should it fail to perform its obligations. transaction, including the expected completion of
Additionally, neither the servicer nor the trustee may transaction documentation and legal opinions.
resign without a successor in place. Provision of draft legal opinions early in the process

Standard & Poor’s 19

 Structured Finance Australia & New Zealand ¨ April 1999

can avoid last minute delays because Standard & The Quality And Sufficiency Of The Collateral
Poor’s must receive final signed opinions before the It is important to fully understand the potential
rating letter can be released. It is also useful for the credit risks inherent in the asset and how the asset
issuer and bank to discuss with Standard & Poor’s can be used to ensure value to the investors. Key
the type of data that will be available on the assets. elements in reviewing and researching any asset, or
During this discussion, Standard & Poor’s is able to pool of assets, which is a candidate for financing,
suggest any preliminary analysis that can be done on are the markets in which it exists and the jurisdic-
the data by the issuer and banker. Also, if the data is tion by which it is governed.
presented in a consolidated spreadsheet format that
The range of potential assets which can be
is available to Standard & Poor’s electronically,
securitised is vast:
credit analysis of the data can be expedited.
♦ Mortgages
The time taken to complete a rating greatly depends
♦ Auto loans
on: the depth of analysis required; the quality of
♦ Credit card
information provided and compiled by the issuer or
the investment banker; the focus given by the issuer ♦ Trade receivables
or the investment banker to attaining a rating; as ♦ Corporate loans and bonds, to name just a few.
well as the characteristics of the market in which the Standard & Poor’s, therefore, has developed a
assets were originated. The rating process is iterative methodical approach to evaluating the quality, risks,
and interactive. However, once hurdles have been and performance of assets in general. However,
cleared for a first transaction of any type, subse- some unique assets do not lend themselves easily to
quent transactions based on the same scheme rating evaluation methodology and require much
become a more straightforward process for all more research to establish a base from which a
parties concerned. methodical analysis can be achieved.
The essence of the structured finance rating process Generally, financial models are used to help with the
is to ensure that both the quality of the assets, and analysis of the underlying assets. Asset default rates
the structure itself, can withstand the stress scenario and their timing patterns over the course of the
that Standard & Poor’s envisages, given the re- transaction, delinquency rates and delays in realising
quested rating level. The higher the desired rating, any recoveries, are estimated. The results are often
the more conservative the stress test, for example, based on historical experiences. Also, expected
the more harsh the assumed financial conditions available reserves, market value declines, seasoning
under which the structure is presumed not to default and prepayments, etc. are translated into future cash
are. This is because it is critical that investors in the flow variance. Adjustments are made to reflect the
rated asset-backed securities receive interest and level of confidence in the accuracy of the numbers.
principal in full and in a timely manner, to the Establishing and collating the credit data is a major
degree of certainty as indicated by the assigned step in the asset analysis. The investment banker or
rating level. issuer usually provides a great deal of background
For rating purposes, Standard & Poor’s assumes information on the originator, the performance of
that all parties to the transaction will, in good faith, the originator and the industry to which the assets
make truthful statements and properly perform belong, and the performance of the seller com-
duties assigned to, and exercised by, them. No rating pounded to the performance of the industry. One of
criteria can prevent fraud or error in all circum- the biggest issues faced by Standard & Poor’s in this
stances. Nevertheless, Standard & Poor’s may research is the amount and quality of information
favourably view certain safeguards intended to available. This applies both in terms of the length of
prevent fraud and error. time that records have been kept, as well as the
Standard & Poor’s reacts to the proposed structure detail of what information has been recorded.
and term sheet by asking many questions according Where available data is less than desired, Standard
to the following three-pronged approach to a & Poor’s is usually able to make some worst-case,
structured finance rating. albeit more conservative, deductive assumptions.
The first category relates to the quality of the Standard & Poor’s also undertakes due diligence
collateral and, therefore, focuses on the market to visits, because it is important to establish the
which the collateral is exposed. The second category integrity of the information provided, since it is not
of questions relates to the cash flow structure of the Standard & Poor’s policy to duplicate the research
transaction, and the third category reflects legal and of others. Therefore, Standard & Poor’s spends time
tax considerations.
Standard & Poor’s 20
 Structured Finance Australia & New Zealand ¨ April 1999

visiting the asset originator(s) and the servicer to to perfection of the asset transfers, availability of the
discuss general procedures and market conditions, assets in an insolvency of parties related to the
and also to establish a better understanding of the transactions (seller, servicer, paying agent etc.), and
operations and people involved in these activities. timeliness and sufficiency of cash flows (for exam-
ple, set-off, forced sales and insolvency-imposed
The Cash Flow Structure
stays). Potential taxes could affect cash flows, so the
Supports must be in place to ensure that investors taxation position of the issuer is assessed.
receive interest and principal when due. It is vital for
While the credit evaluation is being completed,
Standard & Poor’s to understand how the security is
Standard & Poor’s focuses on the documentation of
to be structured because the issuer will usually have
the various agreements. The near final drafts of all
limited ability or capacity to adapt to changing
necessary documents and legal opinions should be
financial and economic conditions, such as interest
submitted to Standard & Poor’s as soon as possible.
rate and prepayment rate changes or increased
Standard & Poor’s will examine all documents
default rates.
relevant to the rating of the transaction. Aspects
Generally cash flow simulations should be pro- affecting the full and timely payment of the issue
duced, typically on a spreadsheet, which reflect the under all foreseeable circumstances are commented
income and payment streams dictated by the asset on by Standard & Poor’s. Standard & Poor’s may
and transaction documentation, and which will need request various legal opinions on both the structure
to incorporate assumptions supplied by Standard & and the assets.
Poor’s. Typically, assumptions will include:
♦ An expected credit loss figure; RATING ASSIGNED
♦ Variations in any variable interest rate to which Standard & Poor’s sends its official rating letter,
cash flows are linked; once all the documentation has been finalised. If the
♦ Reinvestment rates (cash in hand is likely to earn issuer does not accept the rating, it may appeal by
less than the interest rate on the underlying providing Standard & Poor’s with additional
collateral in the transaction); information which is then presented to the commit-
♦ Prepayment assumptions; tee for further consideration.
♦ The default rate; Following an issuer’s acceptance of a rating and the
♦ The value of asset recoveries; and issuer’s agreement to publish, Standard & Poor’s is
♦ The intervals at which such factors are expected
especially conscious of its responsibility to commu-
to impact the cash flow. nicate the assigned public rating, together with
supporting analysis to the appropriate market
The purpose of the simulations is to assess the levels
place(s), in a timely and effective manner.
of credit enhancement and liquidity necessary to
support the issue, since the collateral being incorpo- Once an issue is rated, Standard & Poor’s will
rated into the structure may not be liquid. monitor the transaction until maturity. Standard &
Poor’s reserves the right to change a rating, should
In addition, Standard & Poor’s assesses each
performance not meet expectations, or upon a
transaction’s ability to meet all fees and expenses of
downgrade or upgrade of a supporting rating.
the issuer, as well as the capacity to absorb a certain
level of extraordinary expenses and increasing costs SURVEILLANCE
over the life of the transaction. When Standard & Poor’s has applied a public rating
The higher the rating required, the greater the to an asset-backed issue (or on request of an issuer),
severity of the stress test of the cash flow. This step the rating is subject to surveillance for the term of
in the rating process is an assessment of risk and not the issue. The issuer, the administrator of the issue,
necessarily an attempt to simulate reality. The nature or the trustee is expected to provide regular reports
of the stress relates to the default and recovery on the issue to Standard & Poor’s. As part of
characteristics of the asset, and the general timing of Standard & Poor’s ongoing due diligence process, a
cash flows in the structure. review of the administrator of the collateral will be
Legal And Tax Considerations carried out, usually annually, to assess its ability to
continue servicing a rated issue.
Standard & Poor’s also requires assurance that both
the assets and the cash flows are fully available to There are three main objectives of maintaining
surveillance on rated transactions:
make payments on the rated securities. In this
regard, the more important considerations are given

Standard & Poor’s 21

 Structured Finance Australia & New Zealand ¨ April 1999

The monitoring of the performance of the asset pool Authorised investments: Describe the minimum
backing the transaction. This is to ensure a rating requirements for liquid assets.
continuous and consistent review of credit and Custody of loan documents: Indicate responsibility
liquidity usage, both actual and projected. A
for document custody.
deterioration in performance may lead to a down-
grade in the rating. Seller reps and warranties: Indicate main representa-
tions and warranties to be given by the seller.
The checking of the quality of administration of
asset portfolios. The quality of portfolio servicing Securities
has a considerable impact on the performance of the
Initial issue amount: Indicative issue size.
underlying assets. A deterioration in the quality of
servicing may lead to a deterioration in the perform- Tranche details: Details of the size, coupon and
ance of the asset pool. requested ratings of each tranche.
The surveillance of the ratings of third parties Payment dates: Dates payments are made to inves-
providing elements of financial support to the issue. tors and other counterparties.
A transaction may be dependent on the monetary Maturity date: Date by which all principal and
support provided by third parties. Thus, a change in interest is to repaid.
one of these underlying ratings may trigger a rating
Terms and conditions: Set out relevant details of the
change on the issue being supported.
securities.
INDICATIVE TRANSACTION TERM SHEET Events of default: Proposed events of default on the
Preliminary discussion with Standard & Poor’s is securities.
aided by the provision of a summary term sheet. Optional call date: Outline any circumstances for
Often prospective issuers and their advisors are the assets to be called by the issuer.
interested to obtain feedback on the potential for the
asset-backed securities to achieve the desired rating Credit Support
and the rating sensitivities of the structure and asset First loss protection: Outline primary form of credit
portfolio. A draft term sheet allows Standard & enhancement and likely levels.
Poor’s analysts to focus on the issues which may be Second loss protection: Describe any secondary
relevant in achieving the rating of the asset-backed forms of credit support.
securities and to highlight the credit strengths and Threshold rate: Outline any mechanism to protect
vulnerabilities of the structure and asset pool. the yield on the assets.
While the contents of a term sheet may vary depend- Liquidity support: Describe the amount and form of
ing on the nature of the transaction, the following is liquidity support in the structure.
an example of information typically detailed in a
draft term sheet: Cash Flow Allocation
Transaction Parties Use of proceeds: How the proceeds of the issue will
be invested.
Issuer: Name and place of incorporation of the SPE.
Determination dates: Date when servicer performs
Asset originator: Name of parties responsible for the
calculations and allocations cash receipts.
generation of the assets.
Servicer: Party who will initially service the assets Priority of payments: Set out the order in which cash
and any substitute servicer. will be allocated in the structure.

Trustee: If the issuer is a trust, the party who will act Servicing fee: Amount and frequency of fee paid to
as trustee. the servicer.
Security trustee: Trustee company who holds the Issuer fees and expenses: List all expected costs of
charge over the issuer’s assets. the issuer and frequency of payment.
Swap counterparty: Financial institution providing Bank accounts: List details of all bank accounts of
any currency or interest rate swap. the issuer.
Lead manager: Securities firm which will distribute Bondholder Security
the asset-backed securities.
Charge over assets: Detail the nature of the charge
Paying agent: Party responsible for payments to to be given to the security trustee.
investors.
Governing law: Indicate the jurisdiction governing
Nature Of Assets the transaction documents.
Receivables: Description of the asset portfolio
(including historical performance data). Standard & Poor’s 22
 Structured Finance Australia & New Zealand ¨ April 1999

Mortgage-Backed Criteria
♦ The credit quality of the loans and related
Australian Residential MBS
security, which reflect the experience and compe-
Securitisation of residential mortgage loans has tency of the underwriter as well as the loan
revolutionised Australia’s mortgage market over the characteristics;
past five years, providing borrowers with an
♦ Structural features of the transaction, including
increasing array of loan options. Competition and
the transaction’s cash flows; and
the entrance of new lenders also has lowered the
♦ Legal aspects of the transaction.
cost of home loans. This revolution has resulted in a
refinancing boom, where many borrowers seized the Standard & Poor’s assesses the interaction of all
opportunity to refinance their existing home loan three factors and tests the robustness of the transac-
either with new lenders, or through new loan tion using various assumptions with respect to
products. delinquencies, defaults, interest rates and
prepayments appropriate for the rating of the MBS.
Standard & Poor’s has ratings outstanding on both
The conservatism of the assumptions reflects the
mortgage-backed bonds and mortgage-backed
level of the rating sought on the securities.
commercial paper totalling approximately A$23
billion, where the underlying loans have been CREDIT QUALITY ANALYSIS
originated by national, regional and foreign banks,
The credit quality analysis section is divided into
nonbank lenders, insurance companies, and govern-
three parts.
ment agencies.
♦ Standard & Poor’s review of the market including
Australian residential mortgages have always had a the Australian housing market, the Australian
reputation for low credit risk. Whilst the mortgage housing loan market, and the Australian
market has undergone dramatic change in recent mortgage insurance industry;
years, performance of the loans has continued to be
♦ Standard & Poor’s benchmark pool for
stellar, aided by the falling interest rate environment,
Australian MBS; and
and neutral to positive property markets. Some
♦ Standard & Poor’s benchmark default frequency
fundamental characteristics of the Australian market
and loss severity assumptions, with an
that have underpinned the quality of residential
explanation of how Standard & Poor’s assesses
mortgage loans are likely to continue to support
loans that do not display the benchmark
performance:
characteristics.
♦ The obligation a borrower accepts to pay interest
and repayment principal under a home loan is a Quantifying the amount of loss a mortgage pool will
personal obligation. Should a borrower default, experience in various economic scenarios is the key
and the property not realise an amount to satisfy to Standard & Poor’s approach to modelling credit
the balance of the home loan, the lender has the risk. The method of quantifying expected credit loss
right to recover any residual balance from the for residential mortgage pools is based on studies of
borrower; macroeconomic conditions and risks unique to
residential mortgage loans. In assessing the credit
♦ Australia’s laws relating to home loans remain
quality of a mortgage pool, an estimate must be
creditor friendly provided the requirements of the
made of the amount of potential losses that could
uniform consumer credit code have been met; and
occur as a result of defaults. This estimate of
♦ Because no taxation deduction is available to
potential losses will determine the amount of loss
owner occupiers on interest paid on home loans,
protection needed to obtain a rating. Whether
a natural incentive is provided to borrowers to
analysing one loan or a pool of loans, the required
pay down their loan ahead of the contracted
loss coverage is the product of the probability of
schedule. This causes equity to be built up at an
default (default frequency) and the severity of the
accelerated rate to provide lenders an increased
loss on that loan on liquidation (loss severity).
buffer against loss.
Standard & Poor’s credit analysis of Australian
This article details Standard & Poor’s criteria for
mortgage-backed securities starts with an in-depth
rating MBS backed by Australian home loans. The
review of the Australian market, including
analysis concentrates on three main areas:
macroeconomic factors and the dynamics of the

Standard & Poor’s 23

 Structured Finance Australia & New Zealand ¨ April 1999

housing market, housing loan market, and mortgage loans that mirror the benchmark pool, and then
insurance industry. Data supplied by Australian providing additional coverage appropriate to each
mortgage insurers dating back to the 1960s has been rating category above the expected case. The higher
referenced, however Standard & Poor’s has focused the desired rating on the pool, the more severe the
its attention on the recession of the early 1990s economic downturn the pool should be able to
because it feels that this is an excellent case study of withstand.
how high levels of unemployment, depreciating As most pools that Standard & Poor’s is asked to
property prices, rising interest rates, and static or evaluate do not have the characteristics of a bench-
depreciating real wage growth can interact to affect mark pool, the benchmark assumptions are used as
losses. the analytical starting block. The characteristics of
Using this data, Standard & Poor’s constructed its each loan in the pool are compared to the bench-
benchmark pool and derived default frequency and mark pool and the loan’s probability of default and
loss severity assumptions at each rating category for loss severity is adjusted according to whether it is
that benchmark pool. The benchmark pool leans more or less risky than the established benchmark.
toward prudent underwriting standards but does
The Australian Housing Market
reflect market norms.
Australia is divided into six states and two territo-
Default frequency and loss severity assumptions for
ries. Each state and territory has a capital city,
the benchmark pool have been derived by determin-
around which the majority of the population is
ing a conservative expected case for a portfolio of
clustered (see figure 1).

Figure 1 Australian Geographic Regions And Population

Darwin (NT)

Brisbane (Qld)

Perth (WA)
Sydney (NSW)
•
Adelaide (SA) Canberra (ACT)
Melbourne (Vic)

Hobart (Tas)

State/territory Local currency rating Capital city Population

New South Wales (NSW) AAA/A-1+ Sydney 6,173,000
Victoria (Vic) AAA/A-1+ Melbourne 4,453,300
Queensland (Qld) AAA/A-1+ Brisbane 3,339,000
South Australia (SA) AA/A-1+ Adelaide 1,477,700
Western Australia (WA) AAA/A-1+ Perth 1,755,500
Tasmania (Tas) AA-/A-1+ Hobart 473,200
Australian Capital Territory (ACT) AAA/A-1+ Canberra 306,400
Northern Territory (NT) Not rated Darwin 177,500

Standard & Poor’s 24

 Structured Finance Australia & New Zealand ¨ April 1999

Figure 2

Australian Households
Total number of households
6,858,500

Owners without Owners with

Renters Rent free
a mortgage a mortgage
1,932,600 136,600
2,857,700 1,931,600
(28.2%) (2.0%)
(41.7%) (28.1%)

Home buyers who Home buyers who Public Private Other

did not buy in bought in renters renters landlord
the past 3 years the past 3 years 402,300 1,369,300 161,000
3,700,800 (53.9%) 1,088,500 (15.9%) (5.9%) (20.0%) (2.3%)

Recent first Recent change

home buyers over buyers
415,700 (6.1%) 672,800 (9.8%)

Bought Bought Bought Bought

new home established home new home established home
94,000 (1.4%) 321,700 (4.7%) 189,100 (2.7%) 483,700 (7.1%)

Source: Australian Bureau of Statistics (ABS) 1995-96 Housing Occupancy and Costs Australia 4130.0.

Most Australian houses, whether for owner of Statistics (ABS) Established House Price Index,
occupation or rental purposes, are privately owned. rose by almost 85% between June 1986 and June
Home ownership is an important objective for the 1996. The consumer price inflation (CPI) index rose
majority of Australians. Nearly 70% of Australian by 58% over the same period. A large proportion of
households live in houses that they own, and, the remaining 25% of purchases consist of project
significantly when compared to other markets, more homes. The all-in cost of project homes is often
than 60% of these households own the property cheaper than for established homes, reflecting lower
outright without a mortgage loan. This provides the land values. Project homes tend to be on the
housing market with firm support in severe eco- metropolitan outskirts where there are less facilities
nomic downturns when owners with a mortgage available and higher transport costs.
may be forced to sell the house if unable to service Australia’s housing market has historically reflected
the mortgage loan. Figure 2 shows the ownership the boom/bust nature of its economic cycles. House
composition of all Australian households as deter- prices rose by nearly 50% between 1987 and 1989.
mined by the 1995-96 Survey of Income and This reflected pent up demand, an increasing
Housing Costs conducted by the Australian Bureau number of new households from higher overseas
of Statistics. migration and children of the baby-boomers
Nearly 80% of all dwellings are stand alone, establishing households, and higher demand for real
detached houses. The remaining 20% is made up of estate for investment purposes following the 1987
semidetached or duplex houses, row or terrace stockmarket correction. Additionally, in April 1986,
houses, townhouses, flats, units and apartments. the government lifted controls on housing loan
Almost 75% of home buyers purchase an existing, interest rates that had previously been subject to a
established dwelling. The price of established houses 13.5% cap. This increased the supply of housing
in Australia, as measured by the Australian Bureau loan finance available to house purchasers.

Standard & Poor’s 25

 Structured Finance Australia & New Zealand ¨ April 1999

Demand for housing eased in 1989 with high margins reflects the increasing competitiveness
interest rates and property values deterring purchas- within the home loan market and particularly the
ers, declining overseas migration reducing the new players in the market—namely the nonbank
growth in the number of new households and lower mortgage originators who now write close to 10%
economic growth leading into the 1990s and the of all new housing loans (see figure 3). Competition
1991-92 economic recession. in the home loan market over the past four years
also has resulted in lenders reducing credit standards
The Australian Housing Loan Market
to maintain market share. There also has been an
About 400,000-500,000 new housing loans are increased incidence of debt consolidation to take
written each year in Australia. Banks are the advantage of low housing rates compared to rates
predominant providers of housing loan finance to charged on unsecured debts such as credit cards.
individuals in the Australian market accounting for
about 80% of the total market. The standard loan Performance
product is the 25-year fully amortising variable rate The experience of the Australian mortgage insurance
loan secured by a first registered mortgage over industry has been used to examine the performance
residential property. of housing loans in Australia. Mortgage insurers
Currently the market is characterised by: have statistically significant portfolios and empirical
♦ Intense competition among lenders for scarce,
data dating back to 1965. Standard & Poor’s has
quality business. also used surveillance information collected on rated
MBS programs, however the standard 25-year fully
♦ Product innovations—interest off-set accounts,
amortising housing loan has only been securitised in
redraw facilities, further advances, payment
Australia in the past five years—a very stable
holidays, fixed-rate amortising periods, interest
economic period, with historically high housing
only periods, graduating payments, home equity
affordability.
revolving lines of credit, portability.
♦ Competition among lenders leading to reduced
The Australian mortgage insurance industry’s claims
margins, and higher loan-to-value (LTV) loans. experience to date for residential mortgage loans
insured is relatively low. The average claims
♦ Evidence of real property prices remaining flat or
frequency is approximately 0.73%, resulting in an
falling in certain sectors of the market.
average loss severity of about 0.17% of the total
♦ The rate/term refinancing rate remains high.
value of residential mortgage loans insured by
Housing finance interest rates have been on a Australia’s five mortgage insurers from 1965.
downward trend since the late 1980s. This is mainly Australia’s relatively low incidence of defaults can
due to the likewise trend in the inflation rate, and largely be attributed to a strong ownership ethos
more recently a contraction in lending margins over and the willingness of Australians to reduce discre-
the real interest rate from over 4% to between on tionary spending in order to maintain the family
average 1.2%-1.6%. The contraction in lending home. Other factors include the personal liability

Figure 3

Housing Finance Interest Rates: Banks Versus Mortgage Managers

Banks Mortgage Managers

Indicator lending rates (% per annum)

17
15
13
11
9
7
5
Jan-1986 Jan-1988 Jan-1990 Jan-1992 Jan-1994 Jan-1996
Source: Reserve Bank of Australia Bulletin.

Standard & Poor’s 26

 Structured Finance Australia & New Zealand ¨ April 1999

Figure 4

Claims Experience Of Mortgage Insurers (By Underwriting Year)

(%)
2.5

1.5

0.5

0
1970 1975 1980 1985 1990 1995

Loss frequency (number of defaults as a proportion of total loans insured)

Loss severity (value of defaults as a proportion of total value of loans insured)
Loans written in year immediately preceding sharp interest rate rises
(i.e. borrowers experiencing payment shock)
Property prices spike
Recession
Stock market crash
Property crash/interest rates rising steeply

attached to Australian mortgage loans and, for The Australian economy has been characterised by
insured loans, the practice by the mortgage insurers economic boom/bust cycles. The incidence of
to individually underwrite and approve all policies defaults by underwriting years is higher in periods
(although this practice is being relaxed with pool immediately preceding economic downturns (see
policies available for loans below 80% LTV and figure 4).
open policy arrangements in place for certain This indicates that borrowers in these years may
lenders). Another feature of the Australian market is have had expectations of future economic stability,
that interest charged on mortgage loans financing rising property prices and secure income which may,
owner occupied properties is not deductible, while in turn, fuel demand for property and, in the short
interest earned on investments (including savings) is term, lead to further property price increases. This,
taxed. This increases the incentive to repay a home however, may act as a catalyst such that as the
loan faster, which is evident from the average life of market overheats, government monetary policy is
a home loan (about four years) and the high tightened leading to a corresponding decrease in
proportion of home owners that own their homes affordability (that is, rising interest rates), which
without a mortgage (60%). then triggers a revision in buyer’s expectations and
The major causes of default in Australia are gener- reduces demand resulting in lower property prices.
ally considered to be: Along with an economic recession and possible loss
♦ Loan affordability (predominantly interest rate or reduction of income, the final outcome is an
effects but including income and property prices) increased incidence of default and a higher resulting
and overcommitment by the borrower to debt; loss severity for those mortgages written leading up
♦ Loss of income caused by job loss, decrease in to, and at the height, of the boom. These loans are
overtime, decrease in commissions, or loss of not seasoned enough to have built up substantial
second job); equity, and may in fact have less equity than when
♦ Personal crisis (most commonly marital disputes,
written, as a result of the lower prevailing property
but also illness, death); and prices.
♦ Any of the above accompanied by declining
property values.

Standard & Poor’s 27

 Structured Finance Australia & New Zealand ¨ April 1999

Figure 5

25-Year Fully Amortising Australian Housing Loan Loss Curve

(%)
35

30
25
20

15
10

5
0
0-12 12-24 24-36 36-48 48-60 60-72 72+

Months from origination.

Loss Curve diversified to allow 100% insurance coverage for

Amortising mortgage loans display a definite loss the residential market (including residential invest-
curve as can be seen in figure 5. With lower infla- ment). The latter form of coverage is commonplace
tion, there is the potential for this risk period to today.
become longer, as equity in the property will not Pool mortgage insurance is a related product that
accumulate as quickly as when nominal prices are provides for cover against losses from mortgages
increasing more quickly. One positive outcome of pooled for sale in a secondary market. Losses are
the structural shift to lower inflation and lower primarily covered by policies for individual mort-
nominal and real interest rates (that is, reducing gages in the pool up to some proportion of the total
inflation and reducing margins) has been that many pool value.
borrowers who managed higher repayments while
housing interest rates were higher, have elected to KEY INDUSTRY PARTICIPANTS
continue paying these higher instalments to build The LMI market is currently dominated by five
equity more quickly and pay off their home sooner. major participants: Housing Loans Insurance Corp.
This may act to fully, or partially, counter the effect Pty. Ltd. (HLIC Pty. Ltd.), GE Capital Mortgage
of lower nominal property price inflation on the loss Insurance Corp. (Australia) Pty. Ltd. (GEMICO),
curve horizon. CGU Lenders Mortgage Insurance Ltd. (CGULMI),
MGICA Ltd., and Royal & Sun Alliance Lenders
The Australian Mortgage Insurance Industry
Mortgage Insurance Ltd. (RSALMI), which operate
Lenders Mortgage Insurance (LMI) was introduced on a national basis. HLIC Pty. Ltd. and GEMICO
in Australia in 1965 to cover lenders against losses are wholly owned subsidiaries of GE Capital
on loans secured by mortgages. This type of insur- Australia and have a market share estimated to be
ance became popular because lenders were often approximately 40%. This market share was
unwilling to provide home loans up to the 95% LTV inherited as of Dec. 15, 1997, when GE Capital
ratio as is common practice today. The availability Australia purchased the business name, franchise,
of insurance, to cover the perceived additional risk systems and staff of the existing Housing Loans
of lending to this level, allowed lenders to be much Insurance Corp. (HLIC) from the Commonwealth
less restricted in their views of acceptable loan Government of Australia. All existing policy
profiles, which in turn helped to improve the access liabilities of HLIC remain the responsibility of the
of residential property buyers to the housing loan government under its guarantee, with the run-off of
market. Initially, LMI mirrored the U.S. practice, in the company being managed by HLIC Pty. Ltd. for a
that cover was restricted to 20% of the principal fee. Standard & Poor’s has assigned an insurer
loan balance applying to purely owner-occupied financial strength rating of ‘AAA’ to HLIC Pty. Ltd.,
residential lending. Shortly after, the industry

Standard & Poor’s 28

 Structured Finance Australia & New Zealand ¨ April 1999

Figure 6 Australian Benchmark Residential Mortgage Loan Pool

Pool size: Minimum of 300 loans
Loan seasoning: Minimum one payment made
Loan size: Maximum individual loan size A$400,000
Maximum weighted average loan size A$150,000
LTV: 80%
Loan type: Level pay, fully amortising, variable rate
Loan term: 25 years
Security: First registered mortgage over freehold land or crown lease holds with a lease term at least
15 years longer than the loan term
Security property: Residential property—detached, semidetached, townhouses,
strata title flats, apartments, units
Geographic dispersion: Geographically diverse; metropolitan areas
State concentration limits:
New South Wales/Australian Capital Territory 60%
Victoria 50%
Queensland 40%
Western Australia 25%
South Australia 25%
Tasmania/Northern Territory 10%
Maximum inner city exposure—10%
Maximum nonmetro exposure—10%
Performance: Not delinquent, strong performance over past 12 months
Borrower employment status: PAYE employee or professional
Borrower status: Australian resident
Affordability: Within market standards and standard imposed by UCCC
Loan purpose: Purchase, or refinance without equity release
Property insurance: Fully insured against fire and other major hazards
Underwriting standard: Full

‘AA’ to GEMICO and CGULMI, and ‘AA-’ to ♦ Australian mortgage insurers have typically
RSALMI and MGICA Ltd. underwritten a large proportion of policies in the
past. In the future, it is probable that they will
BENCHMARK POOL move away from this practice and favour open
The benchmark pool is shown in figure 6. policy and pool policy arrangements. The
historical data therefore reflects a second layer of
Benchmark Assumptions
underwriting that may not be there in the future.
Standard & Poor’s expected case default frequency
and loss severity assumptions for the benchmark DEFAULT FREQUENCY
pool are higher than the historical average for the The default frequency is the estimated number of
market reflecting: loans in a pool that will default. Standard & Poor’s
♦ Property prices may not appreciate as quickly in benchmark default frequency assumptions at
the future as has historically been the case, different LTV ratios are shown in figure 7.
reflecting the lower levels of inflation sustained
since the 1991-92 recession. Deviations From The Benchmark Default Frequency
♦ Recent structural changes in the finance industry Most pools that Standard & Poor’s evaluate do not
(continuing deregulation), aggressive competition have the characteristics of the benchmark pool,
from new lenders in the market, and new product necessitating different default frequency assump-
innovations. tions. When analysing pools, Standard & Poor’s
♦ The effect of shrinking public housing programs
adjusts the benchmark default frequency to address
to low and middle income earners—people that the associated increased or decreased risks.
may have qualified for these assistance programs LTV Ratio. LTV ratios historically have proved to
in the past are now seeking housing finance from be key predictors of default frequency rates. LTV is
the private sector. defined as the ratio of mortgage debt divided by the
value of the security property, expressed as a

Standard & Poor’s 29

 Structured Finance Australia & New Zealand ¨ April 1999

♦ Quality controls in place (for example, review

Figure 7 Benchmark Default Frequency performance to improve credit quality in future);
Assumptions By LTV Ratio
and
LTV Ratio AAA AA A BBB ♦ Whether a second layer of underwriting has been
40%* 6.00 4.80 3.90 3.00 performed by the mortgage insurers.
50%* 7.00 5.60 4.55 3.50
60%* 8.00 6.40 5.20 4.00 As competition in the market intensifies, and to save
70%* 9.00 7.20 5.85 4.50 time in the origination process, reduced and alterna-
80% 10.00 8.00 6.50 5.00 tive documentation is increasingly being explored by
90% 15.00 12.00 9.75 7.50
Australian lenders. Reduced or limited documenta-
95% 30.00 24.00 19.50 15.00
100% 45.00 36.00 29.25 22.50 tion loans vary in documentation requirements, but
the focus of the products is to reduce the amount of
*If full property valuations including internal property inspection
paperwork the borrower is required to submit at
are not carried out, Standard & Poor’s typically will not give credit
to loans with stated LTVs of below 80%. loan application. Standard & Poor’s looks for an
increased level of protection, to cover the relative
risk present as a result of underwriting with reduced
percentage. Standard & Poor’s bases its analysis of documentation. The adjustment factors act as
the relationship between LTV ratio and default multipliers to Standard & Poor’s existing default
frequency on empirical data from the mortgage frequency numbers. There will be no adjustment to
insurance industry. Generally, empirical data has the corresponding loss severity factors. The reason
demonstrated that the higher the LTV ratio, the for adjusting the default frequency is that there is a
greater the probability of loan default. This makes higher probability that unqualified borrowers may
intuitive sense. Firstly, borrowers who enter into a be approved in certain limited documentation
lower LTV loan display an ability to save and a programs.
degree of conservatism in not borrowing up to a Standard & Poor’s benchmark assumes the
higher LTV. Secondly, borrowers with lower LTV following minimum underwriting standards:
ratio loans have a higher degree of flexibility to ♦ A full credit review and Credit Reference Associa-
manage their affairs outside a default situation. For tion of Australia (CRAA) check, including
instance, a borrower in financial hardship with a verification of borrower identity;
low LTV loan may elect to sell the property without
♦ Verification of deposit, including examination of
the lender controlling the situation and repay the
account statements for at least three months; and
loan in full, avoiding the stigma of default. This will
♦ Verification of employment and income, includ-
be reflected as a prepayment rather than as a
ing most recent pay slips and tax return.
default. The higher the LTV ratio, the more likely
that the proceeds from the sale of the property will Servicing quality. Standard & Poor’s will apply a
be insufficient to repay the loan in full, with the factor to the portfolio default frequency to reflect its
borrower relinquishing control of the situation to assessment of the servicing quality of the portfolio.
the lender. This will be based on Standard & Poor’s servicer
review and portfolio performance over time that
Quality of Underwriting. Standard & Poor’s will
includes an assessment of:
apply a factor to the portfolio default frequency to
reflect its assessment of the underwriting quality of ♦ The servicer’s collections department structure
the portfolio. This will be based on Standard & and collection strategy;
Poor’s review of the underwriting policy and ♦ Experience of staff;
procedures and portfolio performance over time that ♦ Tracking systems;
includes an assessment of: ♦ Form of borrower contact; and
♦ Company strategy—market share versus quality; ♦ Borrower payment methods—direct debit versus
♦ Underwriting standards and quality of credit manual payments.
review, deposit verification, employment/income Loan purpose. The purpose of any loan falls into
verification etc.; one of two categories: purchase or refinance. A
♦ Frequency of exceptions to established underwrit- purchase mortgage is the term used to describe the
ing guidelines; typical mortgage transaction where a buyer is
♦ Originator experience and training; funding a portion of the acquisition price for a new
♦ Originator compensation structure (commissions home. The collateral value is strongly supported by
versus salary, performance measures etc.); both the purchase price and an appraisal. Within the

Standard & Poor’s 30

 Structured Finance Australia & New Zealand ¨ April 1999

purchase category, Standard & Poor’s does payments, graduated payments, and negatively
distinguish first home buyers from the remainder of amortising mortgages because of higher default
purchasers to reflect the increased level of default frequency assumptions.
probability within this subset. Many lenders Subsidised mortgage loans allow borrowers’
consider first home buyers to be a riskier subset of monthly payments to be subsidised by a third party
the residential mortgage market. This may be due to in the early years of a loan’s life, perhaps qualifying
factors including immaturity and the limited assets a borrower who otherwise would not be considered.
that first home buyers own at the time of purchase, As the payment subsidy disappears, borrower
such as household furniture, or a car that will need default becomes more likely because of payment
to be acquired. Also, a feature of this part of the shock.
market is that borrowers often only qualify for the
Negatively amortising mortgages incur risk as
loan on a joint basis (that is, two incomes are
borrowers’ scheduled payments increase over time.
required to qualify for the loan) and there may be
Initially, payments due are lower than interest owed.
interruptions to the second income, and additional
The resulting negative amortisation causes the LTV
expenses if the borrowers decide to start a family. In
ratio to increase over time, increasing both default
Australia, the desire to start a family is one of the
risk and loss severity.
main reasons listed by first home buyers as influenc-
ing their decision to purchase a residence. Graduated payment mortgages are considered the
least risky of the deviations from the standard level
Within the refinance category, Standard & Poor’s
pay amortising loan. Like negatively amortising
distinguishes between rate/term refinances and
mortgages, graduated payment mortgages require
equity takeout refinances. In a rate/term refinance,
increasing payments, but these increases are applied
the borrower replaces an existing loan with a new
toward the principal balance, allowing the loan to
loan that usually has the effect of lowering monthly
repay faster. As the loan amortises more quickly,
payments. No cash is released to the borrower in a
equity increases and credit risk is reduced. The
rate/term refinance. Standard & Poor’s sees no
overall increased risk, however, lies with the uncer-
additional risk in a loan used for this purpose.
tainty of whether the borrower can handle the
Equity takeout refinances have a higher risk profile. payment increases during the first few years of the
Instead of building equity in the property over time, loan before equity accrues.
the borrower is removing equity. This may be an
Balloon mortgages. A balloon mortgage is a loan
indication of problems and a higher probability of
with principal payments that do not fully amortise
default in the future. Consequently, Standard &
the loan balance before maturity. Repayment of
Poor’s increases the default frequency for loans used
balloon mortgages, unlike their fully amortising
to release equity to the borrower. Standard & Poor’s
counterparts, depends not only on the borrower’s
treats further advances under existing facilities in the
earning capacity, but also on his or her ability to
same way as equity takeout refinances.
refinance at the maturity date. As a result, both the
Occupancy status. Standard & Poor’s does not make borrower and the lender are subject to forces, such
any distinction between the occupancy status of as the movements in interest rates and property
houses in determining default frequency. Empirical values at the time of refinancing, that are beyond
data collected by Standard & Poor’s on portfolios their control. Borrowers who are unable to refinance
rated to date does not warrant such a distinction may default on their balloon loan. In light of this
being made. added credit risk, Standard & Poor’s looks for
Mortgage payment characteristics. Mortgage higher levels of loss protection for rated mortgage-
payment characteristics are important factors in backed securities involving balloon mortgages.
credit quality analysis. The benchmark pool assumes All moneys mortgages. All moneys mortgages are
loans that are level pay and fully amortising. mortgages that may secure many debts, not just the
Standard & Poor’s will assess features such as housing loan. In some instances, the seller retains the
subsidised mortgage payments, graduated payments right to have the mortgage enforced if the borrower
and negatively amortising mortgages to determine defaults on a debt other than the housing loan. As
the affect of such features on the credit risk of the Standard & Poor’s believes that a borrower is more
pool. Level payment loans have lower default risk likely to default on a secondary debt, the default
than a loan with payments that may increase over frequency assumed for loans secured by mortgages
time. As a result, Standard & Poor’s requires more
loss coverage for pools with subsidised mortgage

Standard & Poor’s 31

 Structured Finance Australia & New Zealand ¨ April 1999

that have this feature is higher. Loss severity is not payment record. Accordingly, loans that have a poor
affected, because proceeds are used to repay the payment record over the most recent 12 months will
housing loan in priority to all other debts. be assigned with a higher probability of default in
Borrower employment status. From examination of the future.
performance data on rated MBS, the employment Delinquent status at closing date. If loans are
status of the borrower seems to affect default delinquent on the closing date, there is a higher
frequency. In Australia, the most common status is probability that these loans will default. Conse-
as an employee where income is paid net of income quently, these loans are assigned a higher default
tax (pay as you earn—PAYE). Professionals must frequency.
manage their financial affairs, and annual taxation Loan size. Loan size is another credit quality factor.
and provisional taxation requirements may impose Jumbo loans, defined by Standard & Poor’s as loans
stress on the individual’s debt service capability. with a balance of more than A$400,000, are
Generally, however, cash flow is strong and these considered higher risks. In an economic downturn,
individuals are not deserving of a penalty vis-à-vis jumbos are more likely to suffer greater market
PAYE employees. Borrowers whose salaries have a value decline as a result of limited market for the
large commission component (such as sales repre- underlying properties. This would increase loss
sentatives, real estate agents etc.) are more suscepti- severity on the mortgage. The larger the market
ble to decreased income in an economic downturn. value decline, the more likely the borrower will
Also, there is strong evidence that self employed default if the borrower is in financial difficulty.
individuals are more likely to default on their
Loan maturity. The benchmark uses the 25-year
mortgage loan than PAYE employees, professionals
amortising loan as this is the most common mort-
or individuals paid on a commission basis. This is
gage loan product and empirical data is based on the
not surprising, given that most small businesses will
performance of loans that are concentrated around
fail within the first five years of operation and
this amortisation schedule.
lenders generally require the borrower’s home as
collateral. (In many respects, mortgage loans to self Interest rate. Most Australian mortgage loans are
employed borrowers may be considered as business charged a variable rate of interest that is set at the
loans with proceeds often used to finance business discretion of the lender. Loans fixed for a period of
operations). Trust and company lenders are likewise three to five years are less likely to default due to
penalised to reflect the increased difficulty of payment shock in the early years of the loan when
underwriting vis-à-vis a PAYE loan application default probability is highest. Loans extended to
unless the servicing review displays a degree of borrowers with an initial teaser rate, such as the
sophistication in underwriting these applications. popular 12 month “honeymoon rate” where the
initial period is fixed at a rate of interest below
Serviceability. In a rising interest rate scenario, those
prevailing market rates, are more likely to default
with higher debt burdens are less likely to be able to
due to payment shock at the end of the fixed period.
afford their mortgage loan. In fact, rising interest
rates is one of the leading triggers for loan defaults. Seasoning adjustment. Amortising residential
Standard & Poor’s will assess the underwriting mortgage loans in Australia display a very character-
methods employed by the lender to determine the istic loss curve with the majority of losses being
affordability of the loans being made to individual realised within the first five years. To reflect the
borrowers. These methods may include various decreasing probability of default over time, the
debt-to-income ratio measures and various income default frequency applied to seasoned loans will be
multiple tests. lower than for unseasoned loans.

Standard & Poor’s may reduce its assumed probabil- Pool size. As in any statistical sample, loan pool size
ity of default for a loan if a borrower has loss of is important in determining risk. Standard & Poor’s
income or mortgage instalment insurance. Consid- considers a pool of 300 loans to be of sufficient size
erations will include the rating of the insurer, extent to ensure diversity and the accuracy of Standard &
of coverage (for example, in the case of unemploy- Poor’s default frequency assumptions. Pools with
ment, illness), and the term of coverage (to receive less than 300 loans, but no fewer than 100 loans,
credit, the term should be at least three to five are rateable on an actuarial basis, however an
years). adjustment is made in the pool credit quality
analysis. Standard & Poor’s will not use its actuarial
Poor payment history. Loans that have displayed a
model to estimate default frequency on pools with
poor payment pattern in the past are more likely to
underperform those loans displaying an exemplary
Standard & Poor’s 32
 Structured Finance Australia & New Zealand ¨ April 1999

less than 100 loans. These portfolios are reviewed result in higher weighted average loss severity assump-
on a case-by-case basis to determine an appropriate tions for the pool.
method of default estimation. An example of Standard & Poor’s loss severity
Standard & Poor’s will apply a small pool penalty calculation for an individual loan is shown in figure
for mortgage pools containing less than 300 loans. 9.
The purpose of the small pool penalty is to capture
the uncertainty in Standard & Poor’s assumed Figure 9 ‘AAA’ Loss Severity Calculation
default frequency. Original property value A$100,000
Volatility of funding benchmark rate. In many Less market value decline A$45,000
Equals new market value A$55,000
programs rated to date, the security funding costs
Less loan balance A$80,000
are directly reflected in the rate charged on the loans Equals market loss (A$25,000)
via a threshold rate mechanism. The funding costs of
Less realisation costs
rated programs to date have been based on the 30 or ♦ 15 months accrued interest at 11% (11,000)
90-day bank bill swap rate (BBSW). If a more ♦ Fixed selling, legal and other costs (5,000)
volatile funding base is used, a penalty may be ♦ Variable selling, legal and other costs (2,750)
applied to the default frequency calculation to reflect Total loss (43,750)
the increased payment shock risk in the standard Loss severity (total loss/loan balance) 54.7%
variable rate.

LOSS SEVERITY CREDIT LOSS COVERAGE REQUIRED FOR

Loss severity is the estimated loss that will be AUSTRALIAN MBS BENCHMARK POOL
realised on a defaulted loan. Loss severity is a The credit loss coverage required is the product of
combination of market value decline in the underly- Standard & Poor’s assumed weighted average default
ing property market and costs associated with frequency and weighted average loss severity for the
enforcing the mortgage, as well as accrued interest pool. Figure 10 shows credit coverage levels at
on the loan after the loan defaults, but before the different LTV ratios for pools that otherwise mirror
security property is sold. Standard & Poor’s benchmark pool.

Figure 8 Benchmark Market Value Decline Figure 10 Benchmark Credit Loss Coverage By
Assumptions LTV Ratio (%)
Rating category Market value decline LTV Ratio AAA AA A BBB
AAA 45% 40% 0.12 0.10 0.08 0.06
AA 40% 50% 1.35 0.55 0.10 0.07
A 36% 60% 2.80 1.73 1.08 0.58
BBB 32% 70% 4.16 2.84 1.99 1.29
BB 28% 80% 5.47 3.90 2.86 1.96
90% 9.19 6.72 5.05 3.56
95% 19.20 14.16 10.73 7.65
Standard & Poor’s benchmark market value decline 100% 29.93 22.23 16.95 12.18
assumptions for Australian residential property are
Assumes a 11.7% interest rate for accrued interest costs.
shown in figure 8. Standard & Poor’s assumes that
selling, legal and carrying costs amount to A$5,000
plus 5% of the realised property value. Accrued EFFECT OF MORTGAGE INSURANCE ON LOSS
interest is calculated using a realisation period of 15 SEVERITY ASSUMPTIONS
to 18 months depending on the geographic location
The assumed loss severity and required credit loss
of the property and the size of the loan. Accrued
coverage levels can be reduced if loans are insured
interest is calculated on the outstanding loan balance
under individual primary mortgage insurance
for the term of the realisation period. The assumed
policies, or if loans are insured under a mortgage
interest rate is Standard & Poor’s estimation of the
insurance pool policy.
average worst-case interest rate over the assumed
stress scenario (see cash flow analysis section on The amount of credit that Standard & Poor’s may
page 40). apply to mortgage insurance policies in rated MBS
depends on two factors:
Excess geographic concentrations, as well as higher
♦ The creditworthiness of the insurer. Credit of
than average concentrations of larger loans, will
100% will be given at the insurer financial

Standard & Poor’s 33

 Structured Finance Australia & New Zealand ¨ April 1999

OTHER FACTORS AFFECTING CREDIT QUALITY

Figure 11 Credit To Lower Rated Mortgage
Insurers In ‘AAA’ Transactions General Insurance
Insurer financial Credit at General insurance protecting the value of the
strength rating ‘AAA’ security property, or lack thereof, may affect the
‘AAA’ 100% default frequency for a given pool of loans, and
‘AA’ category 75%
significantly increase the loss severity for loans that
‘A’ category 50%
‘BBB’ category 0% default as a consequence of damage to the security
property. Full fire and general insurance to protect
the value of security properties is an important
strength rating level. As a lower rated insurer may
consideration in determining the overall credit
be expected to perform part way through a
quality of mortgage loan pools in Australia. This is
higher rated stress scenario, proportional credit
especially true as the primary credit protection in
will be applied by Standard & Poor’s to policies
many rated MBS is mortgage insurance policies that
issued by insurers with insurer financial strength
specifically exclude liability for loan losses to the
ratings below the rating sought on the MBS (see
extent that there has been damage to the underlying
figure 11).
security property. Typically, the loan and mortgage
♦ The coverage of the policy and the historical agreement require the borrower to maintain full fire
claims payment record of mortgage insurers in and general insurance, at least equal to the value of
the market. Standard & Poor’s reviews the terms the security property at all times while the loan
of the mortgage insurance policies to determine remains outstanding. Also, some programs maintain
the breadth of coverage and to assess the risk to insurance policies (not necessarily provided by a
rated noteholders of losses not being covered due rated insurer) to help protect the issuer from loss
to policy exclusions. Standard & Poor’s also due to property damage not covered under a general
reviews each insurer’s internal policies and insurance policy due to inadequacy of the original
procedures to assess the risk of the insurer policy or due to the policy having lapsed. (Generally
delaying, reducing or denying future claims. these policies do not cover where there is a general
Generally, in Australia, 100% credit is given to insurance policy in place and the general insurer is
the policies at the insurer financial strength rating insolvent or bankrupt.)
of the insurer. The ability to give 100% credit to
primary mortgage insurance at the given rating Environmental Risks
level of the insurer reflects the payment record of To limit potential exposure to unlimited liability for
mortgage insurers in Australia to date. environmental contamination that may far exceed
the value of the loan, the servicer should ensure that
DETERMINING PROPERTY VALUE before repossessing a property, it is appraised to
Standard & Poor’s ability to rely on LTV ratios determine whether the property is situated on a
plays an important part in both the determination of contaminated site. If there is a risk that this is the
the estimated default frequency and loss severity for case, the cost of cleaning the site and paying
each loan. Historically, securitised loans have associated fines should be assessed before taking
benefited from full property valuations carried out possession.
on every property by a registered valuer. To reduce
costs, many originators are moving away from full STRUCTURAL ANALYSIS
property valuation on every property by a registered An analysis of the structure of the transaction is an
valuer. Standard & Poor’s may adjust the stated LTV important part of the rating process. The interrela-
ratios if it believes the valuation method applied for tionship of the internal and external enhancements,
the security properties is insufficient to use as a along with the behaviour of the underlying assets,
proxy for property values in its credit analysis. will determine the strength of the transaction.
Considerations include:
♦ Whether the credit enhancement is adequate at
the given rating level to protect investors from
underlying asset defaults;

Standard & Poor’s 34

 Structured Finance Australia & New Zealand ¨ April 1999

♦ Whether investors are sufficiently protected from Standard & Poor’s looks to ensure that the
credit risks associated with parties providing subordinated noteholders are sufficiently limited in
support to the transaction; their ability to interrupt payments to senior
♦ Whether there is sufficient liquidity in the noteholders or usurp the rights of senior
transaction to meet all obligations in a timely noteholders. While senior rated obligations of the
manner at the given rating level; and issuer remain outstanding, a failure to pay under the
♦ Whether there are risks associated with the subordinated note terms should not constitute an
structure, other than risks inherent in the under- event of default, nor should it result in the issuer
lying mortgage loan assets, for example commin- being deemed insolvent. To ensure that this does not
gling risk or set-off risk. happen, subordinated noteholders’ claims against
the assets should be structured to be payable only to
Interest Entitlements the extent the issuer has funds available, and if the
A structural element that Standard & Poor’s reviews issuer has insufficient funds, the subordinated
is the actual calculation of interest entitlements to noteholders’ claims should be extinguished. Also, it
both senior and subordinated noteholders. Where is preferable to insert in the insolvency event
Standard & Poor’s is rating the MBS securities, the definition an explanatory note that states for the
calculation of interest should be based on the avoidance of doubt, drawing on support facilities
invested amount and not the stated amount. The and nonpayment of subordinated notes while senior
invested amount equals the original principal notes are outstanding does not constitute an
balance, minus principal amounts repaid to inves- insolvency event. The subordinated noteholders’
tors. The stated amount equals the invested amount, right to take any action against the issuer, and their
minus charge-offs. This is because in assigning a voting rights, should be limited until all senior
rating to each class of securities, Standard & Poor’s obligations of the issuer have been repaid in full.
assesses the likelihood that the issuer will be able to
Prepayment Step-Down Criteria
pay interest on each coupon payment date in full,
and return principal no later than the legal final The manner in which prepayments are allocated in
maturity date. As soon as an interest payment is mortgage-backed structures is addressed when
calculated on the stated amount (if the stated assigning a rating. Where subordinate classes
amount is lower than the invested amount), interest provide credit support to senior classes, allocation of
is paid on something less than the whole and, while all principal prepayments to the senior classes is
interest is paid according to the terms of the issue, viewed by Standard & Poor’s as the most robust
the interest payment is not made in full. method of distributing unscheduled payments of
principal.
Subordination
As a minimum, Standard & Poor’s requires all
Generally, in Australia, Standard & Poor’s assigns its prepayments from variable rate mortgages to be
high investment grade ratings both to senior and allocated to senior classes in the first five years of
subordinated classes of mortgage-backed securities. the pool’s life. This allocation of prepayments
The subordinated securities provide credit and accelerates the paydown of the senior classes relative
liquidity support to the senior securities, however, to the subordinate classes, which provides additional
this support is less liquid than some forms of protection to the senior classes during the initial
external enhancement. years of the mortgage pool’s life, which Standard &
The majority of Australian MBS are senior/subordi- Poor’s views as the highest risk period.
nated structures where the priority of payments to As the collateral pool ages, prepayments are then
noteholders is as follows: allowed to gradually step down, with an increasing
♦ Senior interest, percentage of prepayments released to the subordi-
♦ Subordinated interest, nate classes, as set out below, if certain loss and
♦ Senior principal, and delinquency tests are met.
♦ Subordinated principal. Years one through five. 100% of all prepayments are
This means the subordinated interest is only subor- allocated to the senior classes. That is, the senior
dinated to senior interest, not senior interest and classes receive both the senior percentage of
principal. prepayments and the subordinated percentage of
prepayments.

Standard & Poor’s 35

 Structured Finance Australia & New Zealand ¨ April 1999

Year six. The senior classes receive the senior Prepayments may be released early to the
percentage (based on outstanding balance of senior subordinated classes under the following conditions:
classes) of prepayments plus 70% of the ♦ On any distribution date, the subordinate
subordinated percentage of prepayments, while the percentage represented by the sum of the
subordinated classes share 30% of the subordinated subordinate classes has doubled from the original
percentage of prepayments pro rata. percentage represented by the sum of the
Year seven. The senior classes receive the senior subordinate classes; and
percentage of prepayments plus 60% of the ♦ On any distribution date on which the doubling
subordinated percentage of prepayments, while the test has been met, no more than an average of
subordinated classes share 40% of the subordinated 2% of the mortgage loans have been 60 days or
percentage of prepayments. more delinquent over the immediately preceding
Year eight. The senior classes receive the senior 12 months and cumulative realised losses do not
percentage of prepayments plus 40% of the exceed 30% of the initial subordinated principal
subordinated percentage of prepayments, while the amount. Alternatively, no more than an average
subordinated classes share 60% of the subordinated of 4% of the mortgages have been 60 days or
percentage of prepayments. more delinquent over the immediately preceding
12 months and cumulative realised losses do not
Year nine. The senior classes receive the senior
exceed 10% of the initial subordinated principal
percentage of prepayments plus 20% of the
amount.
subordinated percentage of prepayments, while the
subordinated classes share 80% of the subordinated Provided these conditions are met, the senior classes
percentage of prepayments. would be entitled to the senior percentage plus 50%
of the subordinate percentage of prepayments if the
Year ten. The senior classes receive the senior
doubling occurred before the third anniversary and
percentage of prepayments, and the subordinate
the senior percentage of prepayments if the doubling
classes receive the subordinated percentage of
occurred after the third anniversary.
prepayments.
Increased sizing on the closing date. Standard &
Release of prepayments to subordinate classes is
Poor’s also has established criteria for allocating
subject to:
prepayments pro rata between a ‘AAA’ rated senior
♦ On any distribution date, the current senior
class and the ‘AA’ rated subordinate class before the
percentage does not exceed its initial percentage;
expiration of the five-year lockout period, based on
♦ On any distribution date occurring after year six, the oversizing of the ‘AA’ rated class on the closing
no more than an average of 2% of the mortgage date. The degree to which the ‘AA’ rated class is
loans have been 60 days or more delinquent over oversized determines the period in which
the immediately preceding 12 months; and prepayments may be allocated pro rata between the
♦ Cumulative realised losses do not exceed the ‘AAA’ and ‘AA’ rated classes. The sizing require-
following percentages of the original aggregate ments for the ‘AA’ rated class and relevant lockout
principal balances of the subordinate classes on periods are:
the following anniversaries of the closing date: ♦ times (x) its normal size, no lockout period. (All
fifth anniversary, 30%; sixth anniversary, 35%; prepayments may be allocated pro rata between
seventh anniversary, 40%; eighth anniversary, the ‘AAA’ and ‘AA’ rated classes beginning on the
45%; ninth anniversary; and, thereafter, 50%. closing date);
If any of the foregoing conditions is not met, 100% ♦ 2.5x its normal size, one-year lockout;
of any prepayments will be paid to the senior ♦ 2.0x its normal size, two-year lockout;
classes.
♦ 1.5x its normal size, three-year lockout; and
Rapid prepayment criteria. Standard & Poor’s has ♦ 1.25x its normal size, four-year lockout.
established criteria for releasing prepayments before
In each case, the pro rata allocation of prepayments
the expiration of the five-year lockout period if the
between the ‘AAA’ and ‘AA’ rated classes is subject
aggregate percentage of subordination has doubled
to certain loss tests. The ‘AA’ rated class should
from the original aggregate percentage of
continue to be locked out of prepayments if:
subordination.

Standard & Poor’s 36

 Structured Finance Australia & New Zealand ¨ April 1999

♦ Before year 10, realised losses exceed 50% of the able to be redrawn by the pool of mortgages at any
original aggregate principal balance of the classes point in time (that is, the scheduled amortisation
subordinate to the ‘AA’ rated class; or balance minus the actual loan balances outstanding).
♦ After year 10, realised losses exceed 75% of the In transactions where loans are equitably assigned to
original aggregate principal balance of the classes the SPE, the seller of the loans remains obligated to
subordinate to the ‘AA’ rated class. (In this honour the redraw commitment to the borrower,
example, the assumptions that the oversized class not the SPE. Opinions received from issuers’ counsel
is rated ‘AA’ need not be the case. The oversized have also confirmed that this obligation does not
class below the ‘AAA’ rated class could have transfer to the SPE on legal assignment of the loans.
carried an ‘A’ rating or no rating, for example, Funding Redraws. A variety of methods can be used
and the same criteria would apply.) to fund redraws to borrowers within an MBS
Once the fifth year anniversary has been reached, structure. They are:
those subordinated classes rated lower than ‘AA’ ♦ Use principal collections received in that period
may begin to receive an increasing percentage of the to fund the redraw requests;
subordinated percentage of prepayments, subject to ♦ Maintain a small proportion of bond proceeds in
the loss and delinquency tests mentioned. However, liquid authorised investments to fund the redraw
the subordinated percentage would now refer to requests;
those classes rated lower than ‘AA’. Similarly,
♦ Issue “fast pay” senior securities that are rated by
prepayments also may be released to those classes
Standard & Poor’s. In effect, these securities will
rated lower than ‘AA’ before the fifth anniversary,
have the rights of a class A1 investor where
provided that the percentage interest of those classes
principal is allocated sequentially to class A1
rated lower than ‘AA’ has doubled from their
until repaid in full, then class A2 until repaid in
percentage interest on the closing date, and the
full and so on; and
relevant sizing, loss, and the delinquency tests
♦ Provide a redraw facility from a suitably rated
mentioned have been met.
institution. The rights of the redraw facility
Redraw Facilities provider must not exceed the rights of a class A1
Redraw facilities allow borrowers to reborrow investor (that is, interest on the distribution date
amounts previously prepaid under their loan up to and principal passed through as received). Often
the scheduled amortisation balance of the loan. the term of the redraw facility will be less than 12
Loans that have redraw facilities may be included in months. In these instances, it is important to
mortgage-backed programs subject to meeting the ensure that the SPE is under no obligation to
following conditions: repay advances under the redraw facility at that
♦ The borrower may only apply for principal time, other than to pay through principal received
amounts previously prepaid. That is, the redraw according to the terms of the transaction
will not result in the new loan balance being documents.
above the original scheduled amortisation curve; An important consideration with the issuance of fast
♦ The request for redraw should be denied if the pay securities and the redraw facility is the effect
borrower is currently in arrears; that these additional obligations have on the
♦ The borrower should be required to apply to the structure. It is particularly important to remember
lender for a redraw. That is, the borrower cannot that these obligations are senior obligations of the
elect to miss payments if they are under their SPE. If the credit and liquidity supports (including
scheduled amortisation curve; and subordination) are allowed to amortise, or if the
♦ The redraw should not be an automatic right of
value of senior obligations can increase to an
the borrower. It should be conditional on amount exceeding the initial senior balance (if the
performance and availability of funds. loans are seasoned this is a real possibility), the level
of support after the issuance of fast pay securities or
Where the special-purpose entity (SPE) or trustee is
a drawing under a redraw facility may be insuffi-
the mortgagee, if the borrower has an automatic
cient at the rating level on the notes.
right to redraw, there must be a committed facility
available from a suitably rated counterparty for an Most bank transactions involve a redraw facility,
amount equal to the maximum that may be avail- and the way Standard & Poor’s has accommodated
this to date is to assume the redraw facility is fully

Standard & Poor’s 37

 Structured Finance Australia & New Zealand ¨ April 1999

drawn at closing, and to size the required credit and balance exceeding the scheduled amortisation
liquidity supports assuming the loan pool equals the balance after the further advance is granted. Further
closing loan pool, plus the redraw facility limit. advances are often granted to finance home
improvements or nonmortgage related consumption.
Substitution Period
This borrowing practice allows originators to
Many Australian MBS incorporate a substitution expand their lending business as part of an overall
period. During this period, the issuer reinvests marketing strategy and consumers to borrow at
principal collections received in other eligible rates far lower than rates for unsecured borrowing.
mortgage loan assets to the extent that eligible assets Many rated transactions include provisions for
are available. Substitutions can change the credit accommodating further advances. Similar restric-
profile of a given portfolio and also have the effect tions that apply to redraw facilities and substitutions
of increasing the asset pool and therefore the also apply to the granting of further advances.
number of mortgage loans that may default during Further advances that take the new LTV ratio to
the life of the transaction. Standard & Poor’s has above 80% will be penalised in the same way as
criteria for accommodating the substitution period refinances with equity takeout at LTV ratios above
in rated MBS. Firstly, the initial lending criteria 80%.
should be met before substitutions are made. The
originator’s underwriting parameters then dictate the Threshold Rate Mechanisms
additional coverage required for increased credit Most Australian MBS are backed by mortgage loans
losses and liquidity shortfalls assumed to result from where the interest rate on those loans is set at the
substitutions. discretion of the lender. Often, the MBS structures
Within the confines of rated MBS, there are two look to gain some benefit from this by obligating the
methods for accommodating substitutions. The first servicer to set the interest rate on the mortgage loans
method is to make worst-case assumptions concern- at some minimum rate. Often, a basic premise of the
ing substitutions, and then include them in the initial threshold rate calculation is that all parties are
sizing of the credit loss and liquidity shortfall. performing their duties and obligations under
Standard & Poor’s assumes that substituted loans agreements—for instance, borrowers are not
will have been made using the least conservative of delinquent or in default. If this assumption is made,
the lender’s underwriting guidelines. The additional the threshold rate does not provide liquidity support
credit support required can be limited if the issuer is or any form of credit support to the transaction. A
prepared to limit the total amount of substitutions. stronger threshold rate calculation is one obligating
the servicer to set the threshold rate at a rate that
The second method is administratively more
enables the issuer to meet all its obligations in a
onerous, but generally results in lower credit and
timely fashion.
liquidity coverage levels. It involves the issuer
meeting a test prior to accepting additional loans Full Asset Basis Swaps
into the pool. This is the option that has been A common feature of the securitisation programs
preferred by Australian MBS issuers. In most being established by Australian banks is the desire of
transactions with substitution periods rated to date the selling bank to provide a full asset basis swap
in Australia, the manager generally confirms with transforming the actual yield on the assets to a yield
the rating agency that the substitution will not equal to the bank bill rate plus a predetermined
adversely affect the rating assigned to outstanding margin. The assets are generally discretionary rate
securities, before proceeding with the substitution. assets where the lender has discretion to set the
The purpose is to allow Standard & Poor’s to review interest rate at the level it chooses. The ability of the
the credit quality of the pool and determine that the seller to provide this swap is an important consid-
substitutions will not increase materially the overall eration in determining the feasibility of securitising
risk of the mortgage portfolio. If this is not the case, its assets. From a business standpoint, it means that
substitutions may be permitted in the pool only by the bank can charge its customers whatever rate it
increasing the credit and liquidity supports. wants, and pursue whatever strategies it wishes.
Further Advances From a cost standpoint, it is cheaper for the institu-
tion to provide such a swap than to seek out another
Further advances are becoming a regular feature of
suitably rated counterparty.
mortgage loans in Australia. Unlike redraw facilities,
further advances result in the borrower’s loan

Standard & Poor’s 38

 Structured Finance Australia & New Zealand ¨ April 1999

The basis swap provider need not be rated by Credit support may be required where a right of set-
Standard & Poor’s, however, the basis swap agree- off may exist and where the seller is not rated as
ment should conform with Standard & Poor’s highly as the rating sought on the securities. (In a
criteria for swaps in structured finance transactions. senior/subordinated structure, this may be the rating
Where the basis swap provider is not rated, or rated on the subordinated notes if additional subordina-
lower than the rating sought on the securities, the tion is sized over and above underlying asset defaults
following conditions should be incorporated into to protect senior noteholders from this risk.)
the basis swap agreement: A right of set-off may exist where the seller is a
♦ Where swap payments are made monthly, if the deposit-taking institution. Borrowers may maintain
basis swap provider is rated less than ‘A-1’, it deposit accounts with the seller where:
should cash collateralise its next payment to the ♦ The loan agreement does not contain a waiver of
SPE. The basis swap should terminate immedi- set-off, or contains an explicit right entitling the
ately if this condition is not met. The servicer borrower to set off; and/or
should then be required to set the interest rate on ♦ The borrower maintains deposit accounts that are
the assets using the threshold rate mechanism; “connected” in some way to the loan, and the
♦ Where swap payments are made quarterly or issuer’s lawyers are unable to give an opinion
semiannually, if the basis swap provider is rated confirming that any deposit balances in these
less than ‘A-1+’, it should cash collateralise its accounts will not be available to set off against
next payment to the SPE. The basis swap should the loan balances (irrespective of whether the
terminate immediately if this condition is not loan agreement contains an explicit waiver of set-
met. The servicer should then be required to set off rights).
the rate on the assets using the threshold rate
Standard & Poor’s reviews the assets and the
mechanism;
transaction structure to determine whether there are
♦ On a termination of the basis swap, termination
other set-off risks that may significantly affect the
payments owing to the basis swap provider ability of the issuer to meet its obligations to rated
should be specified to be zero; noteholders in a timely manner.
♦ If Standard & Poor’s believes that the assumed
servicing fee should be higher than the contracted Requirement For Backup Mortgage Servicer
servicing fee, but the seller wishes to use the Standard & Poor’s may request a committed backup
contracted servicing fee in determining the margin servicer be appointed to a mortgage pool where it is
it will pay to the SPE under the basis swap, there concerned with:
should be a requirement that if the servicer is ♦ The quality or experience of the existing servicer;
removed or resigns, the basis swap will terminate ♦ Growth of the mortgage portfolio and stress this
and the replacement servicer will set the interest may place on the capacity of the servicer;
rate on the assets using the threshold rate ♦ Mortgage products that are nonstandard or may
mechanism; and require unique servicing/systems requirements;
♦ The documents should specify how the threshold and
rate would be calculated in the absence of a basis ♦ Particular structural features of individual MBS
swap. programs where delays in replacing the servicer
If the rate charged on the loans is not a discretionary may strain the issuer’s ability to service its
variable rate, any basis swap provider should be obligations to rated security holders.
rated at least as high as the rating sought on the If a backup servicer is required:
securities.
♦ The backup servicer should be committed to
Set-Off Risk providing servicing pursuant to a written agree-
The most common form of set-off risk in Australian ment, generally on the same terms and conditions
MBS programs is depositor set-off risk. Where loans as agreed by the servicer under the transaction
are originated by a bank or other deposit taking documents;
institution, and subsequently assigned to a SPE and ♦ The agreement should provide for immediate
the borrowers maintain deposit accounts with the access by the backup servicer if the servicer
seller, there is a risk that borrowers may be entitled defaults in performing its obligations (generally
to set off any deposit balances against the assigned supported with a power of attorney);
loan balance on an insolvency of the seller, resulting ♦ The backup servicer’s systems should be
in a loss to the SPE. compatible with the servicer’s systems; and
Standard & Poor’s 39
 Structured Finance Australia & New Zealand ¨ April 1999

♦ The backup servicer should agree to a fee transaction’s cash flows are used to confirm that the
upfront, or at a minimum, be subject to a fee cap. cash flows from the loans and support facilities will
be adequate, given the rating sought on the
Liquidity
securities, to meet the obligations of the issuer in a
As well as analysing the ability of a transaction to timely manner, and specifically, that:
pay all obligations in full, a Standard & Poor’s
♦ interest is paid to investors on each coupon
rating assesses the ability of a transaction to meet
payment date;
those payments on time. Generally, in Australian
♦ investors receive principal no later than the final
MBS, the rating addresses the payment of interest in
maturity date; and
full on each coupon payment date, and the return of
♦ any obligations which, if not met, could result in
principal no later than the legal final maturity date.
Liquidity supports, such as liquidity facilities, timely an insolvency of the issuer, can also be met out of
payment cover under LMI policies, or the ability to the transaction’s cash flow.
use principal to pay interest, protect rated security Standard & Poor’s stress scenario, and assumptions
holders from interruptions or delays in receiving regarding the timing of defaults, delinquencies,
cash flows expected under the mortgage loans. The prepayments and other cash flow assumptions are
main liquidity stresses generally occur if loans are devised to test the adequacy of loss protection and
delinquent, or are in default before the security liquidity risks over the term the rated securities
property is sold. Other timing difficulties may be of remain outstanding. To be effective, cash flow runs
a technical nature, such as problems in the banking should reflect the terms of the issue and the nature
system if payments are concentrated at one time of of the assets.
the month. Loss Curve Assumptions
Standard & Poor’s cash flow modelling assumptions For purposes of testing the robustness of the
not only test the adequacy of the transaction’s credit transaction’s cash flow structure, Standard & Poor’s
supports, but the adequacy of the transaction’s assumes the default curve depicted in figure 12.
liquidity supports and ability to meet obligations on
Generally, this default curve will be moved forward
time.
for pools with more than 12 months weighted
CASH FLOW ANALYSIS average seasoning, and for pools comprising a
disproportionately large distribution of high LTV
Cash flows reflect the underlying loan and security
loans reflecting that high LTV loans tend to default
characteristics and the structure of the transaction.
more quickly than low LTV loans.
The assumptions made when modelling a

Figure 12

Standard & Poor’s Assumed Default Curve

(%)
25
Percentage of losses

20

15

10

0
7 12 24 36 48 60

Months

Standard & Poor’s 40

 Structured Finance Australia & New Zealand ¨ April 1999

Delinquency Assumptions Where the servicer holds on to SPE funds, considera-

Reflecting that at any time the level of loan delin- tion should be given to whether the servicer is
quencies will exceed the level of loans in default, a obliged to pay the SPE interest on the collections
delinquency stress equal to one half the pool’s held. This should be taken into account in the cash
assumed cumulative default frequency should be flow modelling of the transaction to determine the
applied during the stress scenario and throughout appropriate reinvestment rate of interest—if the
the life of the transaction. These delinquencies will servicer is not obliged to pay interest on collections
build up over a six-month period and take 12 held, the assumed reinvestment rate should be 0.0%.
months to cure. Prepayment Rate Assumptions
Accommodating “Australian Arrears” Method And There is much variability of prepayment speeds
Payment Holidays across the MBS pools Standard & Poor’s has rated
Many Australian bank lenders manage their collec- to date. Standard & Poor’s prepayment assumptions
tions effort using what is described as the “Austral- are applied to the balance of performing loans in
ian arrears” method. Instead of tracking each monthly period; that is, the balance of loans
delinquencies on a missed payments basis, the that is defaulted or presently delinquent. By apply-
system only identifies a problem once the borrower ing the prepayment assumptions in this way, the
moves above the “control balance” that is, control assumed prepayment speed across the aggregate
balance is the scheduled amortisation curve. If pool will be lower in instances where there is a
borrowers are ahead of the scheduled amortisation higher proportion of loans that are in default or
curve, they may miss many monthly payments delinquent. This is consistent with pool behaviour
before the system identifies a problem. Also gaining observed in both the U.K. and the U.S. Standard &
popularity among Australian lenders is the offering Poor’s runs two prepayment assumptions—high and
of product features such as short-term breaks from low—over each of the two interest rate scenarios
making payments; that is, payment holidays (for (see figure 13).
example, baby payment holidays). Standard &
Figure 13 Conditional Prepayment Rate (CPR)
Poor’s increases the delinquency assumption to two-
Assumptions
thirds the assumed default frequency to
accommodate Australian arrears method and Mortgage Seasoning High CPR (%) Low CPR (%)
payment holidays. Servicers are required to modify 1-12 months 20 0.5
12-18 months 25 0.5
their systems to provide delinquency reports to 18-36 months 35 0.5
Standard & Poor’s on a “missed payments” basis. 36+ months 40 0.5
Interest Rate Scenarios
Typically, two interest rate scenarios will be applied If the assets are particularly susceptible to high levels
at each rating sought—high and low. Standard & of prepayments (products are priced higher than
Poor’s has developed methodology using interest competitors, products do not incorporate standard
rate data for each of the common indicator rates features such as redraw and further advances) or
since 1986 to provide adequate stressing of interest where the transaction structure is heavily dependent
rates at each rating category over the assumed stress on income from reinvestment of assets, Standard &
period for each pool. (See Australian Interest Rate Poor’s may modify this high prepayment stress test.
Criteria for Structured Finance Ratings page 73.)
The duration of the stress period is determined by LEGAL ANALYSIS
the timing of the defaults and the assumed worst- Structured financings are rated primarily on the
case recovery period. basis of creditworthiness of isolated assets or asset
Reinvestment Rate Assumptions pools assigned to secure the rated MBS, and not the
creditworthiness of the seller or borrower. The
Standard & Poor’s makes the following assumptions
structured financing seeks to insulate transactions
as to reinvestment income:
from entities (such as mortgage originators) that are
♦ For amounts in excess of A$500,000, BBSW
either low-rated or unrated and for whom Standard
minus 1%, and
& Poor’s is unable to quantify the likelihood of a
♦ For amounts under A$500,000, BBSW minus potential insolvency or who are rated investment
5%. grade but wish a higher rating for the transaction.

Standard & Poor’s 41

 Structured Finance Australia & New Zealand ¨ April 1999

Standard & Poor’s worst-case scenario generally recharacterised as assets of the seller should be
assumes the insolvency of each transaction partici- minimal. In particular, the assets should not form
pant deemed not to be a “bankruptcy-remote part of the seller’s estate in the event of the seller’s
entity” or that is rated lower than the transaction. insolvency.
Standard & Poor’s resolves most legal concerns by In Australian mortgage-backed security programs, a
analysing the legal documents and, where SPE transfers by way of assignment the right to
appropriate, receiving opinions of counsel that receive present and future receivables under loan
address insolvency issues. agreements and also the seller’s interest in first
The existence of a strong asset pool to secure rated registered mortgages over residential property as
MBS alone cannot determine the rating on such well as other security interests relating to those
securities. The structure of the transaction must loans. Where the seller’s rights under the loan and
provide the means by which assets will be available mortgage are legally assigned to the SPE, Standard
to pay debt service in a timely manner, notwith- & Poor’s is able to give full credit to the assigned
standing the insolvency, receivership, or bankruptcy security interests. Equitable assignment of a seller’s
of the parties to the transaction that are unrated, or rights under first registered mortgages may also be
rated lower, than the proposed issue. This may be given full credit, after Standard & Poor’s has
done on the basis that: assessed the additional risks associated with an
♦ If the pool of assets is owned by an entity, that assignment in equity alone.
entity is bankruptcy remote or rated as high as Transactions involving an equitable assignment of
the transaction’s rating and thus, is unlikely to be the assets to the SPE generally rely on trigger events
the subject of insolvency proceedings; or to perfect the legal transfer against the ultimate
♦ The pool of assets supporting payments on the borrowers before, or on, an insolvency of the seller.
securities is no longer owned by the entity that Depending on when the trigger event occurs in
may be the subject of insolvency proceedings and relation to the timing of an insolvency of the seller,
thus, the pool of assets would not be affected by several risks arise that Standard & Poor’s assesses
delays caused in the event of insolvency when rating MBS. These risks include, that:
proceedings. ♦ Until notified of the assignment, the borrower
In addition, for each entity involved in the transac- will continue to receive good discharge by paying
tion that is not bankruptcy-remote, Standard & the seller (see Commingling Risk section on page
Poor’s evaluates all transfers of property and funds 75);
of the entity to ensure that these transfers would not ♦ The borrower may be entitled to set-off amounts
be deemed preferential transfers or fraudulent owed by the seller to the borrower (see Set-Off
conveyances. Risk section on page 39); and
♦ The SPE needs the co-operation of the seller, its
Bankruptcy-Remote Entities
receiver, or liquidator (as legal owner) to enforce
Standard & Poor’s analysis relies on certain entities
or realise on the asset against the ultimate
that are deemed to be “bankruptcy-remote”.
borrower.
Standard & Poor’s criteria seek to ensure that the
entity is unlikely to become insolvent or be subject Additionally, the costs of legal transfer should be
to the claims of creditors (who may file an involun- considered. Usually the seller agrees to bear the costs
tary petition against the entity). Standard & Poor’s of legal perfection on a title perfection event. If there
criteria for SPEs (see page 94) would substantially is a title perfection rating trigger of at least invest-
need to be met to ensure the entity is a SPE and is ment grade, Standard & Poor’s assumes in its credit
thus bankruptcy-remote. analysis that the seller will have the ability to meet
this obligation at that time. If there is no rating
Transfer Of Assets trigger, or if the seller is not bound to bear the costs
Standard & Poor’s reviews the way in which assets of legal perfection, Standard & Poor’s will estimate
are assigned to the SPE. The assignment should the transfer costs, including registration and stamp
achieve certain objectives. The assets transferred to duty costs. The issuer generally is required to have
the SPE should only be available to the creditors of sufficient resources at closing so that, if necessary,
the SPE and the risk that the assets may be

Standard & Poor’s 42

 Structured Finance Australia & New Zealand ¨ April 1999

the trustee or manager may perfect the issuer’s The trustee/security trustee should take custody of
security interest over an appropriate time period and the documents if:
continue to meet its obligations to rated security ♦ The independent audit shows an adverse result
holders in full, and on time. that is not cured within 30 days;
Document Custody ♦ The servicer does not meet its obligations to
periodically provide information to the trustee/
In many rated securitisation programs, the assets are
security trustee, or fails to seek the approval of
held by the trustee issuer or by a security trustee for
the trustee/security trustee to deal with the
the benefit of secured creditors. As delivery of the
documents;
documents is not required to effect the legal or
♦ The trustee/security trustee believes, in the
beneficial interest in the assets passing to the SPE,
the seller may retain custody of the mortgage interest of the security holders, a transfer of the
documents, subject to meeting the following documents is necessary; or
requirements: ♦ The seller/servicer fails to remit collections on the

♦ The mortgage documents in relation to the loans

designated remittance date.
assigned to the SPE should be marked to distin- Uniform Consumer Credit Code
guish them from loans that have not been sold. Many mortgage loan contracts are regulated under
The mortgage documents should be kept in a the Uniform Consumer Credit Code (UCCC). (For
separate centralised location; Standard & Poor’s assessment of the affect of the
♦ The trustee/security trustee should be provided UCCC on rated MBS, see page 105.)
with the information necessary for it to prepare
caveats or transfers of title on a regular basis; Taxation
♦ The servicer should seek the approval of the Standard & Poor’s assesses the issuer’s ability to pay
trustee before dealing with the mortgage docu- its taxes, if any are due. Generally, MBS issuers in
ments; and Australia are structured to be tax neutral and
♦ An independent audit should be completed at Standard & Poor’s assesses the adequacy of the
least semiannually on the status of the security transaction’s cash flows assuming no tax is payable
packets. Standard & Poor’s may request that by the issuer, based on opinions received from the
audits occur more frequently. issuer’s legal counsel.

Standard & Poor’s 43

 Structured Finance Australia & New Zealand ¨ April 1999

New Zealand Residential MBS the interest of owners and mortgagees in each parcel
of land. The transfer of title of property is facilitated
Securitisation in New Zealand remains in an infancy by this system.
stage because of the small size of the domestic
Lenders who advance money to individuals secured
capital market and limited economic incentive for
by a residential mortgage have recourse against the
institutions holding assets suitable for securitisation
individual and not just against the property that is
to sell these assets. As in Australia, the New Zealand
subject to the mortgage. As in Australia, the debt
banking sector is dominated by a few large institu-
created by mortgagors borrowing against the value
tions. Until the late 1980s, the main lender for
of their property is personal.
residential housing was the government-owned
Housing Corp. of New Zealand (HCNZ), which The most common type of mortgage in New
accounted for approximately 15% of the residential Zealand is the 20-30 year, amortising, floating-rate
mortgage market. Other significant lenders include mortgage. Historically, the providers of this type of
ASB Bank Ltd., Australian & New Zealand Banking product have been the major trading banks, building
Group Ltd., Bank of New Zealand, National Bank societies, trust funds of solicitors, and the HCNZ,
of New Zealand, Westpac Banking Corp., which has had a market share of up to 15%-20%
HongKong Bank and Taranaki Savings Bank. and historically has made loans to less creditworthy
Recently, some nonbank lenders including Ergo and borrowers than other New Zealand institutions.
Sovereign have emerged in the market, and Standard HCNZ’s mortgage portfolio has been progressively
& Poor’s expects this number to increase over time. sold off with the balance running down as mort-
gages are repaid.
MORTGAGE MARKET CHARACTERISTICS In New Zealand, normal banking practice is to
The New Zealand residential mortgage market ensure that each mortgagor maintains a general
exhibits a number of characteristics in common with insurance policy to provide protection against the
Australia. Both countries have a high degree of usual standard hazards (fire, storm, etc.) Part of the
home ownership by world standards. About 70% of premium paid to the general insurer is a compulsory
New Zealand’s dwellings are owned, or are being levy paid to the New Zealand Earthquake Commis-
acquired, by their inhabitants. Home ownership has sion.
been, and continues to be, a traditional aspiration of New Zealand lies in a high-risk zone for earthquake
New Zealanders. and volcanic activity. Wellington, the capital, is
New Zealand operates a Torrens system of land title situated on a fault line and experiences periodic
registration. Nongovernment-owned land is subject earth tremors. The Earthquake Commission indem-
to the land transfer system. A public register records nifies homeowners against damage caused by

Table 1 New Zealand Benchmark Residential Mortgage Pool Characteristics

Mortgage type Amortising, floating-rate loans, original term up to 30 years.
Property type Owner-occupied, single-family dwellings.
Security Registered (Land Registry Office) first legal mortgage.
Minimum pool size 300 loans.
Loan size Auckland metropolitan area. NZ$500,000 maximum
Other major cities (Wellington, Hamilton,
Christchurch, Dunedin). NZ$350,000 maximum
Provincial cities with population
in excess of 35,000. NZ$250,000 maximum
Other cities, towns. NZ$150,000 maximum
Geographic spread Loans spread throughout New Zealand.
Maximum loan-to-value 75%.
Income limits Monthly repayment not to exceed 30% of gross monthly income.
Credit checks Baycorp.
Valuers Registered valuer approved by lender.
Property insurance Fire and all risks insurance from an approved insurer, at least equal
to loan amount; and earthquake and volcanic risk cover to the extent
the loan exceeds the level of Earthquake Commission cover.

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 Structured Finance Australia & New Zealand ¨ April 1999

nine months after default. Standard & Poor’s

Table 2 Credit Loss Calculation (%)#
assumes a recovery period of 15 months.
Default Loss Credit Market value
Assumptions regarding the number of loans that
Rating frequency severity loss decline
AAA 15 53 8 45 may go into default and the loss severity incurred
AA 12 46 6 40 are based on a benchmark pool developed by
A 8 41 4 36 Standard & Poor’s in line with characteristics
BBB 6 36 3 32 observed in the New Zealand market (see tables 1
#Assumes 75% loan-to-value ratio. and 2).
Using the worst-case assumptions for a residential
mortgage, with a 15% per annum interest rate, the
earthquake and volcanic activity up to a maximum level of loss severity can be calculated. Table 3
of NZ$100,000 per residential property. Should the quantifies this loss at the ‘AAA’ level. Levels of
funds and insurance available to the Commission be credit support will vary according to interest rates
exhausted as a result of major earthquake damage, applicable to particular pools. Finally, the resultant
the insured have a right to make a claim against the theoretical loss is used in conjunction with the
government’s consolidated revenue account. assumed default frequency to size the level of credit
The process to foreclose on a property involves the support required at the particular rating level.
sending of a Property Law Act Notice (PLAN),
which formally notifies the mortgagor of the intent
to foreclose. A PLAN can be given any time after a Table 3 Loss Severity For ‘AAA’ Rating#
mortgagor has breached the loan agreement. In (NZ$)
practice, PLAN is generally sent when the loan is 90 Original property value 100,000
Less market value decline 45,000
days in arrears. Equals new market value 55,000
PLAN gives the mortgagor four weeks from the date Less loan balance 75,000
of service to rectify the default. If the loan is still in Equals market loss (20,000)
default at the end of the period, the property Less foreclosure costs
becomes the property of the mortgagee. Complica- ♦ 15 months accrued interest at 15%* (14,062)
tions can arise where service of the notice on the ♦ Legal and other costs (6,000)
Total loss (40,062)
mortgagor cannot be personally effected, in which
Loss severity (total loss/loan balance) 53%
case an application for substituted service must be
obtained from the court. This can add up to three #Assumes a 75% loan-to-value ratio. *The mortgage rate is
assumed to be at least 1.5 times greater than prevailing market
months to the time taken to foreclose. Even in
rates.
difficult situations, foreclosure is achieved six to

Standard & Poor’s 45

 Structured Finance Australia & New Zealand ¨ April 1999

Asset-Backed Criteria
Auto Receivable-Backed actual credit losses. To determine the degree to
which these two factors may affect a transaction, an
Securities analysis will be made of the portfolio from which
This article focuses on Standard & Poor’s approach the asset pool is to be drawn, based on the following
to rating securities backed by a prime pool of auto ratios:
receivables. A prime pool is characterised by: ♦ Repossessions over gross contracts;
♦ Conservative underwriting standards; ♦ Gross losses over gross receivables;
♦ An absence of significant risk concentrations; and ♦ Net losses over gross receivables; and
♦ Stable loss and delinquency history consistent ♦ Delinquencies over gross receivables.
with, or better than, the industry average. In the credit analysis the use of either the historical
In rating auto receivable-backed securities, Standard gross or net loss rates will depend on whether the
& Poor’s relies on an actuarial approach, supported special-purpose entity, as issuer of the asset-backed
by on-site management meetings, to evaluate notes, is legally entitled to receive the amounts
portfolio quality. The likelihood of credit losses is recovered on defaulted loan contracts. The extent
determined by analysing the historical performance and timing of recoveries, prepayments, and insur-
of the portfolio from which pooled assets are drawn. ance also are reviewed.
Performance and characteristics of pooled assets are It is expected that the borrower should be required
compared with industry norms and aggregate to maintain comprehensive insurance on the vehicle
portfolio characteristics. These assets also are and the policy should be assigned to the trustee. If
assessed for any unique legal risks. Automobile the insurance policy lapses, the servicer should force-
financing is generally characterised by an absence of place insurance on the vehicle.
standardised underwriting and servicing. Conse- Historical delinquency data also is carefully analysed
quently, portfolio quality and performance can vary as delinquencies act as a precursor to losses. The
widely among lenders. Evaluating auto receivables is trend in delinquency can sometimes provide us with
done by reference to individual pools of loans, since important clues as to how the loss picture is likely to
performance is more lender-specific. Considerable end up in the future. A trend of increasing delin-
emphasis is placed on each lender’s underwriting quencies may highlight new market developments or
policies and controls, and the review will include a changes to the practices of the originator.
detailed analysis of any credit scoring system used in
Dealer recourse: Recourse loans can entail fewer
the lending process.
risks than nonrecourse loans under certain circum-
EVALUATING CREDIT RISKS stances where the third party is creditworthy and if
The characteristics of each specific pool of the same underwriting standards apply as to
receivables to be securitised are examined, as well as nonrecourse loans. Recourse loan payments are
the way in which the receivables were originated. supported, in part, by recourse to some third party,
This is done to determine whether the pooled generally the dealer. This recourse may act as first
receivables differ significantly from the aggregate loss coverage to the lender, since if the dealer base is
portfolio of the originator in any material way. Any sound, dealers bear most of the loss on
difference will be reflected in the resulting liquidity repossessions.
and credit enhancement requirements. Annual percentage rate: The annual percentage rate
The important characteristics of the receivables (APR) of auto loan contracts may have a substantial
reviewed include the originator’s lending criteria and impact on the level of credit support required in an
portfolio characteristics, including: auto receivables-backed transaction. A high APR
may provide for a high level of excess spread which
Historical losses and delinquencies: Standard &
may be used to absorb credit losses in the transac-
Poor’s evaluation of the credit support needed for an
tion as a form of first loss protection. Analysis will
auto receivable-backed financing considers both the
need to be undertaken to establish if the high APR
stress on the transaction from liquidity needs
levels can be maintained over the life of the transac-
resulting from borrower delinquencies, and the
tion. Data on the distribution and ranges of the APR
permanent impairment of cash flows resulting from

Standard & Poor’s 46

 Structured Finance Australia & New Zealand ¨ April 1999

is necessary to determine a conservative estimate of Concentration risk: Heavy concentration in one

the excess spread likely to be available. geographic region, industry, or type of vehicle may
Maturity: Original maturity appears to have a have a negative impact on quality.
modest impact on receivable quality, with longer Loan-to-value ratios: Loan-to-value ratios differ
maturities performing slightly worse than shorter significantly among issuers. The loan-to-value ratios
maturities. Longer terms affect losses in two ways. are often affected by the inclusion of insurance and
First, the car owner builds equity in the auto more other borrower costs in the amount advanced under
slowly than in an auto contract of shorter term, thus the contract. Greater aggregate loan-to-value ratios
taking longer to reach the break-even point where generally require higher levels of credit support.
the car can be sold and proceeds used to fully Direct versus indirect lending: Auto contracts are
extinguish the outstanding obligation under the underwritten on a direct or indirect basis. With
contract. As a result, car owners may hold onto their direct contracts, the lender is present during the
cars longer, increasing the period during which application proceedings and directly determines the
default is more likely to occur. Second, the vehicle customer’s creditworthiness. Unlike direct contracts,
on realisation is likely to be older, and thus there is a the indirect lender may never meet face-to-face with
higher likelihood that the vehicle has deteriorated, its customer. With an indirect contract, the lender
making defaults more likely. makes a credit assessment based on information
New versus used: Generally, loss severity and provided by the dealer and an investigation of the
cumulative net losses on used vehicles are higher applicant’s credit and employment history. To
than on new vehicles; however, this distinction is not determine if a particular indirect lending program
necessarily the case for all auto lenders. The rela- adds risk to an asset-backed transaction, Standard
tively weak performance of used car contracts can & Poor’s performs a detailed due diligence investiga-
be attributed to several factors. Generally, the tion with emphasis on:
obligor base is of lower credit quality, since most ♦ Dealer relationships (that is, risk concentration
people will purchase a new car if they can afford and fraud);
one. Severity of loss also may be increased due to the ♦ Management experience in this type of lending;
depreciating nature of the vehicle and valuation and
method. New car prices are certain, but the vehicle ♦ Underwriting policies and controls.
condition and valuation method add some risk with
Vehicle insurance: In securitised auto receivable
used cars.
transactions, the maintenance of adequate insurance
The inclusion of used cars within a pool does not over the security vehicle is integral to the quality of
necessarily increase required coverage. Greater risk the portfolio. Generally, the interest of the lender is
of used car lending may be offset by conservative noted on the insurance policy. As part of the rating
loans-to-value determination and underwriting. process, Standard & Poor’s reviews each lender’s
Many lenders offset the expected additional risk by insurance coverage requirements, as well as the
requiring a higher annual percentage rate on used policies and procedures for monitoring and main-
vehicles. This excess cash may or may not be taining coverage. A lack of adequate initial coverage
retained within the issue. and ongoing surveillance can substantially increase
Standard & Poor’s reviews portfolio loss and investors’ credit-loss exposure. Severe damage to an
delinquency data by new and used vehicles. Stand- uninsured or underinsured vehicle can lead to
ard & Poor’s then evaluates each transaction to default. If the lender repossesses vehicles that are
determine whether used cars add incremental risk to damaged and lack adequate insurance, recoveries
the pool of receivables. The servicer’s past perform- will be minimal. Investors in the asset-backed debt
ance as loan underwriter and the criteria used to would incur a high loss severity on that receivable.
select pool assets are important to this assessment. Credit risk from deficient insurance coverage must
Seasoning: Receivable seasoning has a positive be covered by the credit support.
impact on quality. With seasoned receivables there is An additional credit concern arises when insurance
an establishment of a record of payment, and equity premiums are capitalised onto the loan balance,
buildup should increase the incentive for the either as a result of force-placed insurance or when
borrower to continue paying and reduce the severity the lender agrees to finance these premiums at the
of the loss. Typically, auto receivable portfolios time of sale. The resulting impact in the loan balance
exhibit a pattern of losses occurring between six and adversely affects loss exposure by effectively increas-
18 months following receivable origination.

Standard & Poor’s 47

 Structured Finance Australia & New Zealand ¨ April 1999

ing the loan-to-value ratio, which in turn increases Amortisation methods: Three methods may be used
the loss severity if the borrower defaults, the car is to amortise automobile receivable contacts:
damaged, or insurance coverage is inadequate. Loss ♦ Actuarial,
frequency also may rise, as the higher monthly ♦ Rule of 78s, and
payments and slower equity buildup may give ♦ Simple interest contracts.
borrowers facing financial difficulties the incentive
The Rule of 78s and the simple interest contact
to default.
method have certain credit implications when the
Portfolio growth: Receivable portfolio growth can amortised loans are pooled and sold in an asset-
distort the historical loss data provided by the issuer. backed transaction.
Data is used to create a loss scenario that determines
Rule of 78s: The Rule of 78s method, otherwise
the credit support level appropriate for a given
known as the “sum of the years digits method”,
rating category. To isolate the understatement of
determines how much interest the obligor has paid
current loss percentage caused by rapid portfolio
at any one time. Interest earned at maturity, and
growth, and to analyse all issuers on an equal basis,
monthly payments, are the same under both the
Standard & Poor’s derives an adjusted net loss
Rule of 78s and the actuarial method; however, the
percentage by dividing net losses for the period by
interest component under the Rule of 78s method is
the outstanding principal balance of a prior period.
higher at the beginning of the contract and declines
This prior period balance should correspond to the
over time. As a result, the principal balance under
charge-off policy of the lender. For example, if an
the Rule of 78s is always higher than the actuarial
auto lender typically charges off defaulted receiva-
principal balance. Interest payments on the receiv-
bles at 180 days, the net loss figure should be
able contracts and the pass-through certificates in an
divided by the outstanding balance six months prior
asset-backed transaction do not match. The receiva-
to the end of the period. If this data is unavailable,
bles are amortised under the Rule of 78s, and
the average balance for the year is used as a proxy.
interest on the certificates is calculated using the
For portfolios exhibiting a very high rate of growth,
actuarial method. As a result, a shortfall in cash
over 15% per annum, a more conservative approach
flows is possible which must be taken into consid-
of using the outstanding balance 12 months before
eration when determining the appropriate levels of
the period end may be used. In addition, as the
credit support for the transaction.
portfolio grows, servicing and managing an ex-
tended collection and repossession process may Prepayment of the automobile loans does not cause
become increasingly difficult. This may lead to a a shortfall under the Rule of 78s. A full prepayment
higher proportion of delinquencies and losses being by the obligor would entitle the borrower to a
experienced by the pool in the future. refund under the rule. However, no shortfall would
occur because the rebate is only the unearned
Servicing issues: There are many servicing factors
interest portion.
which may affect the credit performance of auto
receivables. The two most important are: Simple interest: Prepayment can cause shortfalls
♦ Underwriting standards—Historical data may not under the simple interest contract method. If simple
always indicate all the inherent risks in the interest loan payments are made on their due dates,
portfolio. The originator’s lending guidelines and the yield equals the actuarial yield. However, interest
practices need to be reviewed in a due diligence on simple interest loans is calculated daily, so any
meeting to determine if historical loss rates may prepayment would reduce the interest earned.
understand future performance of the receivables. Therefore, when simple interest loans are pooled in
an asset-backed transaction, any prepayments can
♦ Collection policies—An assessment of the
cause a shortfall. If such a shortfall possibility exists,
originator’s experience and capability to appro-
the credit support amount will be adjusted to reflect
priately manage the receivables to minimise
it.
delinquencies and default needs to be satisfacto-
rily completed. Without the proper procedures The rating analysis will consider all of these
and sufficient resources, the performance of the attributes to determine the appropriate level of
loans could rapidly deteriorate if an economic credit and liquidity supports.
downturn occurred.

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 Structured Finance Australia & New Zealand ¨ April 1999

LIQUIDITY RISK ANALYSIS monthly payments) on each payment date.

In common with other asset-backed transactions, an Moreover, these structures may require that
assessment is required to ensure that cash flow is bondholders receive full repayment by a specified
sufficient to meet bondholder payments as prom- maturity. Thus, delinquent scheduled payments by
ised. Standard & Poor’s analytical approach to these borrowers may create a shortfall not only of interest,
transactions consists of two separate, yet related, but also of principal.
analyses. To project potential loan losses on the Second, the maximum amount of cash flow that
underlying assets, a review of the originator’s could be unavailable because of delinquent pay-
historical portfolio performance and data related to ments is determined. Delinquency data from the
the specific collateral pool is undertaken. This originator for the prior five years is requested, as
analysis enables an estimation to be made to predict well as written confirmation of the institution’s
cash flow which is unavailable due to consumer receivable charge-off policy. The delinquency data
defaults, but not temporary shortfalls caused by should be prepared on a quarterly basis. The
timing differences (such as delinquencies, instalment information should include the percentage of
contact extensions or revisions, and timeliness of payments past due (as a ratio of average dollars
repossession). Therefore, a second test must be outstanding) for each 30-day period, including those
performed, commonly known as liquidity risk delinquent in the one-to-30 day category. The data is
analysis, to ascertain appropriate liquidity coverage. analysed to estimate the percentage of cash flow
First, Standard & Poor’s determines what bondhold- typically missing from the originator’s portfolio, plus
ers are promised. Frequently, transactions amounts recovered from borrowers during each
collateralised by non-mortgage products have used month.
pass-through or pay-through vehicles which effec- Third, using this data and the pool’s scheduled
tively promise timely interest and principal as monthly principal and interest payments (i.e., no
received. In such cases, timing differences—most prepayments), Standard & Poor’s models the
often due to delinquencies—may cause an interest transaction to determine the required level of
shortfall on the next payment date, but no principal delinquency coverage. Varying degrees of stress are
shortfall. Other cash flow structures, though similar imposed on the model, depending on the underlying
in most respects, promise bondholders both timely assets’ characteristics and the assessment of the
interest and scheduled principal (that is, borrowers’ servicer and the economic environment.

Standard & Poor’s 49

 Structured Finance Australia & New Zealand ¨ April 1999

CBO/CLO Transactions eligible loans during the ramp-up and revolving

period, and lowers the ultimate recovery on
Collateralised bond obligations (CBOs) and defaulted loans.
collateralised loan obligations (CLOs) are securities
backed or collateralised by pools of corporate bonds CREDIT AND CASH FLOW ANALYSIS
or loans respectively. Payments to the noteholders Standard & Poor’s CBO/CLO criteria address credit
are derived from the cash flow of the underlying and liquidity considerations for the rated securities.
pool of assets, while credit risk is tempered by Relevant assumptions include default rates, default
diversification in the portfolio and added credit timing, recovery amounts and timing, up-front and
enhancement in the program. Standard & Poor’s recurring expenses, interest rates, amortisation, and
approach to rating CBOs and CLOs is similar to its payment priorities.
approach on other structured transactions in that its
rating analyses focus on three main areas: Estimation Of Default Rate
♦ Credit analysis, Estimation of default rates in a pool is based on
♦ Cash flow analysis, and Standard & Poor’s default model that reflects the
results of Standard & Poor’s default study on actual
♦ Legal analysis.
corporate default experiences of rated entities since
DIFFERENCE BETWEEN CLO AND CBO 1981. The model takes into account the underlying
obligor credit risk, obligor concentration and debt
While criteria for CLO transactions are very similar
maturity. Other factors which influence the default
to criteria for CBO transactions, there are some key
rate are industry concentration, and whether assets
aspects of loan assets that set them apart from bond
are amortising assets. These factors are addressed
assets and complicate the credit analysis. They
prior to inputting data into the model.
include:
♦ The form of the loan and loan documentation In order to determine the default rate for any pool
can affect the degree to which rights and obliga- of assets, Standard & Poor’s requests the following
tions can be transferred from the selling bank to information:
the transferee. For example, participations ♦ Number of obligors/obligations in the pool;
typically involve a loan negotiated and extended ♦ Obligor credit ratings;
by a lead bank to a borrower and the lead bank’s ♦ Principal amount outstanding;
subsequent transfer of all or part of its interest in ♦ Maturity date of each obligation; and
the loan (which also may include a pro rata ♦ In the case of amortising assets, amortisation
interest in the collateral for the loan) to one or schedules.
more participants. Analysis of participations
The obligor credit risk in the asset portfolio is at the
often entails a detailed review of the loan docu-
heart of all cash flow CBO and CLO transactions.
ments, as well as evaluation of the credit risk of
Standard & Poor’s evaluation of credit risk begins
the seller bank, whose insolvency may interrupt
with credit risk of obligors. To determine default
payments from the borrower to, ultimately, the
frequency, Standard & Poor’s used the rating
issuer as transferee;
assigned to the obligor’s most senior debt if the
♦ Loan terms vary widely in terms of different
obligors have been rated by Standard & Poor’s. If
amortisation schedules, payment dates, rate
the obligors are not rated by Standard & Poor’s, the
indices, index reset dates, and tenors, which
following methods are adopted to size credit risk:
affect the cash flow analysis;
♦ Map bank credit scores to Standard & Poor’s
♦ The lack of uniformity in the manner in which
ratings based on the strength of loan underwrit-
rights and obligations are transferred also results
ing and loan portfolio performance. This tech-
in a lack of standardised documentations for
nique is most appropriate in large bank loan
these transactions. Therefore, loan documents
securitisations in which there is a sufficient
require a more detailed legal review;
number of jointly rated obligors to complete a
♦ Loan portfolios can be restructured substantially meaningful analysis;
to accommodate the diminished or declining
♦ Perform rating estimations for unrated obligors.
repayment capacity of borrowers; and
This is a confidential opinion of the likely rating
♦ The secondary market for bank loans is less category of an unrated borrower based on limited
liquid than the bond market, which both in- information and statistical resources available to
creases the risk of not being able to purchase

Standard & Poor’s 50

 Structured Finance Australia & New Zealand ¨ April 1999

Standard & Poor’s. A rating estimation is only an loss. Defaults are assumed to occur over three to five
estimation and not a formal rating; years.
♦ Adjust ratings provided by another nationally Depending on the transaction’s structural provi-
recognised statistical rating service, and use the sions, payment terms, Standard & Poor’s may test
adjusted rating as a measure of default probabil- various default timing scenarios, including:
ity; and ♦ “Front-end” defaults;
♦ If none of the above methods apply, Standard & ♦ “Back-end” defaults;
Poor’s will assume the unrated asset has a rating ♦ “Middle” defaults; and
of ‘CCC-’.
♦ Defaults occurring evenly over the life of the
Standard & Poor’s does not provide specific obligor transaction.
concentration guidelines, as the model accounts for
If excess interest spread is used for credit support,
the relative size of each asset and penalises portfolios
different default timing scenarios will be tested in
with high obligor concentration. Diversification in
conjunction with varying prepayment and cash
the pool is viewed favourably, as diversification
reinvestment assumptions.
decreases loss exposure per obligor.
Industry diversification limits exposure to any Loss Severity/Recovery Assumptions
particular industry, and thus limits the potential loss Recovery rate assumptions are expressed as ranges,
exposure in a given economic environment. as opposed to a uniformly applied discrete value, for
Standard & Poor’s research indicates that a pool of each loan or bond class (see table 1). These assump-
bonds or loans comprising no more than 8% of tions reflect a review of data and published material
assets per industry, is fairly diversified. If industry on defaulted bond and loan recoveries, as well as
concentrations exceed 8% of the pool, adjustments transaction structure and management considera-
are made to the additional risk by assuming a rating tions.
level one notch lower than the actual ratings for
each obligor in that industry, provided the industry Table 1 Recovery Range Assumptions As %
concentration does not exceed 12%. For concentra- Of Defaulted Amount
tions above 12% and up to 16%, Standard & Poor’s Recovery range assumptions for loans
assumes levels three notches lower than the actual Senior secured bank loans 50-60
ratings for each obligor in that industry. Transac- Senior unsecured bank loans 25-50
tions involving industry concentration in excess of Recovery range assumptions for bonds
16% are reviewed on a case-by-base basis. The Senior secured bonds 40-55
default model broadly classifies industries into 39 Senior unsecured bonds 25-44
Subordinated bonds 15-28
categories which were defined, in part to mitigate
credit risk correlations.
Default rates experienced by a pool of assets tend to
Standard & Poor’s generally assumes the recovery
decrease with its weighted average maturity, and if
rate on defaulted senior secured loans will be higher
the assets are amortising.
than the rate on senior secured bonds. This is
Default Timing And Scenario Analysis because bank loans generally are subject to
In addition to the amount of defaults, the timing of workouts between the obligor and its lenders, they
the defaults affects the ability to withstand portfolio benefit from flexible restructuring and tighter
losses in the cash flow transactions. Stress scenario covenant restrictions and closer scrutiny by the
assumptions for the timing of defaults are required lenders.
to determine the level of credit enhancement Standard & Poor’s makes two general assumptions
required for each transaction. relating to the timing of recoveries on defaulted
Standard & Poor’s believes that the credit enhance- assets. Standard & Poor’s assumes that recoveries on
ment should be sufficient to cover the transaction defaulted bonds will occur one year after default.
under appropriate stress scenarios. Standard & Recoveries on defaulted loans are deemed to occur
Poor’s believes the timing of defaults in the cash over a three-year workout period with half of the
flow model should be tailored to payment alloca- recovery received at the end of the second year and
tions within a transaction’s cash waterfall. It is the remaining half at the end of the third year.
assumed that a transaction will experience credit Standard & Poor’s assumes longer timing on
losses in a period that results in a higher cash flow defaulted loans because the loan markets are not as

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 Structured Finance Australia & New Zealand ¨ April 1999

liquid as bond markets and there is often a long Cash flow transactions can use various methods to
workout process before liquidation. mitigate risks arising from the interest rate mis-
match. Alternatives used on CBO/CLOs include:
Cash Flow Analysis
1. An interest rate swap agreement with a
Cash flow analysis is aimed at evaluating the
counterparty rated at least as high as the long-
availability of funds for full and timely payment of
term rating of the highest rated CBO/CLO
interest and principal in accordance with the terms
tranche.
of the rated securities by analysing the payment
2. An interest rate swap agreement with a
structure and the amount of debt to be supported.
counterparty rated at least as high as the short-
Cash flow analysis is also used for sizing liquidity
term rating equivalent of the long-term rating of
and other reserves.
the highest rated CBO/CLO tranche. In such
As the term and structure of CBO/CLO transactions cases, there should be a ‘trigger” for, and reserves
differ to varying degrees, Standard & Poor’s does and/or collateral, to cover replacement costs or
not employ a standard cash flow model but relies on interest rate shortfalls.
the transaction-specific cash flow model prepared by
3. An interest rate swap agreement which is jointly
the seller or its adviser. As cash flow analysis is
supported by two unaffiliated counterparties, e.g.
based on the terms and conditions of each asset
through a financial guarantee or contingent
included in the pool, Standard & Poor’s requires an
“backup” arrangement. In general, fees for such
independent verification by a third party of the
arrangements must be covered in the transaction,
material terms and conditions of each loan/bond.
and one of the counterparties should meet the
The cash flow model is evaluated to ensure that it rating threshold described in point 2.
reflects the transaction structure and can measure a 4. A liquidity reserve sized to cover the entire
variety of risk factors, including payment terms of interest rate shortfall over the life of the transac-
the debt and collateral, interest rate mismatch, and tion, based on Standard & Poor’s interest rate
basis risks between multiple loan indices, payment stress assumptions for floating-rate collateral
frequency, different amortising schedules of each assets and liabilities. The liquidity reserve amount
asset, and a variety of delinquency, default, and should be invested in eligible securities rated at
recovery risk scenarios. As prepayments after the least as high as the rating on the debt.
revolving period cause the weighted average matu-
Cross currency hedging arrangements are viewed
rity of the assets—and therefore, the expected
differently to interest rate hedges. The exposure and
default rate—to go down, Standard & Poor’s will
replacement cost of a currency swap is higher than
review the prepayment history of a seller’s portfolio
that of an interest rate swap in a major currency,
and give credit, wherever possible, for the expected
while replacing a currency swap may be more
prepayments on the assets. The cash flow analysis
difficult, depending on the currencies involved.
should reflect this prepayment assumption as well.
Therefore, with respect to cross-currency hedging
For bonds and loans that have call options, Stand-
arrangements, any customised alternative will be
ard & Poor’s assumes that the debt will be called on
evaluated on a case-by-case basis.
the first available call date. Bonds with put options
or rated with an ‘r’ symbol are not eligible for Any swap agreements should meet Standard &
inclusion in the asset pool, as they introduce cash Poor’s swap agreement criteria.
flow and market related risks that cannot be Standard & Poor’s continues to evaluate new
adequately measured and mitigated. interest rate and cross-currency hedging solutions to
support structured ratings.
RISK FACTORS: STRUCTURE AND COLLATERAL
Revolving/Ramp-Up Period Risks
Interest Rate And Currency Risks
Issuers generally prefer to have a revolving period,
The interest rate and payment date mismatch which is an option to trade the assets during the first
between rated debt and assets adds several liquidity few years of any CBO/CLO transaction and substi-
risks to the transactions. There are four major forms tute them with other eligible assets. Trading enables
of risk tied to this type of mismatch: the portfolio manager to sell bonds and loans before
♦ Differences in periodicity, they default and to reinvest the proceeds in better-
♦ Differences in payment dates, quality assets or to purely profit from trading
♦ Basis risk, and activities. Standard & Poor’s requires that each new
♦ Reset risk.

Standard & Poor’s 52

 Structured Finance Australia & New Zealand ¨ April 1999

asset meets certain eligibility requirements before Data Requirements

substitution. In addition, a replacement or Standard & Poor’s requires certain portfolio
substitution can be made only if after running the information prior to rating a transaction including:
model with the new replacements, net of any ♦ Number of obligors/obligations in the pool;
defaulted assets, the default rate of the pool after
♦ Principal amount outstanding;
replacement is less than or equal to the default rate
♦ Maturity date of each obligation;
of the pool before replacement. After the revolving
period, proceeds from the sale of any assets should ♦ Applicable interest rate;
be distributed to holders of the senior tranche debt. ♦ Options to change interest rate bases and pay-
ment terms;
If Standard & Poor’s default model is not used as a
replacement test, then the portfolio manager must ♦ Other fee income, if any;
ensure that the before and after positions are within ♦ Amortisation schedule;
the collateral eligibility criteria. If this option is ♦ Position of the loan in the borrower’s capital
chosen, the original credit enhancement level must structure, for example, senior or subordinated
be based on “stressed” eligible portfolio composi- debt;
tion with maximum allowable asset credit risk. ♦ Cross default provisions;
Therefore, in general, the original credit support ♦ Collateral value including the last valuation date
should still cover this risk as long as the portfolio and the valuation methodology;
quality remains within these assumed “stressed” ♦ Brief description of the collateral/lien;
collateral quality parameters.
♦ Embedded options, including option terms; and
Standard & Poor’s requests that the issuer provide ♦ Any other term or condition that may enable the
pool information monthly, or every time a new loan borrower to restrict or alter payment terms on
is added to the pool, whichever is sooner. the asset or that may materially affect the cash
Credit Enhancement flow from the asset.
Credit enhancement can be in the form of: Legal Considerations
♦ Overcollateralisation/subordination, Standard & Poor’s conducts a legal review of every
♦ Cash collateral/reserve account, CBO/CLO transaction to evaluate:
♦ Excess spread/interest, ♦ The transfer of the underlying obligations and
♦ Amortisation, and collateral securing such obligations to the issuer;
♦ Bond insurance. ♦ The formation of the issuer; and
The transaction can be enhanced by any combina- ♦ The pledge of the assets as security for the issuer’s
tion of these methods. obligations, especially in the case of loan
participations.
Small Pool Analysis
There are also several legal considerations that set
Cash flow transactions can be structured in a loans apart from bonds, including loan
relatively small pool of assets with a high degree of participations. The following points will be re-
obligor and industry concentrations. However, since viewed:
there is little value in subjecting a small pool to an
♦ The terms of the loans and loan documentation;
actuarial analysis, the new model will not be applied
♦ Whether the seller is transferring all, or a part, of
to pools with fewer than 10 obligors. Standard &
its interest in the loan and its related collateral;
Poor’s may conduct a loan-by-loan default analysis.
In such an analysis, selecting one loan over others ♦ Whether the term of the participation is different
may materially affect the amount of subordination from the maturity of the underlying loan; and
required to achieve the desired rating level. Sensitiv- ♦ The seller’s or agent bank’s ongoing responsibili-
ity analysis of sample pools indicates that default ties as servicer of the loan.
frequencies tend to increase sharply as the pool size
reduces to fewer than 30 obligors.

Standard & Poor’s 53

 Structured Finance Australia & New Zealand ¨ April 1999

Credit Card Receivable-Backed and is represented by a seller certificate. As

cardholder balances vary, the residual interest will
Securities fluctuate.
The securitisation of credit card receivables presents Allocation Of Cardholder Payments
the issuer with several potential benefits, including
A number of methods have been applied to the
the efficient use of capital, a potentially lower-
distribution of cardholder payments between the
weighted average cost of funds, diversification of
two classes of certificates. Cardholder finance charge
funding sources, improved asset and liability
payments and charge-offs are normally distributed
management, and enhanced balance-sheet, liquidity,
proportionately.
and other benefits from sale of the assets, without
detriment to the customer relationship or foregoing Early Amortisation Events
of the earning power of the asset. Investors are These events are designed to enhance the transac-
attracted to credit card-backed debt because the tion’s credit quality by discontinuing the revolving
underlying assets, in the absence of a change in period if the reinvestment of investor principal
business strategy, tend to exhibit relatively stable payments becomes significantly less desirable. Early
characteristics. Most credit card securitisations amortisation events that could cause the early
display many of the following structural features. distribution of principal to investors may include the
insolvency of the seller, a servicer default, excessive
CHARACTERISTICS OF A CREDIT CARD-BACKED
dilutions, charge-offs or delinquencies and signifi-
STRUCTURE
cant declines in portfolio yield, portfolio growth, or
Two classes of certificates are issued-investor payment rates.
certificates and a seller certificate. Each represents an
ownership interest in the assets of the trust. Under Selection Criteria
normal conditions, the trust will have perfected The credit quality of the pool may be enhanced by
security interest in the existing receivables, future excluding certain high risk accounts. This can be
receivables arising from the selected accounts, and done by excluding entire segments of a portfolio or
the proceeds thereof. New receivables automatically selecting accounts based on age or delinquency
will be conveyed to the trust. When securitising status. Typically, loss rates on credit cards tend to
credit card receivables, it is the receivables them- peak between 18 to 24 months after origination of
selves, not the underlying accounts, that are either the card.
sold or transferred to the trust. The seller of the
Addition And Removal Of Accounts
receivables retains full control and ownership of the
credit card accounts, and thus the ability to change To avoid an early amortisation event and limit the
the terms and conditions of the credit card agree- size of the trust, issuers may be permitted to add or
ment, including minimum payment terms. remove accounts. Restrictions typically are included
in the receivables purchase agreement to control the
Revolving Period number of new accounts that can be added without
During this period, typically the first 18 to 36 a review by Standard & Poor’s.
months, no principal is passed through to investors.
Fee Coverage
Principal payments allocated to investors are
reinvested in new receivables. A minimum fee of 2% should be available to
compensate a servicer. Servicing quality is extremely
Amortisation Period important and could be compromised by a failure to
This period begins at the end of the revolving pay servicing fees. Servicing activities include:
period, or after the occurrence of an early amortisa- transaction authorisation, credit extension, customer
tion event. During this period, a percentage of service, posting of transactions, statement mailing,
principal collections and charge-offs are passed payment processing, accounting, and collections. A
through to investors. deterioration in servicer performance could have an
immediate adverse effect on portfolio credit quality.
Seller’s Interest
If the seller or servicer enters insolvency or defaults,
The residual interest between the total principal the lack of a guaranteed servicing fee could affect
receivables owned by the trust, and the principal the trustee’s ability to obtain a substitute servicer.
amount of the investor interest, belongs to the seller,

Standard & Poor’s 54

 Structured Finance Australia & New Zealand ¨ April 1999

Credit Enhancement dilutions experienced by the portfolio. Dilution risk

For a security to achieve a rating, the assets of the can be either mitigated through the credit en-
trust may require credit enhancement. This support hancement incorporated in the transaction or by
may be achieved using a letter of credit; subordina- having the dilutions entirely allocated to the seller
tion; over-collateralisation; or via the use of some certificate without any allocation to the investor
form of reserve account. certificates.
Portfolio Yield
KEY RATING CONSIDERATIONS
Portfolio yield is influenced by several factors
Key rating considerations for credit card-backed
outside the card issuer’s control. These can include
securities reflect the nature of the collateral and the
competition from other card issuers, convenience
structure of the securities. The analytical focus is on
use, delinquencies, and legislative action on the
the collateral, portfolio yield, payment rates,
interest rates that can be charged on credit card
portfolio growth, regulatory constraints, and credit
debt.
enhancement.
Annual percentage rate income is the major compo-
Collateral Loss Rates nent of portfolio yield. But not all credit card
Credit cards are unsecured, revolving debt obliga- receivables produce this income stream, since
tions, supported only by the customer’s contractual cardholders can avoid interest expenses by paying
promise to pay. Since there is no tangible asset to off their entire balance on each payment date. For
repossess in the event of a cardholder default, example, while interest rates in Australia are higher
recovery of amounts written off is low. In addition, than many U.S. credit card portfolios, yield is
people who cannot pay all of their debts tend to pay actually higher in the U.S. as a result of a lower
their secured loans first. Standard & Poor’s concern proportion of convenience use by cardholders and a
with the nature of the asset is reflected in conserva- slower payment rate. To help mitigate the reduction
tive loan loss assumptions. The severity of the loan in portfolio yield from convenience use, issuers may
loss assumption will vary between lenders. This is increase the yield by including other income items in
because loan losses vary considerably among credit the cash flow, such as annual fees, foreign exchange
card issuers. Pool selection criteria also can influence earnings, and overdue account fees.
the assumed loan loss level. Underwriting standards, Standard & Poor’s evaluates all components of
seasoning of the portfolio or selected accounts, and portfolio yield and any potential future adverse
geographic distribution may all influence loan losses. factors in deriving conservative yield assumptions.
Standard & Poor’s assumes a future write-off rate
after assessing the card issuer’s credit policies and Payment Rates
procedures, historic loss and delinquency data, and Minimum and average payment rates vary across
other portfolio characteristics. portfolios. Payment rates directly influence the
Modelling the cash flows of the transaction is timing of cash flows to investors. If cash flows are
undertaken to size the level of credit enhancement delayed as a result of a decline in payment rate,
required for the asset-backed securities to attain the investor loss exposure is increased. To allow for this
desired credit rating. For a ‘AAA’ rating, historical payment flexibility, Standard & Poor’s will stress
loss rates may be increased by a multiple of five to transaction cash flows by assuming payment rates
seven times in Standard & Poor’s model. well below historic experience. In practice, credit
card balances pay down at a rapid rate. One recent
Dilutions trend affecting payment rates has emerged with
Dilutions represent reductions in the amount that cards which have an affinity relationship, for
can be collected from receivables transferred by the example, the ANZ Telstra Visa card. In many cases,
seller to the trust. Typically, these arise from the the payment rates associated with these portfolios
return by the customer of goods to the retailer or are higher than average.
service provider, discounts for early account pay- Issuers have converted the historically short-term
ment, billing errors, and adjustments. Just as losses credit card receivables into long-term securities by
reduce the amount that can be collected from the incorporating a revolving period. During this period,
receivables, so do dilutions. Standard & Poor’s no principal is passed through to investors. Principal
requests a detailed analysis of the historical level of payments are instead reinvested in further
receivables.

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 Structured Finance Australia & New Zealand ¨ April 1999

The revolving period lasts for a specified duration, increasing, albeit at a slower percentage rate than
after which cardholder principal payments are the growth rate of the portfolio. In these instances,
passed through to retire investor principal. To Standard & Poor’s usually seeks some type of
accelerate the pass through of principal to investors, vintage analysis or static pool information with
issuers allocate principal payments to the investor’s which to base our assumptions.
interest, based on a fixed percentage. This fixed
Portfolio Purchase Rate
percentage is usually equal to the investor’s propor-
tionate interest in the receivables at the end of the This variable will differ depending on the type of
revolving period. The investor’s fixed percentage card portfolio, for example bank card versus a retail
should always be greater than its proportionate store card. Standard & Poor’s evaluates customer
ownership interest in the trust. The revolving period reborrowing patterns and behaviour. Customer
may be terminated early if certain trigger events reborrowing may be affected by several variables,
occur. Examples of trigger events include a substan- including alternative sources of credit, economic
tial decline in portfolio yield; a deterioration in the conditions, and the benefit or utility of the credit
performance of the portfolio, that is, regarding provided by the card.
delinquencies, charge-offs or dilution; and certain Regulatory Constraints
occurrences of issuer, servicer, or trustee default.
Regulatory controls which may govern credit card
Commonly the historical payment rates of a portfo- lending, or cap the allowable credit card interest
lio may be discounted by as much as 50% in rates and/or fees which may be charged, can have a
Standard & Poor’s cash flow modelling of the major impact on cash flows, for example, by
transaction. accelerating payments and reducing the amount of
Portfolio Growth reborrowing. Standard & Poor’s fully evaluates the
regulatory environment and assesses the potential
Cardholder reborrowing, new purchases, and
impact on cash flows and required credit enhance-
advances play an important role in determining cash
ment levels.
flows. The rate of customer reborrowing is deter-
mined by the individual’s approved borrowing Credit Enhancement
capacity and the degree of debt the cardholder is In addition to conservative selection criteria and the
willing to accept. Customer reborrowing rates vary inclusion of amortisation trigger events, credit
across portfolios and may be influenced by the quality may be enhanced by letter of credit support,
availability of alternative sources of credit and a reserve account, over-collateralisation, or subordi-
economic conditions. nation. The adequacy of the level and type of cash
A portfolio that is experiencing a high degree of flow support is measured by the issue’s ability to
growth, and exhibiting low losses, may be masking withstand worst-case scenarios, tested in Standard
the true level of losses, which may in fact be & Poor’s cash flow models.

Standard & Poor’s 56

 Structured Finance Australia & New Zealand ¨ April 1999

Equipment Finance-Backed ment, the level of alternate sources of finance

available to the obligor base, risks associated with
Securities specialised equipment, and specific legal risks. This
The year of 1998 marked the emergence of equip- analysis provides insight into factors beyond an
ment finance as an asset class in the Australian originator’s control.
securitisation market. Commercial hire-purchase Originator history: Standard & Poor’s will examine
contract pools, lease contract pools, automobile, how the originator commenced operations, how
and aircraft were either directly or indirectly many years it has been in business, its past perform-
financed through securitisation. ance, and how its business focus and strategy has
This article focuses on Standard & Poor’s approach changed over time. Consistency in past performance
to rating securities backed by diversified pools of provides an insight into the integrity of an origina-
equipment receivables. Unlike most other securitised tor’s historical portfolio performance data. Three to
classes, equipment finance pools contain various five years of historical portfolio performance data is
subclasses, as different equipment is financed for required and Standard & Poor’s will not rate an
end-users in various industries. As a result, equip- uninsured transaction for an issuer with little or no
ment finance pools contain nonstandard characteris- history.
tics and concentrations that may cause credit quality Management experience: Standard & Poor’s prefers
to vary dramatically by pool and issuer. management with a strong, proven track record in
equipment financing, preferably in the market
EVALUATING EQUIPMENT FINANCE CREDIT RISKS segments in which it currently operates. An assess-
Obligor delinquency and defaults are the primary ment is made of the originator’s strategy to compete
credit risks, so the characteristics of each pool of within the industry. For instance, is management
equipment receivables to be securitised are exam- pursuing private-label programs with vendors
ined, as well as the way in which the receivables making an originator dependent on a particular
were originated. The likelihood of credit losses is vendor which potentially creates an event risk tied to
determined by analysing the historical performance that vendor? Does a vendor have enough leverage to
of the aggregate portfolio from which the pooled pressure an originator to finance all credits, whether
receivables are drawn, in order to provide a projec- it meets underwriting standards or not? Is manage-
tion of the future losses of the pooled equipment ment more sales or credit focused?
receivables. The performance and characteristics of Lease/finance products: The type of contracts
the pooled equipment receivables are also compared written by an originator have a direct impact on the
with the overall characteristics of the industry. Any legal and tax analysis, cash flow, and credit risk of a
differences will be reflected in the resulting liquidity securitised pool of receivables. Contracts are
and credit enhancement requirements. generally structured as either a finance lease,
The Originator commercial hire-purchase contract or an operating
lease. Under finance leases, the fixed-term rental
Given the individualised business practices of
stream and residual payment returns the full cost of
equipment receivable originators, and the frag-
the underlying equipment and provides the financier
mented nature of the industry, Standard & Poor’s
with a return on its investment. Commercial hire-
spends considerable time evaluating an originator’s
purchase contracts are similar to finance leases,
internal operations and competitive position in its
except there is the ability to fully amortise the
market. This evaluation helps determine the level of
amount borrowed over the term of the contract.
integrity in an originator’s operations and its
Operating leases are structured so that the fixed-
historical portfolio performance data. Standard &
term rental stream falls short of the full cost of the
Poor’s meets with the originator and conducts a
underlying equipment, necessitating the remarketing
thorough on-site due diligence visit, to gain an
of the equipment after the contract expires, to
understanding of key originator and industry factors
recoup the initial investment.
that could affect the payment behavior of the
receivables. The structure and cash flows of contracts can vary,
such that cash flows and credit risks can change
Market segments: Standard & Poor’s analyses key
significantly from pool to pool. Step, seasonal, and
factors that could affect the industries that an
balloon payments are common in certain segments
originator services. Risk factors include industry
of the finance industry. A concentration of either
outlook, economic cyclicality, regulatory environ-
type of contract may alter the timing of defaults.

Standard & Poor’s 57

 Structured Finance Australia & New Zealand ¨ April 1999

Step payments may give rise to greater defaults history with such third parties and how formalised
earlier in the transaction because of the start-up this relationship is.
nature of obligors requiring the benefit of low initial Underwriting: A consistent underwriting policy is
payments, while balloon payments may increase the integral to evaluating a pool’s expected loss perform-
severity of defaults late in the transaction. To the ance. Standard & Poor’s assesses the key criteria
extent the payment structure is dependent upon used in underwriting credit risk because the method-
residual cash flows, as may be the case with leases, ology of assessing credit risk can vary greatly,
the value of the underlying equipment, the depend- depending on an originator’s market segment. Since
ency on the remarketing agent, and the timing of underwriting is often a dynamic process, adjusting
residual realisation must each be considered. with current market forces or entry into new
In addition to the cash flow considerations of markets, Standard & Poor’s will attempt to ascertain
contracts, unique terms within the contract also may the history of an originator’s underwriting policy
create risks not seen in other receivable types. Lease and map it against the originator’s historical
agreements may contain maintenance provisions, receivable portfolio performance data. Conse-
which could lead to third-party event risk or set-off quently, to the extent underwriting policies have
risk; or prepayment options, which, depending on changed over time, Standard & Poor’s view on the
bond valuation, may create a shortfall if exercised. performance of the aggregate portfolio, and hence
Origination: An originator’s method of writing the pool and the expected loss level, also may
business can uncover credit and legal risks associ- change. Credit approval policies should be well
ated with a pool of equipment receivables. Standard documented, highlighting internal credit authorities
& Poor’s believes credit and legal risk is potentially and transaction approval procedures. Other key
greater when using indirect origination sources and/ components of a sound underwriting policy include
or portfolio acquisition. From a credit standpoint, a equipment acceptance policies, obligor due diligence,
direct sales approach gives the originator full control documentation requirements, settlement procedures
over underwriting, structuring, and documentation and internal auditing.
processes. However, with indirect origination and Servicing: The ability of the servicer to manage and
portfolio acquisitions, a third party often controls maintain control over the receivables and the
the process. The originator may therefore depend on payment stream from the receivables can directly
that third party to provide accurate and complete impact pool performance and the level of losses.
credit information on the applicant. Vendors and When evaluating the strength of a servicing opera-
brokers have strong incentive to alter credit applica- tion, Standard & Poor’s examines the following
tions in the applicant’s favour, since a credit rejec- areas: billing and collecting procedures, where a
tion potentially equates to a lost sale or commission. proactive system with strong control of cash
Furthermore, an originator may be dependent on payments is favoured; documented collection
third-party documentation that contains inadequate policies highlighting when calls are made; follow-up
rights and remedies. procedures for when legal remedies are pursued and
If the originator is dependent on third-party origina- repossession begins; and the adequacy of backup
tors, Standard & Poor’s needs to be comfortable system capabilities and disaster recovery plans.
with the integrity of the vendor/broker relationship In most equipment finance transactions, the seller of
and the information they provide. A lack of formal the receivables also will act as servicer. If the servicer
underwriting standards for third-party originators is unrated it can become a weak link in the transac-
could subject a pool to increased loss frequency, as a tion. To mitigate this, the transaction must provide
result of inferior obligor credit quality or fraud. for a substitute servicer to assume servicing responsi-
Additionally, third-party origination can expose a bilities if a servicer default occurs, or alternatively, a
securitisation to insolvency of the vendor or broker backup servicer to ensure a smooth transition.
if title to either the contract or underlying equip- Equipment finance receivables also may require
ment was retained. Significant recourse back to the unique servicing techniques because of the specialty
vendor/broker also could affect a true sale. There- nature of the receivables and the underlying equip-
fore, the nature of the relationship with third-party ment that is being financed. For instance, small-
originators, its development, and the level of ticket collecting typically requires frequent contact
monitoring and auditing is assessed. A key compo- to remind the obligor to make its payments.
nent of the assessment is a review of the originator’s Agricultural obligors demand a certain amount of

Standard & Poor’s 58

 Structured Finance Australia & New Zealand ¨ April 1999

flexibility when natural disasters such as floods or quarter or a year, and tracking the receivables on a
droughts occur. To the extent equipment sale monthly basis as they amortise to a zero balance.
proceeds are relied on in the payment structure— Dynamic portfolio data, usually expressed annually,
either through recoveries or residuals—a servicer or records losses in the year incurred, without regard to
backup servicer must be able to adequately remarket when the defaulted receivable was originated.
equipment. This would require staff with knowledge Standard & Poor’s prefers to analyse static pool
of secondary equipment markets and contacts with data, since it demonstrates loss performance over the
particular distribution channels in which to full liquidation period of a pool and allows for
remarket equipment. periods of rapid portfolio growth which can distort
the historical loss data provided by the originator.
ASSESSING CREDIT ENHANCEMENT LEVELS
To isolate the understatement of current loss
Historical performance data is analysed to project percentage caused by rapid portfolio growth,
the future default behavior of a pool of equipment Standard & Poor’s derives a growth adjusted loss
receivables. The evaluation of the credit support percentage by dividing losses for the period by the
considers both the stress on the transaction from outstanding principal balance of a prior period. The
liquidity needs resulting from obligor delinquencies, growth adjustment takes into account that losses of
and the permanent impairment of cash flows new originations may not occur immediately and
resulting from credit losses. therefore occur in the next annual period.
Pool Size During the on-site management meeting, the
When assessing credit support levels, Standard & originator’s documented and historical charge-off
Poor’s approach typically is determined by the size policies are analysed to ascertain the integrity of
of the receivable pool and any concentrations, using historical loss data as a proxy for future pool
including obligor, equipment type, obligor industry, performance, since future performance will be
equipment vendor, manufacturer and geographic governed by the charge-off policy in the transaction
region. If the data is not of sufficient statistical size documents. Since historical defaults are the result of
to actuarially analyse performance behavior of the an originator’s own internal charge-off policy,
pool, these factors may limit the reliance on histori- historical loss data may be based on a policy that is
cal data. Pools with fewer than 300 obligors cannot vastly different from the transaction documents.
be addressed by a pure actuarial approach, since
they contain risk concentrations that are not offset
Table 1 Benchmark Stress Factors For
Requested Ratings
by pool diversification. Although historical portfolio
loss performance may be excellent, such statistics are Requested rating Stress factor (x)
less reliable as an indicator of future pool perform- AAA 5
AA 4
ance when applied to small pools.
A 3
To the extent a receivable pool is small and concen- BBB 2
trated, alternative analytical approaches may be
applied, such as Standard & Poor’s corporate
default study (if the pool contains obligors rated by Standard & Poor’s analyses an originator’s historical
Standard & Poor’s), or defaulting top obligor and portfolio performance to arrive at a proxy for an
vendor concentrations. For larger pools with specific expected level of cumulative losses over the life of
concentrations, the two approaches may be com- the transaction. The expected cumulative loss rate is
bined. Whether a pool is of actuarial size, or small stressed, depending on the rating level, to determine
and concentrated, cash flow models are analysed to the amount of loss coverage. Table 1 sets out the
demonstrate the credit support’s adequacy to benchmark stress factors for the applicable re-
withstand various stressed credit and liquidity quested ratings. Note that these multiples are not
scenarios throughout the life of a transaction. absolute, and may be adjusted upward or down-
ward, depending on the specifics of a transaction
Static Pools Versus Annual Portfolios
such as issuer, data quality, or pool characteristics.
Historical loss data can be presented based on static
pools or dynamic portfolio information. Static pool Recoveries
analysis is performed by isolating receivables Cash flows from recoveries provide an added source
originated within a finite period of time, such as a of credit support to the extent the cash is available
to offset a simultaneous loss. Recoveries can be

Standard & Poor’s 59

 Structured Finance Australia & New Zealand ¨ April 1999

generated either through the disposal of the equip- Seasoning: With seasoned receivables there is an
ment or, as is more typically seen in the small-ticket established record of payment, and equity build up
segment of the industry, through continued hard should increase the incentive for the obligor to
servicing. In quantifying the credit that can be given continue paying reducing delinquencies, thereby
to recovery cash flows, Standard & Poor’s analyses reducing the severity of the loss.
the historical data presented by the originator, the Concentration risk: Credit quality may be negatively
legal rights that noteholders have in the underlying affected where there is heavy concentration, with
equipment, and the timing of realising the recovery one obligor or obligor group, in one geographic
cash flows. The analysis of recovery data depends on region, industry, or type of receivable. Standard &
the size of the pool and whether such information Poor’s will analyse various concentrations over the
can be relied upon from an actuarial standpoint. life of the transaction to ensure the level of credit
Noteholders’ ability to benefit from recoveries support remains consistent with the rating.
depends on the ability to access the equipment in Equipment insurance: As part of the on-site manage-
order to sell or otherwise remarket the equipment. ment meeting, each originator’s insurance coverage
Standard & Poor’s assumes the insolvency of the requirements and procedures for monitoring and
originator; therefore, it is a requirement that the maintaining coverage are assessed. A lack of
security interest in the receivable be assigned such adequate initial coverage and ongoing surveillance
that a noteholder trustee could step into the priority can substantially increase noteholders’ credit-loss
position of the originator. Such transfer should be exposure.
backed up with the appropriate mechanisms
Future excess collections: Future excess collections
required to perfect a security interest over the
serve as additional credit support, although this cash
receivable. Standard & Poor’s assesses the nature of
flow can be reduced by delinquencies, losses, and
the noteholder trustee’s rights to the underlying
prepayments. Standard & Poor’s analysis begins
equipment, and to the extent there are inadequate
with its view on a pool’s loss curve, and more credit
rights, historical recovery performance is discounted.
is given where excess spread is trapped in the
Timing is important to giving credit to equipment structure, as opposed to allowing the spread to flow
recoveries, since the cash flows must be available to back to the originator.
offset a default. The timing of recovery cash flows is
dependent on two factors: how the cash flows are STRUCTURAL ISSUES
treated in the payment structure; and how long it
Credit Enhancement
takes to realise the recovery. Structurally, recoveries
typically are available monthly to offset periodic Standard & Poor’s has rated securities backed by
losses. To the extent the recovery is not needed, any equipment receivables with various forms of credit
excess would flow back to the originator. As a enhancement. These include overcollateralisation,
result, the timing of losses will determine the benefit subordinated classes, letters of credit, cash reserve
that recoveries provide. To assess the time needed to accounts and bond insurance. The structure of the
realise recoveries, Standard & Poor’s analyses the credit enhancement should be consistent with the
methods an originator historically has used to realise receivable’s loss curve and must be sufficient to
recoveries and the historical timing of recoveries. cover the peak loss period. To the extent a pool of
The ability of a substitute servicer to achieve the receivables does not display a distinct pattern of
same recovery performance would also be assessed, loss, or is subject to other event risks, Standard &
and the payment structure must incorporate the Poor’s may not be comfortable with amortising
proper financial incentives to entice the substitute credit enhancement.
servicer to perform the recovery function adequately. Generally in equipment securitisations, the timing of
losses may be less certain than other consumer
General Credit Issues assets. This can be due to large obligor concentra-
Annual percentage rate: The annual percentage rate tions, uneven contract payments or event risk
(APR) of equipment finance contracts may have an associated with originator/servicer or vendor
impact on the level of credit support required, as a bankruptcies. To mitigate the potential uncertainty
high APR may provide for a high level of excess in when losses may occur, it may be appropriate for
spread which can be used to absorb credit losses as a the credit support to either not amortise, or amortise
form of first-loss protection. to a high floor, which factors in tail-end risk because
of concentration factors.

Standard & Poor’s 60

 Structured Finance Australia & New Zealand ¨ April 1999

Credit support floors typically are higher in equip- eligibility criteria governs the receivables sold into
ment finance securitisations compared to other asset the pool at closing and during the revolving period.
types because of: This criteria allows the pool of securitised receiva-
♦ The higher risk concentrations in the pools; bles to maintain its integrity, in terms of its correla-
♦ The uneven repayment schedules of the receiva- tion to the aggregate receivables portfolio originally
bles, as a result of step payments and balloon analysed by Standard & Poor’s, in order to deter-
payments; and mine a pool’s loss number.
♦ The greater event risks of the commercial obligor
LIQUIDITY RISK ANALYSIS
base.
To ensure that cash flow is sufficient to meet
Defaults in a commercial obligor pool generally do documented noteholder payments, a two-part
not follow the same loss behavior pattern as those in assessment is made by Standard & Poor’s. Firstly, to
consumer pools. As a result, Standard & Poor’s will project potential losses on the underlying receiva-
review the risks and merits of each specific pool bles, a review of the originator’s historical portfolio
when assessing the size of the credit support floor. performance and the data related to the composition
Payment Allocations of a specific pool is undertaken. This enables an
Most equipment finance securitisations have used estimation to be made to predict cash flow which is
either a senior/sub or overcollateralisation structure, unavailable due to defaults. Secondly, Standard &
in which the senior notes are supported by a note or Poor’s performs a liquidity risk analysis to assess the
equity holder that is subordinated in payment appropriate liquidity coverage to offset temporary
priority. Collections are allocated pro rata between shortfalls caused by timing differences (such as
the senior noteholders and the subordinated delinquencies, contact rewrites or extensions and
noteholders and/or the originator, to maintain a repossession timing).
constant level of overcollateralisation on the notes. The liquidity risk analysis determines the maximum
The senior noteholder’s percentage of defaulted amount of cash flow that may be unavailable
finance contracts is covered through subordinated because of delinquent payments. Standard & Poor’s
cash flows. If there was uncertainty about a pool’s requests delinquency data, on a quarterly basis, from
loss curve, an overallocation of cash flow to rated the originator for the prior five years. The data
noteholders—instead of releasing cash flow to the should include the percentage of payments past due
originator—would create an increase in (as a ratio of average dollars outstanding) for each
overcollateralisation, providing greater protection to 30-day period, including those delinquent in the
cover losses. one-to-30 day category. This data is analysed to
estimate the percentage of cash flow typically
Revolving Periods missing from the originator’s portfolio, plus
During the revolving period, payments that would amounts recovered from obligors during each
otherwise be used to amortise noteholder principal month. Using this data and the pool’s scheduled
are retained by the originator to purchase additional monthly principal and interest payments (i.e., no
receivables. An amortisation period follows, during prepayments), Standard & Poor’s models the
which noteholders receive distributions of principal. transaction to determine the required level of
Early amortisation events are incorporated in these delinquency coverage. Varying degrees of stress are
transactions to maintain credit quality by discon- imposed on the model, depending on the pool
tinuing the revolving period if certain conditions, composition, underlying receivables’ characteristics
such as nonmaintenance of a minimum pool APR and Standard & Poor’s assessment of the servicer
yield are not met, or receivable performance and the economic environment.
deteriorates. Early amortisation events can, in effect,
set limits on Standard & Poor’s worst-case receiv-
able composition scenarios. In revolving structures,

Standard & Poor’s 61

 Structured Finance Australia & New Zealand ¨ April 1999

Export Receivable-Backed And produce a given product. Therefore, the probability

of continued production could be higher than the
Future Flow Transactions probability of timely payment connoted by a local
Standard & Poor’s has received numerous requests currency credit rating. The strength of a given
to consider secured transactions that aim to reduce company within its industry and its competitive
the risks of cross-border debt issues. Typically, these position form a basis for estimating the likelihood of
involve a company that exports a product, usually a continued production. A company’s position related
commodity, such as oil or copper. The exports to a specific product may be more pertinent than its
generate offshore dollar-denominated receivables overall business position, especially in the case of a
under a contract with a foreign buyer or from sale diversified firm.
through an established exchange, such as the Nevertheless, the overall financial condition of a
London Metals Exchange. The cash generated from company is still relevant in this analysis. A company
the future receivables is captured offshore and is close to bankruptcy or in bankruptcy/receivership as
used to service the debt. However, there may be a result of its financial condition, regardless of its
other types of noncommodity products such as underlying business strength, is more likely to be
transactions backed by remittance payments made unable to meet production and delivery obligations
by overseas workers to their home country. Depend- than one with a strong financial profile. Standard &
ing on the configuration, it is possible for some of Poor’s also reviews the local laws for bankruptcy/
these transactions to achieve a rating above the receivership to assess whether and to what degree
foreign currency sovereign rating of the seller’s these might affect a financially stressed company
country of domicile. from meeting its obligations. For example, do the
In analysing the likelihood of timely payment of regulations allow for the cancellation of existing
such transactions, seven factors must be considered: contracts? Can secured creditors execute quickly
♦ The company;
against assets assigned to them as security?
♦ The company’s ability to produce; Companies considering issuing securitised receiva-
♦ The ability to export;
bles debt frequently are in countries with low credit
ratings. Typically, operating conditions in such an
♦ The product;
environment are more difficult or volatile than those
♦ The nature of the receivables and the purchase
in a higher rated country. Country considerations
contract, if any;
that could affect a company’s ability to produce are
♦ The size and term of the debt issue; and the impact of sovereign risk on the local business
♦ The terms and legal structure of the debt issue. environment, including changes in economic activity,
the price and availability of credit, market volatility,
THE COMPANY
competition, and labor relations. Also considered is
Assessing the underlying strength of the company the potential for regulatory oversight and govern-
producing the product is the first step, since it ment intervention affecting pricing, production,
clearly has a bearing on the ability to produce. In distribution, and access to raw materials and other
this process, Standard & Poor’s examines both the inputs, as well as potential nationalisation.
underlying business risk and financial risk of the
company. This is the same procedure used in ABILITY TO EXPORT
assigning any corporate credit rating. As part of this The ability to produce must be followed by contin-
corporate credit rating process, Standard & Poor’s ued ability to export the finished product. The
assesses the ability of the company to meet all its historical track record of the country, in terms both
financial obligations, whether denominated in of controlling exports generally and controlling
foreign or local currency, on a timely basis. exports of a specific product or industry, is the
starting point for this analysis. However, since
ABILITY TO PRODUCE
governments, industries, and products change, the
Standard & Poor’s recognises that a credit rating historical track record is just one factor to consider
does not exactly quantify the probability of contin- in determining the continued probability of export.
ued production, since the former only assesses the Overall, what must be assessed is the existence of
likelihood of timely payment of financial obliga- strong underlying economic and political incentives
tions. A company can be in default, or even in to allow for the continued export of the product.
bankruptcy/receivership, and still continue to

Standard & Poor’s 62

 Structured Finance Australia & New Zealand ¨ April 1999

Factors considered include: generated by the exports to ensure repatriation of

1. How important is the product to the country? the receipts rather than allow their use for
This can be either positive or negative, depending offshore debt payment. At the company level, the
on the circumstances. If exports of the product greater the percentage of the receivables that
are a large generator of foreign exchange, the ultimately will flow back into the country to meet
country would have a strong incentive to permit raw material or labor costs, the greater the
continued exports. A product deemed to be incentive to continue production and export
strategically sensitive may be treated differently. under the terms of the transaction being
Brazil, for example, is a net importer of oil, and securitised.
has defined oil independence as a policy goal. The 6. Are the export sales contracts arm’s length? A
Brazilian government’s view of oil exports would contract that is generated under standard market
probably be very different from the view of conditions and containing standard market terms,
Venezuela, which produces far in excess of its including pricing, is less likely to be modified by a
domestic needs, and its oil exports represent government than one that represents a one-sided
approximately 90% of foreign exchange genera- benefit to the foreign buyer. For example, a 20-
tion. Another example could be gold, which can year contract with an offshore affiliate company
be used as a reserve asset to back up a country’s using transfer pricing to maximise remittances or
foreign reserves or settle balance of payments avoid taxes or potential exchange controls has a
deficits. As a result, some countries could see gold greater risk of being modified or abrogated by the
as strategically important. Thus, there is a higher producer’s government. The terms of the con-
likelihood of interference with gold exports. tract, particularly how easily one of the parties
2. Is the product a net export? If the country could renege on its obligations, also is critical.
produces more of the product than can be used Any terms that reduce the uncertainties, whether
domestically, the likelihood of continued export in terms of price or volumes, make the transac-
is higher than that likelihood in a situation where tion easier to analyse.
the country is a net importer. The previous 7. Could interference with exports affect future
example of Brazilian and Venezuelan oil exports foreign investment in the country? A unilateral
also applies here. modification or abrogation of an offshore third-
3. Does the industry or the company specifically party sales contract could jeopardise the amount
represent an important source of employment to of investment coming into that country. Depend-
the country? The exports of such an industry or ing on the importance these inflows have for
company would most likely be viewed more economic development, the likelihood of reduced
favourably, since failure to allow the exports foreign investment as a result of government
could involve increased unemployment. interference and the degree of governmental
4. What raw materials are used to make the concern for the nation’s economic welfare could
product? If the industry or company must import represent an important deterrent to governmental
the raw materials to produce the product, it is intervention.
possible that in a crisis these imports would be This list represents the major considerations that
limited. However, if domestic raw materials are must be addressed in determining the likelihood of
used, the relative value added and consequent continued exports. Each situation must be addressed
ability to generate foreign-exchange from export on a case-by-case basis since each country, industry,
could be more important. In general, the greater and potentially, each company or export contract,
the proportion of value-adding in the country, the will present a different mix of issues.
greater the likelihood that exports would con-
tinue. NATURE OF THE PRODUCT
5. How large a proportion of export receivables Apart from any potential governmental interference
must be used to meet external debt service? This with the export of the product, demand for the
factor is addressed for the company, the industry, product in the international market is an important
and the country. For example, if such a transac- factor to consider. Commodity products with deep
tion or series of transactions represent an impor- international markets, such as copper traded on the
tant percentage of a country’s export receipts, London Metals Exchange, tend to be viewed more
there is a greater likelihood that the government favourably for these transactions, since they enjoy
might interfere with the exports or the cash flows

Standard & Poor’s 63

 Structured Finance Australia & New Zealand ¨ April 1999

the depth and liquidity of the international market where the offshore entity has a strong credit rating.
to support sales under a specific export contract. To be viewed most positively, the ownership interest
Manufactured products tend to lack the liquidity must be a controlling interest, must represent an
inherent in commodity products, although there are important part of the offshore entity’s global
exceptions. A manufactured product that may be operations or source of product supply, and should
more difficult to sell readily on the international be accompanied by a clear statement of support. In
market may still be viewed favorably if the exporter addition to statements made by the offshore entity,
is an important source of the goods for the offshore Standard & Poor’s also looks for evidence of
buyer and other sources are not readily available. tangible support by the offshore parent in times of
For example, MABE Export S.A. de C.V. in Mexico crisis. Such a relationship can increase the likelihood
is the only significant supplier of gas ranges for of continued cash generation to service the debt
General Electric Co. to sell in the U.S. market. obligation.
Limitations on securitising additional receivables are
THE RECEIVABLES AND THE PURCHASE
important. One of the positive factors in these
CONTRACT
transactions is the preferred position in which such
Typically, these transactions are structured so that bondholders are placed relative to other creditors
receivables are generated from a long-term sales and the offshore cash flow. Often holders of
contract for the purchase of the product by an securitised debt are effectively placed in a position
offshore buyer. Alternatively, for certain commodi- superior to all other creditors of the issuer, even
ties, as noted above, the sale may be made through a those notionally secured. However, if a significant
recognised market. If the transaction relies on a portion of the future receivables can be used as
purchase contract, the underlying credit strength of security for future debt issues, these benefits are
the purchaser is assessed to determine its ability and largely undone.
willingness to honor its contractual commitments
and generate the receivables. SIZE AND TERM OF THE DEBT ISSUE
Standard & Poor’s also assesses the importance of The size of the transaction relative to the seller’s cash
this particular source of supply for the buyer. flow also is important. If the cash generated by a
Standard & Poor’s considers whether there are relatively large amount of receivables is diverted to
strong economic reasons for the buyer to honor the pay the specific debt obligations, the seller could
contractual arrangement. A tightly structured, long- face a crisis if the export receipts, which are being
term contract containing minimum purchase used for the sole benefit of securitised debtholders,
requirements with a strong offshore entity strength- are unavailable, and the company needs these
ens the transaction. However, it is possible to have receipts for working capital purposes. This would be
loosely worded contracts, short-term renewable a difficult situation for a company to handle for any
contracts, or no contracts at all. These transactions length of time and might increase its incentive to
would rely on the liquidity of the product in the divert production away from the securitised transac-
international markets. tion to other purchasers. The likelihood of a default
When reviewing purchase contracts, an analysis under the contract by the company would be higher.
includes the sensitivity of the contracts to commod- A smaller debt issue relative to the cash needs of the
ity price declines, production interruptions, volume company would be easier to service and would not
fluctuations, and exposure to construction and provide this type of diversionary incentive.
technical risks. Standard & Poor’s notes the ability Likewise, Standard & Poor’s prefers to see amortis-
to increase the volume of exports if the price should ing debt issues or issues with a sinking fund. Bullet
decline. If the product is a commodity and a fixed payments imply the need for refinancing and again
quantity of product is being purchased, the strength subject the debt to country risk issues. An amortis-
of debt service coverage during a down cycle is ing issue will have principal paid from the cash
assessed. Standard & Poor’s expects to see strong generated by the receivables on a regular basis and
coverage ratios even in the down cycle. Standard & allows the amortisation of the debt to benefit from
Poor’s also reviews the likelihood of supply interrup- the structure of the transaction. In addition, the
tion. This helps to determine the size of any reserve shorter the term of the issue the easier it is to predict
fund that is set up for contingencies. the severity of the risks involved and to rely on any
Ownership of the producer by the buyer, whether mitigating factors.
full or partial, can enhance secured debt issues

Standard & Poor’s 64

 Structured Finance Australia & New Zealand ¨ April 1999

STRUCTURE OF THE ISSUE of the product, the contract, the underlying risk of
Many of the characteristics of traditional asset- the sovereign, and the frequency of payments. Such
backed securitisation are used to help mitigate a reserve acts to cover temporary interruptions in
potential disruptions in the generation of cash to product delivery and cash flow, whether from
service debt. One of these aspects is the establish- reduced prices, delayed receipts, or other
ment of an offshore bankruptcy-remote issuing occurrences.
vehicle and collection accounts in which all the cash A fourth characteristic is triggers in the transaction
flows are held. These structures are used to help documents that require trapping of all cash flow at
distance the issue and the cash flows from the the issuer level if certain adverse events occur. This
uncertainties within the home country, as well as helps to provide more cash to bondholders to assure
facilitate control and security interests in the timely payment and additional security when these
underlying receivables and cash flow. However, adverse events occur, regardless of whether they are
unlike typical structured transactions, these debt the result of action by the sovereign or events
issues also are backed by a guarantee from the affecting the issuer/producer, product purchasers, or
producing company. This guarantee gives additional the market as a whole. For example, the imposition
recourse and protection to bondholders and added of export restrictions or currency controls that
motivation for timely payment. might serve to undermine the transaction, declara-
Standard & Poor’s recognises that in some very tion of force majeur, radical changes in the market
limited instances, the offshore bankruptcy-remote for the product, or similar occurrences might set off
issuing vehicle may not be needed. In one recent such triggers. The triggers also provide strong
transaction, YPF Sociedad Anonima, a major incentives to the ultimate producer to either prepay
Argentine oil company, securitised receivables from the issue or to quickly and satisfactorily resolve the
the sale of oil to Empresa Nacional del Petroleo- events that caused the trigger mechanism to come
Chile (ENAP), the state-owned company of the into play.
Republic of Chile. In this structured export note The fifth asset-backed characteristic that helps
transaction, which was rated ‘BBB’, YPF was the mitigate potential disruptions in the generation of
borrower. Sales were made directly by YPF to ENAP cash to service debt is assignment to the SPE issuer
without the benefit of an offshore special-purpose of all the sales and purchase contracts, and rights to
entity (SPE). The solid underlying business position all the relevant cash flows, rather than those
of YPF in Argentina, coupled with strong govern- attributable to just one or a narrow group of
mental incentives to assure continued production purchasers. This eliminates any incentive to either
and the export of oil, allowed a debt structure the producer or the sovereign to divert supply to
without an SPE for this transaction. purchasers outside of the security arrangement and
A second characteristic of asset-backed securitisation ensures that the preferred status of the secured
is secured export volumes that result in receipts from debtholders is preserved, and timely payment met.
the purchase contracts or market sales that cover
POPULARITY TO GROW
multiples of the issuer’s debt service. This coverage
helps to ensure timely cash flow if there are changes Standard & Poor’s expects that the popularity of
in contracts, production, and international markets export receivables transactions will continue to grow
or prices, which could reduce overall cash flow and that the nature of these transactions will
availability. For example, an export contract calling continue to evolve. For these transactions to gain
for delivery of a fixed volume of goods at current even greater acceptance with investors and issuers,
market prices that just exactly meets the amount of they must be carefully structured to provide real
debt service provides no protection if market prices economic incentive and proper legal certainty.
decline. If the volume of exports under contract at The relative weight placed on each of the elements
current market prices covers several times annual of the transaction varies, depending on the nature of
debt service, there is substantial inherent protection the particular transaction. The greater protection
against such price changes. and strength of one element might offset some
A third characteristic is the establishment of a debt relative weaknesses elsewhere. Standard & Poor’s
service reserve fund. Generally, this reserve, estab- rating of the debt issue ultimately reflects the
lished at the outset of the transaction, is equal to at inherent economic viability and strength of a
least one scheduled principal and interest payment. particular transaction along with its legal structure.
This amount can be greater depending on the nature Together, these factors determine an issue’s likeli-
hood of timely payment.
Standard & Poor’s 65
 Structured Finance Australia & New Zealand ¨ April 1999

Real Estate-Backed Securities Criteria for rating property-specific transactions is

broken into three components: real estate quality,
Standard & Poor’s rating of a property-specific payment structure, and legal issues.
financing addresses the ability of a special-purpose
entity, as the owner of an income-producing prop- REAL ESTATE QUALITY
erty, to service payment obligations to the debt There are numerous quality attributes to consider
holders, and encompasses a study of both the real when analysing property. The following explains in
estate market and the bond structure. Standard & more detail the specific criteria Standard & Poor’s
Poor’s analyses the viability of the property (and any employs in property-specific and pool transactions.
additional collateral), as well as the security’s
payment structure, to determine the likelihood of Location
timely and ultimate payment to security holders. Commercial real estate depends on its location for
Standard & Poor’s does not rate the physical real its economic viability. Several factors are addressed
estate, but rather securities backed by mortgages on in examining location including diversity of the local
real estate and other collateral. economy, competition, zoning requirements, and
The basis for Standard & Poor’s rating is the relative other locational risk factors.
risk underlying the collateral and the ability of the Tenancy
cash flow from the collateral to be received on time
A building occupied by one tenant is vulnerable to
and in full by security holders. A thorough review of
the risk of that tenant vacating the entire space. A
the property and the determinants of its cash flow
building with a multitude of tenants in diverse
and value are performed. The elements of the
industries, and in which there is not a large percent-
analysis entail a review of specific property features
age of leases rolling over at the same time, is least
such as:
vulnerable to this risk. The lease expiry schedule
♦ Location, must be examined in conjunction with the bond
♦ Tenancy, maturity.
♦ Leases,
Leases
♦ Market rental rates and expenses,
The value of commercial property is derived from its
♦ Building quality assessments,
cash flow, which is a function of the leases already
♦ Supply and demand considerations, and
signed by the owner and current tenants, and of
♦ Management. leases that may be signed by the owner and future
The key financial indicators are the property’s debt tenants. This cash flow is reduced by the expenses
service coverage and loan-to-value ratios. Standard incurred from building operation and by tenants of
& Poor’s analysis seeks to determine a stabilised net poor credit quality, who may prove unable to meet
cash flow for each property in a securitisation. Based scheduled payments. The pertinent aspects of each
upon this figure, Standard & Poor’s will determine lease—its length, concessions (if any) given to the
the appropriate amount of debt at various rating tenant; timing and amounts of step-ups; and
categories in accordance with certain debt service provisions for expense pass throughs—are analysed
coverage and loan to value ratios. The debt structure to determine the effect each will have on cash flows.
payment mechanisms that allow the proceeds from In addition, rental rates and expenses are analysed
the properties to pass through to security holders are to determine if they are at supportable market levels.
also evaluated. These elements are not separate and Above-market rental rates are lowered to market
distinct, but part of an integrated credit picture of rates to derive a property’s stabilised net cash flow.
the asset. In many cases, the property may not be
History
sufficient by itself to enable the issuer to obtain its
desired rating. In these situations, additional Understanding a property’s past performance and
collateral, such as cash or letters of credit, may be track record helps evaluate its ability to support the
necessary to achieve the desired rating. rated debt. While past performance is not necessarily
indicative of future results, the operating perform-
Standard & Poor’s general approach outlined above
ance of a property can be a good source of informa-
is used for all income-producing real estate, includ-
tion on its inherent strengths and weaknesses.
ing office property and retail property. Given that
most transactions feature unique elements, however,
Standard & Poor’s analysis is tailored to each
specific transaction.

Standard & Poor’s 66

 Structured Finance Australia & New Zealand ¨ April 1999

Management down so that the combined loan-to-value (LTV)

Given the competitive environment in most markets ratio at the refinance date is equal to Standard &
today, management has become a critical factor in Poor’s targeted LTV at maturity. Standard & Poor’s
the success of any property. Quality management, must also be sure that the transaction documents,
illustrated by continued reinvestment in the prop- the subordinated debt documents, and applicable
erty, leasing expertise, and tight control of day-to- insolvency legislation do not give rights to subordi-
day operations, can ameliorate lessee turnover and nated debt holders that would provide subordinated
support an argument for long-term stable cash flow. debt holders with an incentive to seek to wind up
the borrower.
Construction Quality/Energy Efficiency
Commercial real estate used to secure debt varies
An independent engineering report may need to be enormously. Location desirability, lease terms and
provided to Standard & Poor’s to determine the other features unique to certain properties result in
construction quality of the premises. These reports evaluations on a case-by-case basis.
should contain reliable information on the remain-
ing economic life of the building, its structural PAYMENT STRUCTURE
integrity, operating systems, and interior finish. Such A commercial mortgage-backed security has risks
information helps ascertain the continued ability to beyond those of the pledged property’s performance.
lease, stability of future income generation, amount The rating on the security reflects the likelihood of
of deferred maintenance and needs for capital the debtor fulfilling all payment obligations on a
improvements, levels of maintenance expenses, and timely basis.
reserves for replacement presented in the appraisal.
The costs for on-going general maintenance and Security Term Risk
future capital needs will be sized into Standard & There are three basic payment terms that a security
Poor’s stabilised net cash flow used for debt sizing. can take (and occasionally a combination of the
A report by a qualified, third party engineer will three is used): fully amortising; interest-only with a
help determine these costs. balloon payment; and zero coupon.

Insurance Requirements Fully amortising is considered the least risky. There

is limited risk of having to refinance or sell the
Standard & Poor’s requires that sufficient insurance
property at maturity and, with each debt service
coverage be in place to protect against loss. For
payment, the mortgage increases its equity in the
example, in the case of general insurance, the insurer
property.
must have a financial strength rating not less than
one rating category below the rating of the securi- Interest-only debt is considered more risky than fully
ties, but in no event less than ‘BBB’. amortising debt. There is no gradual build up of
equity by the owner, which means that the bond-
Environmental Risk holders’ risk remains constant throughout the life of
Due to a proliferation of laws for hazardous waste the issue rather than diminishing over time. Also,
cleanup, the risk of a lien being placed on a pledged there are added risks associated with the need to
commercial property must be assessed when rating meet the balloon payment at maturity. The market
debt secured by that property. This risk is assessed in which the property is located may be in a down-
by a site visit by Standard & Poor’s analysts, close turn at the time of maturity, or interest rates may be
scrutiny of current tenants and their activities, prohibitively high. And there is the risk that the
consideration of prior site usage and adjacent land property, having aged, may not be as attractive to
uses, and a check of currently known hazardous prospective lenders as other buildings. Through
substance sites. An environmental study may be careful property and cash flow analysis, debt sizing,
required from a qualified professional engineer. and deal structuring, Standard & Poor’s may be able
Standard & Poor’s reviews the scope of the report to get comfortable with certain balloon refinance
for sufficient coverage and determines the overall risk.
quality of each report and the potential environmen- Zero-coupon debt is the riskiest type of financing.
tal risk. While fully amortising debt has equity build up,
Subordinated Debt zero-coupon debt has equity erosion over time
because interest accrues, becoming principal. In
Standard & Poor’s will not generally rate a transac-
addition, like interest-only balloon debt, zero-
tion with subordinate debt unless the subordinated
coupon debt has financing risk.
debt is nonrecourse, and the total debt amortises

Standard & Poor’s 67

 Structured Finance Australia & New Zealand ¨ April 1999

TRANSFERS, OWNERSHIP, SECURITY INTERESTS Recent transactions have made increased use of
Standard & Poor’s bankruptcy analysis involves the various funds and cash deposits as credit support.
evaluation of the nature of each party’s property Issuers and developers have used various structures
rights and whether third parties have retained rights to address preference concerns including ageing of
that may impair the timely repayment of debt service funds with trustee, providing letters of credit (LOC),
on the bonds. bankruptcy insurance policies, and capital contribu-
tions to a bankruptcy-remote entity. Standard &
Standard & Poor’s examines the documents to
Poor’s will cooperate with each issuer to ensure that
ensure that the trustee has a first priority fixed and
the transaction meets the rating criteria.
floating charge over the property pledged to secure
the bonds. Depending on the structure of the Standard & Poor’s may require opinions that, in an
transaction, this may involve a mortgage, one or insolvency of the party exercising control over the
more assignments of mortgage, assignments of rents funds, such funds will not be deemed to be ‘property
or leases, the establishment of various reserve funds, of the estate’ of such party, and that payments of
or credit support under the trust deed. debt service would not be subject to an automatic
stay.
Standard & Poor’s requires an opinion of counsel to
the effect that the trustee has a first priority security SPECIAL-PURPOSE ENTITIES
interest in the trust estate. If a transaction involves
In property-specific transactions, Standard & Poor’s
transfers of property, Standard & Poor’s also
credit analysis focuses on the property mortgaged by
evaluates these transfers to ensure that the bank-
the borrower as collateral for the loan. It is critical
ruptcy of the transferor will not affect the transac-
to the analysis that the borrower not be subject to
tion.
economic problems unrelated to the borrower’s real
If the transferor is not a bankruptcy-remote entity, estate collateral. It is for this reason that the bor-
Standard & Poor’s may require opinions of counsel rower in the property-specific transaction must be a
to the effect that, in an insolvency of the transferor: special-purpose entity (SPE). In structures where the
♦ the transfer would be viewed as a ‘true sale’ of borrower is a different entity than the owner of the
the property by the transferor; property, the owner of the property must also be a
♦ the amounts (or property) transferred and the SPE.
related debt service payments to the bondholders
would not be recoverable as a preference pay-
ment.

Standard & Poor’s 68

 Structured Finance Australia & New Zealand ¨ April 1999

Trade Receivable-Backed Early Amortisation Events

Early amortisation events are designed to enhance a
Securities transaction’s credit quality by discontinuing the
One of the growing areas of the asset-backed revolving period if reinvestment of investor cash
securities market has been the issuance of securities flows becomes significantly less desirable. Early
backed by corporate trade receivables. Although the amortisation events can, in effect, set limits on
majority of trade receivables are funded in commer- Standard & Poor’s worst-case scenarios. A strong set
cial paper conduits, term securities have been an of early amortisation events will minimise credit
emerging vehicle for funding trade receivables. This enhancement levels. Although amortisation events
article focuses on the methodologies used when enhance credit quality, they can trigger the early
analysing trade receivable-supported commercial unexpected return of investor principal. Standard &
paper and medium-term note programs. (See Poor’s rating does not address the likelihood of the
Standard & Poor’s April 1999 publication “Trade occurrence of an early amortisation. Examples of
Receivables Criteria” for more detail.) early amortisation triggers commonly used in rated
The term “receivables” covers a diverse range of issues are:
assets, for example, long-term lease receivables ♦ Insolvency of the seller or servicer;
arising from commercial aircraft finance to very ♦ Material breach of representations, warranties, or
short-term receivables arising from the supply of covenants;
consumer electrical goods. Here, the focus will be on ♦ Servicer default;
key points in the general assessment of credit risk for ♦ Deterioration of portfolio performance beyond
short-term trade receivables, which are defined as specified levels (typically delinquency, write-off,
amounts due on a company’s credit sale of goods or or dilution triggers); and
services to corporate or other obligors. ♦ Decline of credit enhancement below required

STRUCTURAL CONSIDERATIONS levels, or a borrowing base deficiency that is not

cured within a specified period of time.
There are many important structural considerations
in a trade receivable securitisation, some of which In addition, there may be seller-specific triggers, such
are discussed below. as the sale of a significant subsidiary.

Revolving Period Yield Reserve

Under normal circumstances, the typical trade A yield reserve is needed to cover both interest and
receivable pool will liquidate in less than two servicing fees expected to be incurred over an
months, assuming the pool is relatively constant and assumed amortisation period. Trade receivables are
all collections are used to pay down debt. To extend noninterest-bearing assets, and, as such, Standard &
the life of trade receivable-backed securities, inves- Poor’s needs to be comfortable that the discount
tors are paid interest only during the transaction’s applied to the receivables purchased by the special-
initial stage. During the initial interest-only period, purpose vehicle prior to amortisation is sufficient to
payments that would otherwise be used to amortise cover interest, as well as the increased servicing cost
investor principal are paid to the seller to purchase throughout the assumed amortisation period.
additional trade receivables. Thus, revolving The yield reserve is sized to cover interest and
interest-only periods allow the issuer to set a servicing fees throughout the assumed liquidation
maturity that matches the company’s overall funding scenario, which is a multiple of the days-sales-
strategy as well as meet the investment targets of outstanding (DSO). The DSO is a measure of
potential security holders. The revolving period is receivable turnover. Important considerations in
followed by a principal amortisation period during determining the carrying costs include the volatility
which investors receive monthly distribution of and length of the DSO, the assumed loss horizon
principal and interest. As with earlier credit card and the frequency of interest payments. The analysis
receivable-backed issues, principal can be paid out assumes a worst-case amortisation period and
as received, distributed on a controlled basis or paid factors in the maximum number of interest rate
into a principal accumulation account for payment resets during the wind-down and an adverse interest
in one lump sum. To protect investors against a rate environment using historical volatility of the
deterioration in investment credit quality, early interest rate index over the maximum number of
amortisation events are incorporated in the struc- resets. Of course, if a transaction offers a fixed
ture.

Standard & Poor’s 69

 Structured Finance Australia & New Zealand ¨ April 1999

coupon, then no interest rate volatility mechanic products that have not been shipped. In addition,
would apply. collecting payment on other shipments to the
customer may be difficult if there is bill-and-hold
Cash Flow Allocations
inventory that has been paid for, but is not in the
To date, most trade receivable securitisations have possession of the customer.
used a borrowing-base concept. While the calcula-
♦ Legal criteria: In all rated trade receivables-
tion of the borrowing base has varied, most rated
backed transactions, the seller grants the issuer a
issues have calculated the borrowing base as net
security interest in the receivables, which is
eligible receivables, less reserves. Net eligible
perfected through the necessary legal filings.
receivables is defined as eligible receivables, minus
Receivables in which the issuer does not have a
excess concentrations. The rated instruments are
first-priority, perfected security interest should
then issued against the borrowing base. In this type
not be considered eligible.
of structure, investors are entitled to receive a
percentage of collections equal to the investor In a trade receivable transaction, the pool is screened
amount (including any reserves allocated to the on a periodic basis, and receivables that have
investor’s interest) over the borrowing base. The become high-risk are continually removed from the
approach is designed to properly allocate collections eligible pool. The investor is typically entitled to
to investors, as well as to ensure that stipulated receive a share of all collections. The investor’s share
reserves are maintained. This percentage is generally is calculated using the eligible pool as the denomina-
fixed upon the occurrence of an amortisation event. tor. As receivables become ineligible, the investor’s
A borrowing base deficiency usually will trigger an share of collections increases. In addition, if the pool
early amortisation, if not cured after a certain of eligible receivables falls below a specified level,
number of days. Also, no collections are released the transaction will enter early amortisation.
from the issuer if a borrowing-base deficiency exists. Collections on ineligible receivables remain in the
transactions and are allocated to the various classes
Eligibility Criteria of securities in the same way that collections arising
The eligibility criteria define the pool characteristics, from eligible receivables are allocated. As with early
and limit investor exposure to high-risk receivables. amortisation events, a strong set of eligibility criteria
There is typically a long list of eligibility require- will minimise credit enhancement levels.
ments relevant to each individual transaction.
Among the more common ones are: EVALUATING CREDIT RISKS
♦ Delinquent accounts: Borrowing-base calcula- Receivable Risks
tions typically exclude receivables once they The composition of a trade receivable pool and its
become past due beyond a specified delinquency inherent risks will differ depending on the origina-
category. tor’s industry and performance. When assessing the
♦ Excess concentrations: To limit investor exposure receivables, a number of factors must be reviewed.
to a default by a large obligor, most structures set
size limitations for individual obligors. Such
Obligor Default Risk
concentration limits are generally set on the basis Historic delinquency and write-off performance
of the credit rating of the obligor and the credit generally is the best indicator of portfolio credit
enhancement floor. quality. Most companies carry delinquent trade
♦ Unperformed service contracts: Receivables billed receivables far longer than a bank or finance
before completion of service or delivery of company would before writing them off. This can be
product are generally limited for two reasons. viewed as a positive because accounts are worked
First, obligors are less likely to pay for a service until collection opportunities are exhausted. How-
or product that has not been received. Second, ever, if charge-off policies are discretionary and
the receivable may be considered an executory subject to manipulation, it is difficult to determine
contract that could be rejected by the originator the value of delinquent receivables. For this reason,
on its insolvency. Standard & Poor’s focuses on analysing late-stage
delinquency categories as credit quality indicators.
♦ Bill and hold receivables: In these instances, the
Although the impact of a bankruptcy of the seller-
supplier sells the goods to the customer but holds
servicer is a major consideration in analysing a trade
the inventory until the customer needs it. In the
receivable pool, seller-servicer credit quality is not a
event of an insolvency of the supplier, the
major factor in the rating process. Standard &
customer may attempt to stop payment on

Standard & Poor’s 70

 Structured Finance Australia & New Zealand ¨ April 1999

Poor’s generally takes a weak-link approach and that it adjusts for changes in actual performance. As
assumes that the seller-servicer, if not rated as highly with credit support, dilution coverage is derived on
as the securitised issue, will, for purposes of the the basis of performance, dilution horizon, and
structured analysis, enter bankruptcy. Notwithstand- portfolio-specific stress factors.
ing the bankruptcy of the seller-servicer, the struc-
Obligor Risks
tured issue should survive.
Many trade receivable pools contain substantial
Standard & Poor’s has developed a framework for
obligor concentrations. For example, if a pool has a
rating transactions that uses dynamic credit en-
concentration to a particular obligor of 5%, and
hancement. The credit support analysis is driven by
that obligor were to become insolvent, the transac-
performance-based formulas tailored for the
tion could lose this entire amount. With short-term
portfolio’s specific risk profile.
receivables, obligor concentrations may increase
The formulas used to analyse credit support consist over time. It is therefore important that limits are
of three key variables: established to prevent any potential increase to
♦ Loss horizon, individual obligors. Limitations on industry concen-
♦ Credit quality indicator, and trations also may be required.
♦ Stress factor.
Seller Risks
DILUTIONS A basic assumption of Standard & Poor’s is that the
Standard & Poor’s uses the term dilution to refer to seller of the receivables will become insolvent,
any noncash reduction to a receivable balance that is (unless its rating is as high as the rating sought on
not attributable to default or write-off. Product the securities to be issued). This assumption gives
returns, cash discounts, advertising allowances, rise to a number of potential concerns, all of which
volume rebates, good customer programs, and must be addressed. These include:
standard pricing disputes are examples of dilution. Commingling: Trade receivable portfolios exhibit
Companies must grant dilutive credits to remain higher rates of payment and turnover than other
competitive. The level of dilution is driven by factors asset types, and as such, commingling risk takes on
such as industry practice and product complexity. significant importance. Since it is likely that the
Pools of trade receivables arising from the sale of seller of the receivables will continue to collect and
high technology and fashion goods, for example, remit cash periodically to the issuer from the
generally have higher dilutions than those arising receivable pool, the impact of, and potential inter-
from the sale of more commodity-type goods. ruptions to, cash flow must be assessed and any
Companies often use dilutions in the form of volume shortfalls covered. In most rated transactions, all
rebates to encourage additional sales. Also, dilutions collections on receivables are remitted to accounts
are almost always used to encourage prompt held in the name of the issuer, thus eliminating any
payment (for example, 2% discount if payment is potential commingling shortfalls.
received within 10 days of invoice). Servicing issues: In most trade receivable transac-
When analysing dilutive credits, Standard & Poor’s tions, the seller of the receivables also will act as
attempts to categorise dilutive items as either servicer. This is perhaps the most efficient way of
contractual or variable. Contractual items are those servicing a securitised portfolio. Nonetheless,
that can be easily quantified by assuming that all Standard & Poor’s requires that two features
obligors take advantage of the contract. For exam- relating to servicing be in place in each rated trade
ple, the obligors meet volume rebate targets and take receivable securitisation. First, there always must be
full advantage of early payment discounts. All other provisions for a substitute servicer if the seller-
dilution risks must be quantified by stressing historic servicer is unable to continue to service the portfolio
performance. As with obligor default risk, dilution or is relieved of its responsibilities as a result of a
risk can be significantly affected by a change in servicer default. This does not necessarily mean that
company philosophy or industry practice. In there has to be a live backup servicer. Factors
addition, certain types of dilution such as offsets are influencing the need for an on-line backup servicer
impossible to quantify as they do not follow an include:
historical pattern. These types of dilution must be ♦ The credit quality of the seller-servicer;
eliminated from a receivables pool through eligibility ♦ The adequacy of the seller’s systems; and
criteria and cannot be addressed through a dilution ♦ The industry and nature of the seller’s business.
reserve. Dynamic credit support often works best in

Standard & Poor’s 71

 Structured Finance Australia & New Zealand ¨ April 1999

Second, the fee to be paid to the substitute servicer liquidity facility equal to 100% of the face value of
should be stipulated in the transaction documents the notes to be provided by an appropriately rated
and be a sufficient amount to adequately financial institution. The liquidity facility should be
compensate a substitute servicer for its role, in the available to support the repayment of maturing
event that it has to take on servicing and collecting commercial paper in circumstances where the issuer
activities. is unable to reissue notes to fund performing assets.
Other concerns: Other concerns may include any
SPECIFIC PROBLEMS WITH CROSS-BORDER
potential liability of the issuer to pay stamp duty
PROGRAMS
upon a seller insolvency, where legal title to the
receivable is perfected. The following are two potential problematic areas in
cross-border trade receivable securitisations. A
DATA REQUIREMENTS number of solutions exist, and more are likely to be
Standard & Poor’s requires certain portfolio created to deal with these points in the future.
information prior to rating a transaction. Depending Hedging Strategy
on the characteristics of the transaction, the follow-
To the extent that securities issued are denominated
ing additional information may be required:
in a different currency than the receivables, a
♦ Monthly receivable balances (net of any credit
currency risk is created.
notes) for the past three years;
For Standard & Poor’s to assign strong investment-
♦ Monthly sales figures for the past three years;
grade ratings to the securities, any potential interest
♦ Monthly delinquency statistics for the past three
and currency mismatch must be assessed and
years with an explanation of the aging process; covered, either structurally or via some form of
♦ A summary of the payment terms offered and a credit enhancement. Standard & Poor’s will not rely
historical analysis of the percentage of the on the best efforts or normal policies of a program
receivable pool subject to a particular payment manager to cover these exposures. A specific
term; hedging strategy must be put in place.
♦ Monthly dilution figures for the past three years;
To the extent that swaps, foreign exchange agree-
♦ Historical DSO variance analysis; ments and other hedging instruments are used in a
♦ An analysis of the top customer concentrations; structure, the counterparty to the agreement must be
and sufficiently rated. For example, if ‘A-1+’ commercial
♦ A sampling of credit memos to estimate the paper is being issued, any swap or foreign exchange
length of the dilution horizon. counterparty will require an ‘A-1+’ rating.
If the information provided is insufficient, Standard A review of management and procedural controls
& Poor’s will work with the available data and also will be undertaken to ensure that any proposed
make conservative assumptions where gaps exist. In hedging strategy is implemented as described in the
some cases, this may lead to higher credit support transaction documentation. It is essential that the
levels until adequate portfolio data is available. individuals executing the various hedges understand
the terms under which they operate.
SURVEILLANCE
Legal Analysis And Complexity
Once the transaction has been rated, the issuer is
required to submit monthly surveillance reports A separate legal analysis must be undertaken for
containing prespecified information. Standard & each jurisdiction involved in a transaction. The same
Poor’s Structured Finance Ratings group maintains basic analysis and assumptions must be made for
surveillance on all rated transactions, to ensure the each jurisdiction, for example, regarding true sale of
rating continues to reflect the ongoing performance the assets, effects of originator insolvency, and the
and structure of the transaction. tax position of the transaction. Answers to problems
in one jurisdiction will not necessarily solve the same
TRADE RECEIVABLE—SUPPORTED or similar problems in another.
COMMERCIAL PAPER
In circumstances where a portfolio of trade receiva-
bles is to be financed through the issue of commer-
cial paper notes, Standard & Poor’s requires a

Standard & Poor’s 72

 Structured Finance Australia & New Zealand ¨ April 1999

Structural Issues And Legal Criteria

Australian Interest Rate Criteria risk has been addressed by generally assuming a
fixed spread between the two rates for the term of
For Structured Finance Ratings the transaction, which is imprecise, as spreads will
move over time.
INTRODUCTION
The new model may also be used for sizing the
Standard & Poor’s has developed a new, sophisti- interest rate risk where the assets have a floating
cated modelling approach for sizing the interest rate rate, while the liabilities have a fixed rate, or vice
spread risk in structured finance transactions. The versa, resulting in negative carry in the structured
new approach simulates interest rate vectors via finance transactions. Negative carry risk arises when
Markov Chain Monte Carlo techniques overlaid the pay-off value of the assets is insufficient to cover
onto the auto-regressive model, and governs the principal, plus interest on the liabilities. Standard &
simulation via probability-transition matrices for the Poor’s needs to size this risk and ensure the transac-
volatility assumptions and interest rate levels. While tion provides reserves to cover such a shortfall.
the new modelling approach allows for a recurrence Potential shortfalls resulting from negative carry risk
of the highly volatile periods, it avoids overstating are found in transactions with noninterest-bearing
the variance by appropriately weighting these assets paying interest-bearing liabilities such as trade
scenarios by the likelihood of their occurrence. (For receivables transactions; transactions with fixed-rate
details of the new model, refer to “Interest Rate assets and floating-rate liabilities; or transactions
Criteria for Structured Finance Research Report, with floating-rate assets and fixed-rate liabilities. In
December 1998. Parisi, F., Standard & Poor’s each case, a shortfall arises with either an increase or
Ratings Services”.) decrease in interest rates.
INTEREST RATE RISK RESULTS
Interest rate spread risk occurs when either the Australian interest rate data from October 1986 to
assets underlying a transaction, or the securities July 1998 has been included in developing the new
issued, or both, have floating rates. The changing interest rate assumptions in Australia. These new
spread between the two rates may cause shortfalls in interest rate assumptions will be used in sizing
the cash flow needed to pay the bonds. To date, this reserves for cash flow short falls, carry costs, and

Table 1 Example Of Simulation Outcome

90-day Bank Bill (AUS)
Month AAA AAA AA AA A A BBB BBB NIG NIG
High Low High Low High Low High Low High Low
1/11/98 6.09 4.78 5.87 4.79 5.83 4.79 5.8 4.79 5.72 4.81
1/12/98 6.23 4.78 6.1 4.79 6.07 4.79 5.91 4.79 5.8 4.8
1/01/99 6.21 4.78 6.13 4.78 6.03 4.79 5.9 4.79 5.78 4.8
… … … … … … … … … … …
… … … … … … … … … … …
1/08/01 8.15 4.78 7.83 4.79 7.62 4.79 7.49 4.8 7.14 4.82
1/09/01 8.53 4.78 8.05 4.79 7.65 4.79 7.44 4.79 7.16 4.81
1/10/01 8.53 4.78 7.8 4.79 7.7 4.79 7.5 4.8 7.19 4.82
30-day Bank Bill (AUS)
1/11/98 6.094 4.783 5.874 4.793 5.834 4.793 5.804 4.793 5.723 4.813
1/12/98 6.43 4.979 6.3 4.989 6.27 4.989 6.11 4.989 5.999 4.999
1/01/99 6.412 4.981 6.332 4.981 6.232 4.991 6.102 4.991 5.981 5.001
… … … … … … … … … … …
… … … … … … … … … … …
1/08/01 7.969 4.937 7.648 4.927 7.438 4.927 7.308 4.917 6.958 4.897
1/09/01 8.573 4.82 8.093 4.83 7.692 4.83 7.482 4.83 7.202 4.85
1/10/01 8.485 4.801 7.754 4.791 7.654 4.791 7.454 4.781 7.143 4.771
NIG—Noninvestment grade.

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 Structured Finance Australia & New Zealand ¨ April 1999

Table 2 Sample Fixed-Spread Analysis: 90-Day BBSW (AUS) To 30-Day BBSW (AUS) (%)
Month range AAA Spread AA Spread A Spread BBB Spread NIG Spread
1 to 36 (0.07) (0.07) (0.06) (0.06) (0.05)
37 to 72 (0.07) (0.06) (0.06) (0.06) (0.05)
73 to 108 (0.09) (0.09) (0.08) (0.08) (0.07)
109 to 144 (0.07) (0.06) (0.06) (0.05) (0.04)
145 to 180 (0.08) (0.08) (0.07) (0.07) (0.06)
181 to 216 (0.07) (0.06) (0.06) (0.06) (0.04)
217 to 252 (0.04) (0.03) (0.03) (0.02) (0.00)
253 to 288 (0.07) (0.07) (0.06) (0.06) (0.04)
289 to 324 (0.07) (0.07) (0.07) (0.06) (0.05)
325 to 360 (0.11) (0.10) (0.10) (0.09) (0.08)
Fixed Spread (0.07) (0.07) (0.07) (0.06) (0.05)
NIG—Noninvestment grade. Figures in brackets are negative numbers.

any other interest rate risks. The Australian 90-day For the first three years of a 30-year transaction, for
bank bill swap rate (BBSW) is used as the bench- example, the assumed ‘AAA’ spread would be
mark, and all other Australian rates are modelled negative 0.07%; for the next three years, negative
against it. Benchmarking ensures consistent results 0.07%, and so on. However, if only one fixed
across the spectrum of rates and avoids unrealistic spread was used for the whole cash flow analysis,
inversions. the spread would be negative 0.07% for the full 30
For each rating category, two paths from the years.
simulations are used, representing a low-rate and a The fixed spreads displayed in the final row of the
high-rate scenario. For higher ratings, simulated table are simply the averages over different horizons
paths closer to the extremes are used. of the simulation results. For example, the 30-year
Suppose in a transaction that the rate on the fixed spread is the average of the 10 three-year
securities is based on the 30-day BBSW and the rate averages from months one to 36 through to months
on the assets is based on the 90-day BBSW and the 325 to 360 for the 30 years. The fixed spread
term is six years. The simulation illustrates monthly calculation weights the earliest years more heavily
high and low interest rates for different rating than the later years.
categories over the term of the transaction (see table Where one of the interest rates is fixed, the fixed-
1). These results would then be used in a cash flow rate spread is the average spread between the fixed
model to size for basis risk. In another scenario, rate and the floating rate simulated for the term of
where one of the rates is fixed for the term of the the transaction.
transaction, then this fixed rate would be applied for
the term of the transaction to size the fixed to RESET RISK AND INTEREST RATE EXTREMES
floating rate spread. In addition to the interest rate spread risk addressed
either through simulations or fixed spreads, there
FIXED SPREADS are other applications that may require custom
Not all issuers and bankers can use the vectors analysis of historical interest rates. In some transac-
created by the simulation in their modelling. tions, the risk is that the rate on the liabilities resets
Therefore, the simulation results are used to deter- at different times than the underlying assets. The
mine a fixed spread for various horizons. Generally, analysis hinges on the likelihood of the rates
using a fixed spread rather than the simulated inverting over rolling fixed-length windows, and it
interest rate vectors will result in more stressful cash estimates the expected interest rate shortfall that
flow tests. An example of three-year average spreads could occur. In other cases, the likelihood of
for 90-day BBSW (assets) versus 30-day BBSW exceeding some upper or lower limit may be of
(liabilities) appears in table 2. interest. (See Parisi, 1998 for detail.)

Standard & Poor’s 74

 Structured Finance Australia & New Zealand ¨ April 1999

Commingling Risk Collections should be transferred within five days

of receipt if the amounts held by the servicer
Standard & Poor’s assesses the cash flow character- along with amounts held by the SPE in other
istics of the underlying assets and the creditworthi- ‘A-1’ authorised investments exceeds 20% of the
ness of the servicer (if collections are received into outstanding balance of rated securities;
the servicer’s accounts and not directly into an
♦ Unless collections on the assets are concentrated
account of the trustee in trust structures or an
at certain times of the month, for a period of up
account in the name of the special-purpose entity
to two business days after receipt, any servicer,
(SPE) in company structures) to determine the
whether or not rated, may keep collections on the
appropriate approach in adequately protecting rated
assets in any account of the servicer’s choice,
security holders from commingling risk at a given
commingled with other money of the servicer or
rating level. The risk is that if a servicer becomes
of any other entity. Before the end of the two-
insolvent, the transfer of amounts held in the
business-day period, the collections on the assets
servicer’s own accounts to the SPE account may be
should be deposited into an “eligible deposit
delayed and possibly unavailable to the SPE. This
account”. The amount of commingling risk
risk is assessed by looking to both the rating of the
present over this two-day period is considered by
servicer and the amount of funds likely to be held in
Standard & Poor’s when analysing the credit
a servicer account at any given time.
risks asssociated with the transaction; and
In a ‘AAA’ rated transaction: ♦ If collections on the assets are concentrated at
♦ If the servicer has a short-term rating of ‘A-1+’, certain times within a month, a servicer rated
any collections that the SPE is entitled to receive below ‘A-1’ should not keep/commingle collec-
should be paid to the SPE collection account in tions on the assets even for a two business day
time for the issuer to make payments to security period. Rather, to prevent a potentially significant
holders on the payment date, that is, no later loss on the assets, either additional credit support
than the distribution date in immediately avail- should be provided to cover commingling risk, or
able funds; obligors should be instructed to make payments
♦ If the servicer has a short term rating of ‘A-1’, directly to the SPE account.
any collections should be forwarded to the SPE
collection account within 30 days of receipt.

Standard & Poor’s 75

 Structured Finance Australia & New Zealand ¨ April 1999

Criteria For Australian Issuers Of ♦ For each series, the underlying assets should be
acquired in a true sale transaction from an
Segregated Series Of Debt unaffiliated seller.
This article outlines criteria for program issuers in ♦ Each swap transaction entered into by the issuer
Australia who would like to issue segregated series for a series should be separate from any other
of debt; each series of which is secured by separate swap transaction entered into for other series,
assets and which may have a different rating. A and should comply with Standard & Poor’s swap
program issuer issues multiple series of securities agreement criteria.
under documentation that has been established in Criteria Relating To Charges And Limitations On
form for each series. Creditors’ Rights
Standard & Poor’s has rated multiple series of ♦ A first-priority fixed charge over the assets of
securities by program issuers in Australia, but has each series should be granted by the issuer to a
usually required that each series by the same issuer security trustee for the benefit of secured credi-
have the same rating. This rating limitation reflects tors of that particular series.
Standard & Poor’s traditional view that allowing ♦ The documentation, including the notes, should
“segregated” series to be backed by assets of contain the following limited recourse provisions
different credit quality, with the resulting split which should be upheld upon the insolvency of
ratings, may provide too great an incentive for the issuer:
holders of a defaulted series, or other parties, to
- For each series, the noteholders and any other
attempt to reach the issuer’s other assets, particu-
secured creditors should agree to look only to
larly those of higher credit quality, by taking actions
the underlying assets charged as security for
that may result in the issuer’s bankruptcy.
the series and not to have recourse to any
Standard & Poor’s has reviewed and revised its other assets of the issuer for satisfaction of the
bankruptcy-remoteness criteria to determine under issuer’s obligations under the related notes.
what circumstances an Australian issuer is still a - If the issuer were to default on its obligations
bankruptcy-remote entity, even though it may issue with respect to a series, only the security
segregated series of differently rated securities. The trustee, on behalf and to the exclusion of the
revised criteria are summarised in the next section related noteholders, should be entitled to
and discussed in greater detail in the following exercise the remedies provided under the
sections. security trust deed.
Additional issues may arise in connection with - For each series, the noteholders should have
Standard & Poor’s review of a particular program claims against the issuer only to the extent that
that may result in further requirements and support- the related underlying assets are available to
ing legal opinions. satisfy the issuer’s obligations under the notes.
Any difference between the amount realised
SUMMARY CRITERIA
upon enforcement of the fixed charge over the
Criteria Relating To The Issuer’s Structure underlying assets and the amount the issuer
♦ The program issuer should be a limited-purpose, otherwise would have been obligated to pay
orphan subsidiary or special-purpose trust. under the related notes should not constitute a
♦ The issuer should be structured so that it will not claim against the issuer.
have taxable income, or will have enough cash - The noteholders, all transaction participants,
flow or other financial resources to meet any tax including swap, liquidity, or credit support
liability to a degree that is consistent with the providers, and any other secured creditors
issuer’s highest rated debt. should agree not to petition for the insolvency
of the issuer.
Criteria Relating To Separation Of Series And
♦ Legal opinions should be delivered by counsel to
Segregation Of Assets
the effect that the limited recourse language is
♦ The issuer should issue separate series of debt
enforceable when the issuer is insolvent.
obligations, with the assets that support each
♦ The issuer should agree to Standard & Poor’s
series being unambiguously identified and held
reviewing, and maintaining surveillance of, each
separately from assets relating to other series.
series, whether or not rated by Standard &
Poor’s.

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 Structured Finance Australia & New Zealand ¨ April 1999

THE ISSUER’S STRUCTURE Elimination Or Coverage Of Tax Liability

Corporate/Trust Organisation The issuer’s exposure to potential liabilities to
preferred creditors, or liabilities to creditors, (such
The issuer should be an orphan subsidiary or a
as the tax authority, who are not subject to limited
special-purpose trust. An orphan subsidiary is a
recourse provisions) should be minimised.
special-purpose corporation whose shares are owned
by a third party which is independent of the origina- The exposure of the issuer to claims of preferred
tor of the assets. A properly organised orphan creditors and the risk that it would be subject to
subsidiary is also separate from the originator for preferred employment-related claims, environmental
accounting purposes. The orphan subsidiary’s shares liabilities, or other similar public interest claims, that
often are held by a trust for the benefit of a charity, often would rank prior to the issuer’s obligations to
foundation, or similar entity. its noteholders, is greatly reduced by strictly limiting
the structure, activities, and operations of the issuer.
The special-purpose trust structure commonly used
These limitations are reflected in Standard & Poor’s
in Australian securitisation transactions also is an
criteria for special-purpose entities.
effective way to separate the assets of the originator
from the issuer of the debt. In this structure, a third It also is necessary to eliminate or cover any expo-
party trustee company is appointed to hold the sure of the issuer to creditors who are not subject to
assets and issue the debt. limited recourse provisions. As discussed in the
section below titled “Charges and Limitations on
For a program issuer with differently rated series of
Creditors’ Rights”, in order for the issuer to issue
notes, each backed by assets with different
differently rated series of debt, each of its creditors
likelihoods of default, Standard & Poor’s believes
must expressly agree to limit their recourse to
that the orphan subsidiary or special-purpose trust
certain assets of the issuer. However, it will be
structure reduces the risk of a voluntary or involun-
impossible to subject certain creditors of the issuer,
tary bankruptcy or insolvency proceeding related to
such as the tax authority in Australia, to a limited
the issuer. If a lower-rated series defaults while the
recourse position.
higher-rated series is performing, an operating
company parent may direct the issuer to commence If the issuer is unable to pay a tax liability in
a bankruptcy or insolvency proceeding or to take connection with one series, the tax claim could be
similar actions under applicable law to protect the asserted against the issuer without regard to the
parent’s economic interest in the issuer. Similarly, separation of assets for each series. For example, the
creditors and others with claims against a poorly tax liability could arise because of the
performing or defaulting parent may have an recharacterisation of income received on the under-
incentive to attempt to penetrate the corporate lying securities or other assets of the issuer or the
structure to reach the issuer’s assets. failure of the entity to achieve a tax “neutral” status.
For program issuers with multiple series of debt
The seller of the underlying securities should not
with different ratings, where the likelihood of
have an equity interest in the program issuer. This
default for the various series differs, a tax liability
limitation is intended to avoid the incentive that the
could equally affect each series. As a consequence,
seller, as owner, may have to cause the issuer to
the structure would violate Standard & Poor’s
commence a bankruptcy or insolvency proceeding or
supporting ratings criteria, which otherwise would
to take other actions to protect the seller’s interest in
require that each series be rated to reflect the highest
the issuer as a financing vehicle.
likelihood of default among the various series.
Although an attempt to reach the issuer’s assets may
The risk associated with the potential tax liability of
not ultimately succeed, it may prevent timely
a segregated issuer is difficult to mitigate. Generally,
payments in full of amounts due to the holders of
in order to mitigate this risk, the issuer should be
performing series of notes. The suggested structures,
organised in a jurisdiction that has no corporate or
by separating the ownership interest from the power
other applicable taxes, or should have received a
to direct the issuer’s activities and by separating the
specific tax ruling to that effect from the appropriate
issuer from the economic interests of an operating
tax authorities.
company parent, reduces these risks.
In Australia, unlike many other jurisdictions, the tax
Each of these types of entities also should comply
authority is not a preferred creditor, nor does it
with Standard & Poor’s special-purpose entity
become a secured creditor of the issuer with respect
criteria. (See Special-Purpose Entities criteria on
to the issuer’s tax liability. The incentive for the
page 94.)

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 Structured Finance Australia & New Zealand ¨ April 1999

Australian tax authority to take action against the any other sort of revaluation that may result in a
issuer is reduced because it stands behind the tax gain. For example, are there any circum-
secured creditors of the issuer in an insolvency. stances pursuant to Australian tax law in which a
Therefore, it is possible for Standard & Poor’s to tax gain could be recognised without cash
take a different approach to the potential tax actually being received by the issuer?; and
liability of segregated issuers in Australia. ♦ A draft tax neutrality opinion and discussion of
The first step in addressing the risk is a detailed the potential tax liability of the issuer if any of
analysis of the tax position of the issuer and each the characterisations relied on in the opinion are
proposed new issue. This analysis is undertaken by incorrect.
Standard & Poor’s based on information and Separation Of Series And Segregation Of Assets
assistance provided by the issuer and its tax advi-
Effective charges and limitations on creditors’ rights
sors. Based on this analysis, it may be possible to
are fundamental to Standard & Poor’s analysis of
identify and quantify potential tax liabilities that
the incentives for noteholders and other creditors to
could result because of, for example,
take action against the issuer that might result in its
recharacterisation of income or a timing mismatch
insolvency or bankruptcy. Both charges and limita-
between accrued income and expenses/deductions. If
tions on creditors’ rights depend on the unambigu-
these potential tax liabilities are sized into the cash
ous identification of the assets and obligations of the
flows or otherwise covered to a level consistent with
issuer that are the subject of the interests and
the issuer’s highest rated debt, then it may be
limitations. Imprecise identification or commingling
possible for Standard & Poor’s to consider the issuer
of the issuer’s assets may result in a determination
to be bankruptcy-remote.
that the assets are not amenable to segregation by
Another potential method to mitigate the risk of tax series for purposes of the exercise of remedies. This
liability for a segregated issuer, without sizing extra determination could lead to the satisfaction of
support, is to structure the issuer to be tax “neu- claims relating to one series from assets that were
tral”. Both trust and corporate issuers in expected to be available only to satisfy the issuer’s
securitisation programs in Australia typically are obligations relating to another series.
structured this way, meaning that the issuer expects,
Similarly, if any of the issuer’s secured obligations
and receives legal opinions to the effect that, its
are stated generally, such as the payment of fees and
revenue will be offset by an equal amount of
expenses, and not on a series-by-series basis, the
deductions or exemptions.
issuer’s failure to fulfill its obligations relating to one
In order to assess the situation for each proposed series may entitle the trustee or the noteholders of
issuer, the issuer’s legal and tax advisors should other series to exercise remedies. This would result
provide the following analysis: in the same likelihood of default for each series.
♦ Identification of creditors of the issuer who are
The unambiguous identification of the assets and
not subject to limited recourse/nonpetition
obligations of the issuer on a series-by-series basis is
language. (For example, state and federal tax
also essential from the perspective of limitations on
authorities, advisors to the issuer, preferred
creditors’ rights. If a creditor purportedly has agreed
creditors pursuant to legislation);
to look only to specified assets for satisfaction of its
♦ Discussion of the nature of the interest that such
claims, but the assets have been imprecisely identi-
creditors would have over the assets of the issuer fied or commingled to the extent that the subject
relative to the holders of the rated debt. What assets cannot be segregated from other assets of the
recourse would these creditors have to enforce issuer, then it may be determined that the creditor
that interest, or, alternatively, do the holders of has not effectively agreed to the limitation. The
the rated debt have any way under Australian law creditor would then have an incentive to attempt to
to prevent these creditors from liquidating the recover against the issuer’s assets generally in an
assets of the issuer?; insolvency, bankruptcy, or liquidation proceeding.
♦ Indication of the manner in which any liability
The following criteria first address separation of
(income tax, capital gains tax, employee claims)
series and segregation of assets. They then address
to such creditors is mitigated or neutralised in the
effective charges and limitations on creditor’s rights.
structure;
♦ Identification of circumstances in which the
vehicle could incur a tax liability upon the
liquidation of the assets of one series, or upon

Standard & Poor’s 78

 Structured Finance Australia & New Zealand ¨ April 1999

Separate Series assets for any other series. The issuer’s records
The issuer should issue separate series of debt should include separate accounts to which the assets
obligations. The obligations of the issuer and the will be credited, clearly identifying the assets and the
related underlying assets should be unambiguously related series. The books and accounts of the trustee
identified on a series-by-series basis on the face of and any custodian to which the assets will be
the documents. credited should include separate entries clearly
identifying the assets, the related series, and the
For purposes of documentation, the clearest and
capacity in which the party is acting. Subaccounts
preferred case of separate series secured by separate
within a trust account on the books of the trustee or
underlying assets would be a new set of documents
custodian may be acceptable if the arrangement is
for each series, with no cross references of any kind
consistent with the creation of fixed charges over
to any other series or documents. The form of
those assets.
documents would be established when the issuer is
organised and would be reproduced for each new Segregation of the assets, and the unambiguous
series with information specific to the new series and identification of the assets and the obligations of the
the related underlying assets. Typically, the program issuer that are secured by those assets in the docu-
issuer enters into agreements with the same parties ments, are intended to ensure that in the event of the
for each series and the parties seek to reduce the issuer’s default on any of its obligations it would be
volume of documents. Often this reduction takes the clear which assets of the issuer would be available
form of standard terms and conditions that are for the exercise of remedies relating to that obliga-
incorporated into documents for each series or tion in any enforcement action or proceeding. These
master agreements that are supplemented for each provisions also are intended to ensure that, in any
series. enforcement action or proceedings, the related
noteholders’ agreement to look only to those assets
Standard & Poor’s reviews the program issuer’s
of the issuer to satisfy the obligation should be
documents to determine whether the obligations of
upheld by a court even in the insolvency of the
the issuer and the related underlying assets are
issuer.
unambiguously identified and segregated on a series-
by-series basis. Areas of particular concern include Acquisition Of Assets By True Sale
the granting of charges over the series’ assets, the Standard & Poor’s criteria requires that the transfer
remedies that can be exercised upon default, and the of the underlying securities to the issuer from any
payment of fees and expenses, including enforce- entity whose creditworthiness will not be reflected in
ment expenses. Agreements by the issuer to indem- the rating must be a true sale. In certain circum-
nify other parties in the transaction also are stances, an apparent sale could be recharacterised as
problematic because the issuer will not have an a loan from the issuer to the seller secured by a
uncommitted source of revenue to fund these pledge of the underlying securities to the issuer.
indemnities. Consequently, in an insolvency of the seller, the
If master documents are used, Standard & Poor’s underlying securities and related proceeds may be
may request an additional opinion to the effect that treated as property of the seller and applied to pay
the legality, validity, and binding effect and enforce- the seller’s creditors. See Standard & Poor’s “Legal
ability of the obligations of the parties to the Opinions—Overview of Rating Requirements” on
documents for a series of notes would not be page 87 for a discussion of opinions that may be
affected by the illegality, invalidity, or lack of requested regarding true sale, preference, and other
binding effect or enforceability of the obligations of similar concepts under applicable local law.
any of the parties to the documents for any other If underlying assets are securities, they may be
series of notes. When a series is issued in accordance certificated securities or uncertificated securities. In
with master documents, the legal opinions should either case, the underlying securities must be held in
address the enforceability of the master documents a form and in a system under which a first priority,
as well as the documents for the specific series. fixed charge, or its equivalent, may be created.
Segregation Of Assets Separate Swap Transaction
The underlying assets, including any proceeds from Any swap transaction entered into by the issuer for a
these assets, should be held separately on a series-by- series should be separate from any other swap
series basis and not commingled with the underlying transaction for any other series. If the swap for one
series will, by its terms, be affected by events

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 Structured Finance Australia & New Zealand ¨ April 1999

affecting the swap for another series, then each any unsecured creditors of the issuer would have
series will become a supporting rating for the other little to gain by commencing proceedings against the
and would have the same rating. Cross-defaults, issuer.
cross-termination events, and the netting of pay- The issuer’s cash flows should be structured so that
ments among swap transactions are some of the there are, in effect, no uncommitted revenues or
provisions that would result in the conclusion that excess cash flows that could provide an incentive for
the swaps are not separate. noteholders or other creditors to attempt to reach
For purposes of documentation, the clearest case of such amounts through insolvency proceedings.
separate swap transactions would be a separate The series should not be cross-collateralised or
master agreement, including the schedule and cross-defaulted with other series, because this would
confirmation, for each series. The program issuer, result in each series becoming a supporting rating
however, typically enters into a swap with the same for the others, and be inconsistent with different
counterparty for each series and the parties seek to ratings for each series. Although there are collateral
reduce paperwork. So long as the legal effect is to structures in which common collateral, intercreditor
create separate agreements, other documentation agreements, and internal credit support may result in
may be acceptable. If properly drafted, a master an issuer having various securities that are rated
swap agreement and schedule with separate confir- differently by Standard & Poor’s, this article is only
mations may be acceptable. For example, a separate addressing the circumstances under which Standard
confirmation for each series may incorporate the & Poor’s may conclude that a program issuer of
standard terms of a master agreement, while deleting separately secured series of securities could be a
provisions in the master agreement such as netting, bankruptcy-remote entity.
and expressly providing that one transaction is to be
Standard & Poor’s ratings address the full and
created.
timely payment of the rated obligations. If an
(See “Swaps and Structured Finance” on page 97 for insolvency or administration proceeding is com-
further discussion of swap agreement criteria.) menced, then the timeliness of payments to
noteholders may be affected. The effectiveness of the
CHARGES AND LIMITATIONS ON CREDITORS’
fixed charges discussed above must be analysed in
RIGHTS
light of the provisions of Australia’s corporate
Charges insolvency legislation, which may affect the enforce-
A first priority fixed charge should be created over ment of these charges. The effect of a stay itself may
all of the underlying assets on a series-by-series basis provide sufficient benefits for a noteholder or other
and should be enforceable even in the issuer’s creditor to commence proceedings, frustrating the
insolvency. effect of the first priority fixed charge in Standard &
Poor’s analysis of incentives.
This criterion is central to Standard & Poor’s view
that the incentives would be reduced for creditors of In Australia, secured creditors are protected from
the issuer to commence bankruptcy or insolvency the stay provisions that may apply to an issuer in a
proceedings in the event of a default by the issuer on winding up or administration. The type of charge
its obligations. The noteholders of each series would that provides protection from the stay provision
have the first claim on the related underlying assets varies, depending on whether the action against the
upon the enforcement of their security. A corollary issuer is for winding up, or for administration.
to this statement is that no noteholders of another In the case of a winding up, the stay will not affect
series would have a first claim to those underlying the ability of any secured creditor to enforce its
assets. If, even when the issuer is subject to insol- charge, hence the requirement that the security
vency, bankruptcy, or liquidation proceedings, little trustee must hold a valid charge over the assets for
could be gained by the noteholders of any series in the particular series.
addition to realising their security over the assets In the case of an administration proceeding, the stay
relating to their series, then the noteholders’ incen- will not affect the rights of a secured creditor with a
tive to commence such proceedings would be charge over all, or substantially all, of the assets of
reduced. Similarly, if all of the issuer’s assets are the issuer. Therefore, to avoid the administration
subject to first priority fixed charges that would be stay provisions, the transaction should be structured
effective even when the issuer is subject to insol- to make sure the security trustee holds a charge that
vency, bankruptcy, or liquidation proceedings, then

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 Structured Finance Australia & New Zealand ¨ April 1999

meets the standards outlined in the administration Even if the attempt to reach the issuer’s other assets
legislation. does not ultimately succeed because of the first
Standard & Poor’s request opinions addressing the priority fixed charges granted to a security trustee
creation, perfection, priority, and effectiveness of the for the benefit of the other noteholders, it may
stated charges in the underlying assets for each series prevent timely payments of amounts due to the
in both the winding up and administration of the other noteholders. Standard & Poor’s generally
issuer. The opinion should specifically address the requires an agreement by the program issuer to
effectiveness of the charges with respect to the stay include limited recourse provisions for all secured
provisions in the legislation. parties in every series it issues, including any unrated
series.
In many jurisdictions, the actions that should be
♦ For each series, the related noteholders and other
taken to enable counsel to deliver opinions that
satisfy the criteria regarding interests in the underly- secured parties, including the swap counterparty,
ing securities will depend on whether they are if any, and the trustee, should agree to look only
certificated or uncertificated securities. See Standard to the underlying assets securing that series and
& Poor’s “Global Synthetic Securities Criteria” for not to have recourse to any other assets of the
discussions of criteria applicable to different forms issuer for satisfaction of the issuer’s obligations
and systems in which the securities may be held. under the related notes.
Standard & Poor’s believes that rated certificated ♦ Standard & Poor’s may request an opinion to the
securities held in physical form and rated certificated effect that, as a result of the limited recourse
or uncertificated securities held through major provisions, a court would not uphold the claim of
clearing houses or exchanges, in each case where the the noteholders of a series that any other assets of
charge granted over the assets would be effective the issuer would be available to them following
notwithstanding the issuer’s insolvency, would be realisation over the assets securing their series,
suitable assets for multiple series program issuers even if the issuer is subject to an insolvency,
with differently rated series. bankruptcy, or liquidation proceeding.
♦ For each series, only the trustee should be entitled
Although Standard & Poor’s currently has not
concluded that other types of assets such as mort- to exercise remedies on behalf of the noteholders.
gages and receivables are suitable assets for program ♦ Limiting the exercise of remedies to the trustee
issuers with differently rated series, Standard & should reduce the risk that a noteholder, by
Poor’s will review the suitability of other types of mistake or deliberately, will seek to enforce its
assets for these program issuers. If the assets are rights in a manner that is inconsistent with the
deemed to be inappropriate or too complicated to be segregation of assets among the series and the
held directly by the issuer, a structure in which a restrictions on creditors’ rights, including the
separate special-purpose trust or corporation holds limited recourse provisions.
the asset and sells a secured debt instrument to the ♦ Any difference between the amount realised from
issuer may be acceptable. Issuers and arrangers are the underlying assets upon enforcement of the
encouraged to contact Standard & Poor’s early in security and the amount that otherwise would
the process of establishing any program for which have been due under the related series of notes
ratings will be requested to discuss the proposed should not constitute a claim against the issuer.
underlying assets. ♦ The noteholders of each series agree to look only
to the related underlying assets for satisfaction of
LIMITED RECOURSE PROVISIONS the issuer’s obligations to them. Upon default and
Each series of notes should include limited recourse the enforcement of the charge over the related
provisions that would be upheld even in the issuer’s underlying assets, the amount realised should
insolvency. If any series is issued without effective constitute a complete discharge of the issuer’s
limited recourse provisions, the noteholders of that obligations to the related noteholders. If the
series may be entitled to satisfy the issuer’s obliga- noteholders are unable to assert claims for any
tions to them from any of the issuer’s assets. In the further amounts upon realisation of the underly-
event of a default, this would provide a significant ing assets, there will be no claim to provide a
incentive for these noteholders to commence basis for a proceeding for further recovery against
bankruptcy or insolvency proceedings or to take any other assets of the issuer. In addition, there
other actions to attempt to reach the issuer’s assets will be no basis for a proceeding against the
that secure other series. issuer on the grounds that it is insolvent. It is

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 Structured Finance Australia & New Zealand ¨ April 1999

important that such claims do not arise, which REVIEW AND SURVEILLANCE OF ALL SERIES—
avoids technical insolvency, because the directors RATED OR UNRATED
may have a fiduciary duty to take actions, Each program issuer should agree to provide for the
including filing an insolvency petition, if the review and surveillance by Standard & Poor’s of
issuer is technically insolvent. In addition, other each series it issues.
creditors may seek to file against the issuer if it is
The effectiveness of the collateral and legal structure
technically insolvent. Standard & Poor’s usually
of the issuer to reduce the incentives for parties to
requests an opinion of counsel to the effect that
initiate a bankruptcy or insolvency proceeding
this provision would be upheld by a court even if
against the issuer, depend on the effectiveness of the
the issuer is subject to an insolvency, bankruptcy,
documents for each series issued, including any
or liquidation proceeding.
unrated series, to separate the series, segregate the
♦ The noteholders, all transaction participants, and
underlying assets, create effective security arrange-
any creditors, should agree not to file a bank- ments, and limit creditor’s rights, even in an insol-
ruptcy or insolvency petition against the issuer. vency of the issuer. If the documents for any series
♦ The noteholders should agree not to file a are ineffective to do so, or if a new issue affects the
petition or to take any other action for the tax position of the issuer, Standard & Poor’s will be
bankruptcy, insolvency, or liquidation of the unable to conclude that the issuer continues to be a
issuer. Standard and Poor’s will request an bankruptcy-remote entity. In that event, the out-
opinion to the effect that this agreement is standing series should be rated the same as the series
enforceable. Similarly, all transaction partici- with the greatest likelihood of default. The severity
pants, including any swap counterparty or credit of this result has prompted Standard & Poor’s to
support provider, and any subsequent creditors of require that each program issuer provide for the
the issuer should agree not to file a petition or review and surveillance by Standard & Poor’s of
take any such action until after all of the issuer’s each series it issues, to enable ratings confirmation
rated obligations have been satisfied, including for any outstanding rated series.
any preference period.
CONCLUSION
It is important that the noteholders have notice of
the limited recourse provisions. These provisions If a program issuer of multiple series of separately
should be included on any notes or global securities secured debt securities complies with the criteria
in the transaction documentation, including the outlined in this article, it is possible for Standard &
information memorandum. If the notes are traded Poor’s to conclude that the issuer is a bankruptcy-
on an electronic medium such as Austraclear, the remote entity even though the underlying assets
limited recourse provisions should be included in the relating to the respective series may be of different
trading screens for the notes. Counsel delivering the credit quality and each series may carry different
legal opinion for the transaction will need to credit ratings, or be unrated.
ascertain that procedures are in place to enable the
delivery of an unqualified opinion that the
noteholders are subject to the limited recourse
provisions.

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 Structured Finance Australia & New Zealand ¨ April 1999

Due Diligence Review ♦ Dilution review, including a detailed description

of the causes of dilution and any reserves estab-
A due diligence meeting between Standard & Poor’s lished for dilution (supported by appropriate
and the originator and servicer provides the oppor- documentation);
tunity to meet with the executives responsible for the
♦ Dilution/delinquency horizon analysis in both an
generation and servicing of the assets and to physi-
anecdotal and statistical manner;
cally review the operations of the originator.
♦ Cash management policies and procedures;
Prior to the due diligence meeting, the banker or ♦ Document and file maintenance procedures;
issuer should prepare a preliminary information
♦ Review of loan and security file systems;
memorandum outlining the proposed transaction,
♦ Concentrations and management of concentra-
information about the seller, the seller’s business and
tions;
industry, audited financial statements and annual
reports, and portfolio information. The main topics ♦ Marketing materials used by the servicer to
for discussion generally include: promote its product. Compliance of this material
with the Code where appropriate, for example,
♦ The seller’s business, including financial perform-
mortgage-backed and credit card transactions;
ance, organisational structure, background,
history, and any recent significant developments; ♦ Asset performance statistics (preferably at least
three years of performance data on the asset to be
♦ The seller’s competition, including market share
securitised);
statistics and prospects for the future;
♦ Asset management systems and any proposed
♦ Credit and collection policies, including an
changes to them. If a company is affected by the
overview of the credit department, experience of
Code it will need to show any changes that have
credit personnel, procedures for granting new
been put in place, and how they comply with the
credit, ageing policy, special programs, return
Code;
policies, collection procedures, and write-off
policies; ♦ Disaster recovery procedures; and
♦ Management of the portfolio, including staff ♦ Audit procedures (internal and external) and
training, manuals for underwriting policies and audit certificates.
procedures, Uniform Consumer Credit Code (the Depending on the information presented, the scope
Code) training where required, levels of report- of the due diligence process may be broadened to
ing, and control; cover additional items, or narrowed to focus in
♦ Customer/obligor profile, including areas of high greater detail on particular items.
concentration; In addition to reviewing information provided by
♦ Collections and bad-debt write-offs procedures the issuer or banker, the analyst may consult with
and policies. Experience of collections personnel other Standard & Poor’s analysts responsible for
and their workload, including areas of specialisa- rating the issuer or the issuer’s industry if the issuer
tion; is not rated. This may provide additional insight
into the issuer’s business practices, and any risks
associated with the assets.

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 Structured Finance Australia & New Zealand ¨ April 1999

Eligible Deposit Accounts An eligible deposit account should be maintained

with an eligible institution. An eligible institution is
An eligible account is: an institution whose:
♦ A separate and identifiable account, segregated ♦ Commercial paper, short-term debt obligations,
from all other funds held by the holding or other short term deposits are rated at least
institution; ‘A-1+’, if the deposits are to be held in the
♦ An account established and maintained in the account for less than 30 days. (‘A-1’ ratings are
name of the SPE (for company SPEs) or the name acceptable so long as the deposits are held less
of the trustee on behalf of the trust (for trust than 30 days and the SPEs aggregate exposure to
SPEs); ‘A-1’ rated entities is limited to 20% of the
♦ An account under the sole dominion and control outstanding security balance.)
of the trustee for the benefit of the holders of the ♦ Long-term unsecured debt obligations are rated
rated securities, and containing only funds held at least ‘AA-’ if the deposits are to be held in the
for their benefit; and account more than 30 days. Following a down-
♦ An account where the trustee possesses all right, grade, withdrawal, or suspension of the institu-
title and interest in all funds on deposit from time tion’s rating, each account should promptly be
to time in the account and in all proceeds thereof. moved to an eligible institution.

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 Structured Finance Australia & New Zealand ¨ April 1999

Eligible Investments Any investment not included in this list may be

approved by Standard & Poor’s after a review of the
The following investments are eligible for ‘AAA’ specific terms of the security and its appropriateness
rated transactions: for the issue.
♦ Cash;
Eligible investments should:
♦ Bonds or securities issued by the Commonwealth
♦ Be held in the name of the issuer;
of Australia, or any state or territory that has a
♦ Be domiciled in the currency of the rated securi-
long-term credit rating of ‘AAA’ if the maturity is
ties;
greater than 365 days, or ‘A-1+’ if the maturity is
♦ Mature in time for the trustee or manager (as the
less than 365 days;
case may be) to meet all obligations of the SPE as
♦ Deposits with, certificates of deposits or securities
and when they fall due in a timely manner;
issued by, or bills of exchange, promissory notes,
♦ Not have any significant non-credit risks, for
commercial paper or other negotiable instru-
instance securities with the ‘r’ symbol attached to
ments, accepted, drawn or endorsed by, a bank or
the rating and all mortgage-backed securities
financial institution rated ‘AAA’ for maturities
should not be included as eligible investments
exceeding 365 days, or ‘A-1+’ for maturities less
unless reviewed by Standard & Poor’s before
than 365 days; and
their inclusion;
♦ Investments in certain short-term debt of issuers
♦ Have a predetermined fixed-dollar amount of
rated ‘A-1’, with certain restrictions. The total
principal due at maturity that cannot vary or
amount of ‘A-1’ investments should not represent
change; and
more than 20% of the rated issue’s outstanding
principal amount, and each investment should ♦ Have interest tied to a single interest rate index
not mature beyond 30 days. Investments in ‘A-1’ plus a single fixed spread, if any, and move
rated securities are not eligible for reserve proportionately with that index.
accounts, cash collateral accounts, or other forms
of credit enhancement in ‘AAA’ rated issues.

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 Structured Finance Australia & New Zealand ¨ April 1999

Guarantee Criteria that the guarantor waives the right of set-off,

counterclaim, etc. In relation to lease transac-
The term guarantee can apply to any form of tions, the guarantee also should provide that in
guarantee, including a parent guarantee, a debt the event of a rejection of a lease in a bankruptcy
purchase agreement, a surety bond, or an insurance proceeding, the guarantor will pay the lease
contract. In structured transactions utilising guaran- payment, notwithstanding the rejection and as
tees as a form of credit enhancement, the evaluation though the rejection had not occurred.
of the creditworthiness of the primary obligor is
♦ The guarantee reinstates if any guaranteed
shifted to an evaluation of the creditworthiness of
payment made by the primary obligor is recap-
the guarantor and the compliance of the guarantee
tured as a result of the primary obligor’s bank-
with certain criteria. These criteria are intended to
ruptcy or insolvency.
ensure there are no circumstances that would enable
♦ The guarantor waives its right to subrogation
the guarantor to be excused from making a payment
until the guaranteed obligations are paid in full.
due to the holders of the rating securities.
♦ The guarantee is binding on successors of the
Guarantees that are being relied upon by Standard guarantor and a statement that the trustee is a
& Poor’s should contain the following concepts: beneficiary of the guarantee.
♦ The guarantee is one of payment and not of
♦ The holders of the rated securities are explicit
collection.
third-party beneficiaries of the guarantee.
♦ The guarantor agrees to pay the guaranteed
♦ The guarantee cannot be amended or terminated
obligations on the due date and waives demand, without the consent of 100% of the holders of
notice and marshalling of assets. the rated securities.
♦ The guarantor’s obligations under the guarantee
♦ The guarantor has subjected itself to jurisdiction
rank pari passu with its senior unsecured debt and service of process in the jurisdiction in which
obligations.
the guarantee is to be performed.
♦ The guarantor’s right to terminate the guarantee
The above concepts are used in reviewing guarantees
is restricted.
from structured finance transactions in Australia. If
♦ The guaranteed obligations are unconditional,
the transactions involve entities that are domiciled
irrespective of value, genuineness, validity, waiver,
outside Australia, tax provisions and currency
release, alteration, amendment and enforceability
exchange provisions also should be considered.
of the guaranteed obligations; and a statement

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 Structured Finance Australia & New Zealand ¨ April 1999

Legal Opinions—Overview Of factual assumptions (for example, solvency verifica-

tion for distressed sellers) and/or independent
Rating Requirements valuation of the assets.
Legal considerations, in addition to credit considera- The legal opinion will also contain a section with
tions, are an integral part of the rating process for qualifications of the “opinions”. These qualifica-
structured transactions. Standard & Poor’s resolves tions are often general matters of law that may affect
most legal concerns by analysing the transaction the enforceability of the parties’ obligations or the
documents and, where appropriate, by accepting claims of the holders of the rated securities. With
legal opinions of experienced legal counsel. Gener- some qualifications, Standard & Poor’s may ask the
ally, there are four categories of opinions that law firm to make a statement that the law firm does
Standard & Poor’s may require of a structured not have any reason to believe that the qualification
transaction: would apply to the transaction.
1. True sale opinions.
CORPORATE AND ENFORCEABILITY OPINIONS
2. Security interest opinions.
Standard & Poor’s rating is a credit opinion based
3. Insolvency opinions.
on the information provided by the issuer and its
4. Tax opinions.
advisors. Standard & Poor’s is entitled to rely on the
Standard & Poor’s may require additional opinions, representations made by issuers and managers that
including corporate and enforceability opinions, if the information is true and accurate. Although
warranted in a particular transaction. As a general Standard & Poor’s conducts limited due diligence in
rule, opinions required by Standard & Poor’s should each transaction, and may withhold a rating if in its
be addressed and delivered to Standard & Poor’s. opinion the information is not accurate, it has no
The opinions listed below refer to Australian law. To duty to verify all aspects of the transaction. Standard
the extent that the laws of other jurisdictions differ, & Poor’s relies on the transaction participants to
the opinion requirements will be adjusted accord- ensure that the documents are effective, including
ingly. corporate enforceability matters, as follows:
♦ The party is duly incorporated and existing with
COMPONENTS OF A LEGAL OPINION
power to enter into and deliver the documents
The form of legal opinion provided by most law
and to exercise its rights and perform its obliga-
firms is divided into a number of different sections.
tions under the documents.
One section contains the actual “opinions”. This
♦ All corporate action and other action required to
article focuses on the “opinions” that Standard &
authorise the execution and delivery of the
Poor’s requires, but first briefly addresses other
documents and the performance of the obliga-
sections of the legal opinion, such as the overview
tions thereunder have been taken.
section and the assumption and qualification
♦ The obligations of the party under the documents
sections.
are legal, valid, binding, and enforceable.
The overview section contains a discussion of the
♦ Each debt security will constitute a legal, valid
documents, jurisdictions, and parties to which the
and binding obligation of the issuer enforceable
opinion relates. Standard & Poor’s will review this
in competent courts of the relevant jurisdiction.
section to make sure the subjects of the opinion is
♦ The party is capable of suing and being sued in its
consistent with the transaction.
corporate name.
The assumption section contains a list of facts and
♦ The party cannot claim immunity for itself or its
circumstances that the law firm has not attempted
assets in any proceedings.
to, or is unable to, verify. Standard & Poor’s
♦ The governing law chosen will be recognised.
requests that the documents include representations,
warranties or officer’s certificates that cover the ♦ Any judgment obtained against the party will be
factual assumptions. Standard & Poor’s also relies recognised and enforced.
on statements included in the opinion to the effect ♦ All acts, conditions, approvals, etc., which are
that the lawyers involved in the transaction have no required for the party to lawfully enter into,
reason to believe that the assumptions are incorrect. exercise its rights and comply with its obligations
For certain transactions, Standard & Poor’s may under the documents, ensure that its obligations
require third party independent verification of the

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 Structured Finance Australia & New Zealand ¨ April 1999

are legal, valid, binding, and enforceable and ♦ If the procedures contained in the purchase
make the documents admissible as evidence, have agreement are followed, title to the assets will
been done. pass to the issuer.
♦ The execution, delivery and the performance by ♦ If the seller is wound up, the assets transferred to
the party of its obligations under the documents the issuer will not constitute assets of the seller.
will not conflict with or result in the breach of ♦ Title to the assets will pass to the issuer, notwith-
any of the terms or provisions of its memoran- standing the seller, or an affiliate of the seller,
dum and articles of association or the laws of the retaining custody of the mortgage and loan
relevant jurisdiction. documents on trust for the issuer (where
If a transaction relies on a letter of credit, swap, or applicable).
guaranteed investment contract to provide full or
partial credit support for the transaction, Standard
SECURITY INTEREST OPINIONS
& Poor’s will request and review corporate and In structured transactions, the issuer usually grants a
enforceability opinions in respect of the letter of charge over its assets to a security trustee. The
credit, swap or guaranteed investment contract. In security trustee holds the charge for the benefit of
addition, in jurisdictions outside Australia that may the holders of the rated securities and other secured
not be familiar to Standard & Poor’s, and may not creditors. Standard & Poor’s typically requests
have a significant number of structured finance opinions that address the effectiveness of the charge
ratings, Standard & Poor’s may request that corpo- and various other aspects of the security trust as
rate and enforceability opinions be addressed to it. follows:
In Australia, Standard & Poor’s may comment on ♦ The security trust is properly constituted.
the enforceability opinions only to the extent they ♦ The security trust deed creates a floating and/or
affect the true sale, security or insolvency opinions. fixed charge over the charged property.
♦ The charge is registrable under the Corporations
TRUE SALE OPINIONS
Law.
Often a structured transaction involves a sale of ♦ The charge and any powers of attorney have been
assets to the issuer of the rated securities. In ex- or will be registered.
change for the transfer of assets to the issuer, the
♦ If the issuer is wound up, the charged property
seller of the assets will receive the proceeds of the
will be available to the security trustee for the
issue of the rated securities.
benefit of the secured creditors.
One of the concerns that Standard & Poor’s has in ♦ If the security trustee is wound up, the assets held
connection with the transfer of the assets is whether by it will not be available to its general creditors
the transfer constitutes a “true sale”. Even though but only to those creditors to whom debts were
the transfer of the assets is accomplished by means incurred in its capacity as security trustee.
of a “purchase” agreement, circumstances surround-
♦ If the issuer is wound up, the assets covered by
ing the transfer may lead a court to conclude that
the charge will be required to be applied in
the transfer of assets is not a sale, but a financing
satisfaction of amounts owing to secured credi-
transaction whereby the issuer made a secured loan
tors in priority to unsecured creditors of the
to the seller. Such circumstances might include the
issuer.
retention of rights by the seller with respect to the
♦ The order of application of payments set out in
assets or the ability of the issuer to seek indemnifica-
the security trust deed is enforceable.
tion from the seller if the assets fail to perform in a
satisfactory manner. If the transfer of assets is INSOLVENCY OPINIONS
characterised as a secured financing, there is a risk
The laws with respect to insolvency in a given
that the assets could be affected by the insolvency
jurisdiction will allow certain transactions of an
and winding-up of the seller resulting in an interfer-
insolvent party to be set aside, or moneys paid by
ence with payments on the rated securities.
the insolvent party to be recovered by a liquidator.
To provide Standard & Poor’s with comfort that the Although rated transactions are structured to
foregoing characterisation will not occur, opinions minimise the risk that the issuer will become
may be required to the effect that: insolvent, Standard & Poor’s requires opinions to

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 Structured Finance Australia & New Zealand ¨ April 1999

the effect that the insolvency of the issuer or security whether the issuer will have the resources to cover
trustee will not affect the rated securities. The the tax liability. Typically, the tax opinions that are
specific opinions usually requested are as follows: required address the former.
♦ In the event of the insolvency of the issuer or Examples of such opinions are:
security trustee, the creation of the charges and ♦ No ad valorem stamp duty is payable with
the making of payments to the holders of the respect to the documents or transaction.
rated securities will not be an unfair preference. ♦ In the case of a trust, the issuer is structured to be
♦ The issue of the rated securities does not consti- tax neutral.
tute an unfair loan. ♦ No withholding tax is payable on payments
♦ The transactions effected by the documents are under any swaps entered into by the issuer.
not uncommercial transactions.
For segregated issuers, or in multi-jurisdictional
♦ There are no other provisions of the Corpora-
transactions, Standard & Poor’s may receive
tions Law under which payments made by the additional tax comfort. (See Criteria for Australian
issuer or security trustee may be set aside. Issuers of Segregated Series of Debt on page 76.)
TAX OPINIONS
Important considerations for Standard & Poor’s are
the extent of the issuer’s liability for tax, and

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 Structured Finance Australia & New Zealand ¨ April 1999

Liquidity Facilities In Structured ♦ Insolvency of the issuer, which includes the

winding up of the issuer; the appointment of an
Deals administrator, liquidator, or receiver; the com-
In most circumstances, issuers of asset-backed mencement of any recovery or enforcement
commercial paper (CP) should have a liquidity proceedings; and the failure to comply with a
facility backup to ensure timely payment in the event statutory demand. It should not include the
of any market disruption that prevents the CP from necessity of the issuer to borrow under the
being rolled over, or any systemic delay in the receipt liquidity facility to pay its debt.
of cash flows from the underlying assets. The ♦ Occurrence of an event which causes the provi-
liquidity facility should cover 100% of the face sion of the liquidity facility to be illegal.
value of CP issued, and the maturity date of the
liquidity facility typically extends at least two
LIMITED RECOURSE AND NONPETITION
business days beyond that of the CP issued. When To ensure that the liquidity provider does not cause
the liquidity facility is drawn, the liquidity provider an event of default and thereby terminate the facility,
is, in effect, an investor, in the same way as CP the following limited recourse language typically is
holders might be. included in the facility agreement.
Liquidity facilities also may be used to cover short- Limited Recourse
term liquidity shortfalls in certain bond structures. The liquidity provider may enforce its rights against
In these structures, the liquidity provider’s role is the issuer only to the extent of its rights under the
slightly different in that the liquidity facility ensures security of the transaction.
the timely payment of interest and/or principal to
rated security holders. It protects rated security Nonpetition
holders from delays that may arise due to delinquent In the case of company special-purpose entities, in
assets or defaulted assets before the security can be addition to the limited recourse provisions, the
enforced and a claim made on the primary credit liquidity provider usually covenants not to appoint,
support provider, as well as covering any systemic or agree to the appointment of, an administrator to
delay in the receipt of cash flows from the underly- the issuer; or apply for the winding up, or dissolu-
ing assets. In the absence of other liquidity supports tion of, the issuer.
in the transaction, the liquidity facility should at The nonpetition language may incorporate a
least cover Standard & Poor’s estimation of liquidity minimum period of time during which a petition is
delays using asset delinquency and default assump- prevented from occurring. Typically, the minimum
tions consistent with the rating sought on the period of time is two years and one day after the
securities. Also, the term of the liquidity facility payment of the last securities issued by the issuer,
should usually match the term of the rated securities. reflecting the preference period of the Australian and
New Zealand jurisdictions, to ensure that payments
EVENTS OF DEFAULT
made by the issuer to securities holders cannot be
To achieve investment grade ratings with respect to clawed back from them.
asset-backed securities, the liquidity facility should
be available to the issuer at all times and in all PRIORITY OF PAYMENTS
circumstances to the extent that the underlying Standard & Poor’s criteria on priority of payments
assets are performing. This is in not in conflict with depends on whether or not a default has occurred
the Reserve Bank of Australia Prudential Statement and security enforced. It also depends on the
C2 on the issue of liquidity facilities in purpose of the liquidity facility.
securitisation, which requires that a liquidity facility
should only be capable of being drawn to the extent Pre-Enforcement Of Security
that there is sufficient level of nondefaulted assets to Where the security has not been enforced, payments
cover drawings under the facility. Usually, the events to the liquidity provider may rank ahead of the
of default under a liquidity facility that allow the securities holders to ensure the continuance of the
liquidity provider to make no further advances to liquidity facility in the transaction. However, while
the issuer are: the repayment of advances under the liquidity
♦ Failure of the issuer to pay under the liquidity facility can be repaid in priority to securities holders,
facility, subject to a grace period of at least three the liquidity facility should be available to be
business days. redrawn by the issuer.

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 Structured Finance Australia & New Zealand ¨ April 1999

Post-Enforcement Of Security liquidity provider, or if a suitable replacement

Where the liquidity facility is used to back up CP liquidity provider cannot be appointed, or if so
issues, payments to the liquidity provider should desired by the liquidity provider, the liquidity
rank no higher than pari passu with the CP holders. provider should post cash collateral equal to the
In certain circumstances where the liquidity facility total facility commitment amount to support its
is merely providing cover for short-term liquidity obligations under the facility.
shortfalls, payments to the liquidity provider may Collateral should be invested in eligible investments
rank ahead of the bondholders. (other than debt of the liquidity provider) in the
currency of the rated securities, and should be
LIQUIDITY PROVIDER RATING deposited in an eligible account in the name of the
The rating of the liquidity provider usually is trustee or special-purpose entity. The funds should
commensurate with the rating of the securities be invested with an eligible institution other than the
issued. Two exceptions to this are where two liquidity provider collateralising its obligations,
counterparties jointly support the obligations under unless the sole purpose of the liquidity facility is to
the facility, and where the facility provider agrees to support asset delinquencies (such as missed pay-
cash collateralise its obligations under the facility. ments on mortgage loans). In this instance, the
collateral may be invested in the issuer’s collection
Joint Support
account, even if the account is maintained with the
In the case of jointly supported obligations from two same entity providing the liquidity facility, subject to
liquidity providers, Standard & Poor’s may apply a the rating restrictions that apply to that account and
probabilistic approach, in recognition of the fact eligible investments of the issuer generally. If the
that default risk is reduced, where two entities funds do not mature before the next interest
whose credit risk is not highly correlated guarantee payment due on the rated securities, additional
the same obligation. It is, therefore, possible to have collateral may be required. The costs associated with
a liquidity facility jointly provided by two entities, posting the collateral should be borne by the
each of which is rated lower than the rating assigned liquidity provider. Guarantees or third-party credit
to securities issued. (See Probabilistic Approach to support may be substituted for collateral at any
Joint Support on page 92.) time.
Cash Collateral
COSTS
Liquidity providers that are rated lower that ‘AAA’
Drawings and interest on drawings, as well as
may be acceptable providers in ‘AAA’ rated transac-
commitment fees and other fees under the liquidity
tions where the provider agrees that within 30 days
facility, are generally senior obligations of the issuer.
of being downgraded below ‘A-1+’ (and within five
Using assumptions consistent with the rating sought
days of being downgraded below ‘A-1’) to appoint a
on the securities, and taking into account the
replacement liquidity provider rated ‘AAA’, or
individual terms and conditions of the liquidity
‘A-1+’, subject to the same downgrade provisions.
facility, Standard & Poor’s assesses the issuer’s
The replacement provider should be bound by the
ability to meet its obligations under the liquidity
same terms and conditions as the existing provider.
facility agreement to the liquidity facility provider.
Any costs of replacement should be borne by the

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 Structured Finance Australia & New Zealand ¨ April 1999

Probabilistic Approach To Joint rating notches for ‘BBB+’ and ‘BBB’ and one
rating notch for ‘BBB-’. For instance, if the
Support stronger supporter is rated ‘A’ and the second
Standard & Poor’s uses a probabilistic approach to supporter is rated ‘A-’, the highest possible jointly
jointly supported obligations in structured finance supported rating will be ‘AA’—three notches
ratings, recognising that default risk is reduced above the stronger supporter’s rating of ‘A’.
where two companies guarantee the same obliga- Likewise, if the second supporter’s rating is
tion. ‘BBB+’ or ‘BBB’, the highest possible jointly
supported rating is ‘AA-’ which is two notches
When an obligation is fully guaranteed by two
above the stronger supporter’s rating of ‘A’, and,
companies, it has a lower risk of default—better
finally, if the second supporter is rated ‘BBB-’, the
credit quality—than an obligation solely backed by
highest possible jointly supported rating is ‘A+’
either guarantor (supporter). This criteria reflects the
or one notch above the stronger supporter’s
benefits of joint support.
rating of ‘A’.
METHODOLOGY ♦ No credit enhancement will be allowed if the
Probability theory explains that if two companies, weaker supporter is speculative grade (‘BB+’ and
each with an independent default risk of 5%, jointly below).
support an obligation, the obligation’s risk of ♦ No credit enhancement will be allowed for a
default is only 0.25% (0.05 x 0.05). The risk that third or fourth supporter.
they will both default is much less than the risk that The resulting guidelines for rating jointly supported
either one will default. Standard & Poor’s corporate obligations are shown in table 1. The assumed
default studies now enable the default risk of each ratings of the two supporters are displayed in the
rating category to be quantified, forming the area across the top row and down the left column of
foundation for the new criteria. the table. The table shows that a bond would be
The above example assumes completely independent rated ‘AAA’ if jointly supported by one counterparty
credit risks for the two supporters. In reality, rated ‘AA’ or higher and another rated ‘A-’ or
however, credit quality is often correlated for higher. Both counterparty ratings, under the new
companies in the same industry and geographic and old criteria, continue to recognise the potential
market. Attempting to measure the degree of liability for the supported obligation, regardless of
correlation would be extremely difficult and its rating.
impractical. Thus, Standard & Poor’s new criteria Short-term ratings may be similarly enhanced for
employs somewhat conservative guidelines regarding joint support. Guidelines for jointly supported
correlation of supporters’ default risk. The method- short-term debt are derived from the supporters’
ology generally assumes the lower-rated supporter long-term ratings.
has a 50% default rate, which is equivalent to a Joint support credit enhancement is not applicable
50% correlation of the supporter’s actual default to obligations supported by organisations such as
risk. Using the above example, the obligation’s specialised derivative product companies and
jointly supported default risk, recognising the 50% monoline bond insurers whose credit ratings already
correlation, would be 2.50% (0.05 x 0.50)—still reflect the joint strength concept.
significantly below the risk of default with only one
supporter. SEVERAL GUARANTORS
Reflecting the high degree of credit risk correlation, When an obligation is severally, not jointly, guaran-
there will be no joint support credit enhancement teed, each guarantor guarantees only its own piece
for affiliated companies (e.g., parents and subsidiar- of the obligation. For example, each of two support-
ies), companies in the same industry and narrowly ers might be responsible for 50% of the obligation.
defined region, or other economically co-dependent If one supporter defaults, the other supporter is only
entities. liable for half the obligation. These obligations have
Ratings of jointly supported obligations will be usually been rated the same as the lowest rated
further constrained as follows: supporter.
♦ Credit enhancement of the stronger supporter Obligations severally backed by a few supporters
will be limited to three rating notches when the may have greater default risk than that of the lowest
second supporter is rated ‘A-’ or above, two rated supporter. If each of five severally obligated

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 Structured Finance Australia & New Zealand ¨ April 1999

Table 1 Jointly Supported Ratings

AAA AA+ AA AA- A+ A A- BBB+ BBB BBB-
AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA
AA+ AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA
AA AAA AAA AAA AAA AAA AAA AAA AA+ AA+ AA+
AA- AAA AAA AAA AA+ AA+ AA+ AA+ AA+ AA+ AA
A+ AAA AAA AAA AA+ AA+ AA+ AA+ AA AA AA-
A AAA AAA AAA AA+ AA+ AA AA AA- AA- A+
A- AAA AAA AAA AA+ AA+ AA AA- A+ A+ A
BBB+ AAA AAA AA+ AA+ AA AA- A+ A A A-
BBB AAA AAA AA+ AA+ AA AA- A+ A A- BBB+
BBB- AAA AAA AA+ AA AA- A+ A A- BBB+ BBB

supporters had a 5% risk of default, the obligation’s Standard & Poor’s collateralised bond obligation
risk of default would be 22.62% [1 - (0.95 x 0.95 x model already recognises the heightened default risk
0.95 x 0.95 x 0.95)]. The risk that any supporter of severally supported obligations.
defaults is much greater than the risk that one Other financing structures based on several obliga-
particular supporter defaults. tions are now under review by Standard & Poor’s to
Corporate obligations, which generally have joint evaluate any exposure due to the adoption of this
support in addition to several support, are probabilistic methodology.
unaffected by this concern, and may now experience
credit enhancement as a result of the joint support.

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 Structured Finance Australia & New Zealand ¨ April 1999

Special-Purpose Entities— documents. Their rationale is briefly explained

below, while the precise terms of these criteria are
Creating A Bankruptcy-Remote found in the following section.
Issuer Restrictions On Objects And Powers
Structured financings are rated primarily on the The fundamental SPE characteristic is that the
basis of the creditworthiness of isolated assets or entity’s objects and powers be restricted as closely as
asset pools assigned to secure the rated securities, possible to the bare activities necessary to effect the
and not the creditworthiness of the seller or bor- structured transaction. The purpose of this restric-
rower. The structured financing seeks to insulate tion is to reduce the SPE’s internal risk of insolvency
transactions from entities that are either low-rated as a result of the claims created by activities unre-
or unrated. Standard & Poor’s worst-case scenario lated to the securitised assets and the issuance of the
generally assumes the insolvency of each transaction rated securities.
participant deemed not to be a bankruptcy-remote In structured transactions, Standard & Poor’s
entity, or that is rated lower than the rating sought generally requests that the SPE embed in its organic
on the transaction. document of establishment (constitutions for
Standard & Poor’s legal criteria for securitisation corporations, trust deeds for trusts) an objects clause
transactions are designed to ensure that the entity constraining the SPE to those activities needed to
owning the assets and required to make payments ensure the sufficiency of cash flow to pay the rated
on the rated securities is bankruptcy-remote, that is securities, and to those powers incidental to this
the entity is unlikely to be subject to voluntary or purpose. Standard & Poor’s generally requests that
involuntary insolvency proceedings. Standard & where possible, this limited objects clause, as well as
Poor’s considers the incentives of this special- other SPE criteria, be reiterated in appropriate
purpose entity (SPE) or its equity holders to resort to transaction documents.
voluntary insolvency proceedings, and also the In brief, the SPE should not engage in unrelated
incentives for other creditors of the SPE to resort to business activities unless the parties to a transaction
involuntary proceedings. The analysis also examines are willing to allow the rating to reflect the effect of
whether third-party creditors of the SPE’s parent these activities on the entity’s resources, cash flows,
would have an incentive to reach the assets of the and the ability to pay the entity’s obligations in a full
SPE (for example, if the SPE is a trust, whether and timely manner.
creditors of the beneficial holder would have an
incentive to cause the dissolution of the trust to Debt Limitations
reach the assets of the trust.) The SPE should be restricted from issuing other
debt, except in circumstances that are consistent
THE CHARACTERISTICS OF BANKRUPTCY RE- with the rated issuance. For example, the SPE may
MOTENESS issue multiple classes of debt, so long as the classes
Standard & Poor’s has developed the following SPE all have the same issue credit rating (or the SPE
criteria, which an entity should satisfy to be deemed complies with Standard & Poor’s segregation of
bankruptcy-remote. An entity that satisfies these assets criteria). In some cases, the SPE may be able
criteria is regarded by Standard & Poor’s as being to issue subordinated nonrecourse debt that is
sufficiently protected against both voluntary and related to the rated issuance. Because creditors can
involuntary insolvency risks: file involuntary petitions against an entity, determin-
♦ Restrictions on objects and powers; ing whether an entity is bankruptcy-remote involves
♦ Debt limitations; analysing the likely creditors of the SPE and their
incentives to reach the assets supporting the rated
♦ Independent director;
securities.
♦ No merger or reorganisation;
♦ Separateness; and
The thrust of additional debt criteria is to ensure
that a holder of additional indebtedness would be
♦ Form of the charge over the assets.
unable to affect the creditworthiness of the SPE and
Each of these characteristics is important to the would be unable or unwilling to seek to wind up the
overall concept of bankruptcy remoteness and, SPE (because there is no recourse to the SPE and the
regardless of the specific organisational structure of holder is subordinated to the rated securities), or,
the special-purpose entity, these elements generally alternatively, the risk to the SPE would be no greater
should be treated in the relevant organisational

Standard & Poor’s 94

 Structured Finance Australia & New Zealand ¨ April 1999

than that posed by the original issue (because the reorganisation, dissolution, liquidation, or asset sale.
additional debt is rated at least as high as the rating Standard & Poor’s generally also requests that the
assigned to the original issue). Standard & Poor’s SPE not amend its organisational documents
looks for nonpetition language in any agreement without prior written notice to Standard & Poor’s.
between the SPE and its creditors whereby the
Separateness Covenants
creditors agree not to file the SPE into bankruptcy
and not to join in any bankruptcy filing. Separateness covenants are designed to ensure that
the SPE is seen to be an entity that is independent
The Independent Director from its parent, on the basis that if the entity does
SPEs that are corporations generally act through a not act as if it has an independent existence, a court
board of directors. The directors are elected by the may seek to bring the SPE and its assets into the
shareholders, the company’s owners. parent’s insolvency proceeding. A court may seek to
Among the major decisions taken by the board of exercise this remedy when a controlling entity, such
directors is the decision to file the corporation into as the parent of a SPE, so disregards the separate
bankruptcy. In some structured transactions, the SPE identity of the SPE that their enterprises are seen as
is established by a non-SPE operating entity parent. effectively commingled. The remedy is sought by
This parent is, at times, either unrated or has a creditors with claims against an insolvent parent
rating below its SPE subsidiary. Moreover, the who believe funds can be properly traced into the
directors of the parent may well serve as the direc- subsidiary.
tors for the SPE. These interlocking directorates An important element of the SPE analysis is to limit
present a potential conflict of interest. If the parent the circumstances where the SPE entity may be
becomes insolvent but the SPE is performing consolidated with its parent. In this regard, the
adequately, the parent entity may have an incentive entity should observe certain separateness covenants.
to voluntarily file the SPE into bankruptcy and The separateness covenants that the SPE should
consolidate its assets with those of the parent. abide by are detailed in the following section. In
Alternatively, the directors may be representatives of addition, where the SPE is owned by an operating
entities that are providing credit or liquidity sup- company, Standard & Poor’s may request legal
ports in the transaction. Often, the directors of the opinions to the effect that the SPE would not be
SPE may be officers of the seller, or support provid- consolidated with its parent.
ers. These concerns prompt Standard & Poor’s to
Charges Over The Assets
request an “independent director” who will be
obliged to act in the best interests of rated Generally, a charge is required to be granted over the
noteholders. assets of the SPE to a security trustee for the benefit
of rated security holders. This element helps Stand-
If the SPE has at least one director who is independ-
ard & Poor’s in reaching the analytic conclusion that
ent from the operating parent of the SPE, and from
an issuer is in fact a SPE by reducing the incentives
parties providing credit and liquidity supports in the
of third party creditors to the SPE and, where the
transaction, and this director’s vote is required in
SPE is not an orphan SPE, by reducing the incentives
any board action seeking bankruptcy protection for
of the parent to involuntarily seek to wind up the
the SPE or the amendment of the organic documents
entity. By reducing the practical benefit of an
of the SPE, then the SPE is unlikely to voluntarily
insolvency filing, the likelihood of voluntary
file an insolvency petition. Standard & Poor’s
insolvency is decreased.
requests that, where possible, the organic documents
of the SPE recite that, in voting on bankruptcy SPE CRITERIA
matters, the independent director takes into account
the interests of the holders of the rated securities, as General SPE Criteria
well as those of the stockholders. This approach is Based on the principles discussed above, Standard &
designed to provide additional protection against the Poor’s has developed criteria to help it conclude that
SPE being filed into bankruptcy. an entity is a SPE:
♦ The entity should not engage in any business or
No Merger Or Reorganisation
activity other than those necessary for its role in
This requirement ensures that, while the rated the transaction.
securities are outstanding, the bankruptcy-remote
♦ The entity (and, as applicable, its affiliates)
status of the SPE will not be undermined by any
should not engage in any dissolution, liquidation,
merger or consolidation with a non-SPE or any

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 Structured Finance Australia & New Zealand ¨ April 1999

consolidation, merger, or asset sale, or - To allocate fairly and reasonably, any over-
amendment of its organisational documents as head for shared office space;
long as the rated securities are outstanding, unless - To use separate stationery, invoices, and
Standard & Poor’s provides written confirmation cheques;
of any outstanding ratings. - Not to pledge its assets for the benefit of any
♦ The entity should not incur any debt (other than other entity or make any loans or advances to
indebtedness that secures the rated securities) any entity;
unless (a) the additional debt is rated by Standard - To hold itself out as a separate entity;
& Poor’s at least as high as the issue credit rating - To correct any known misunderstanding
requested for the rated securities in a given regarding its separate identity; and
structured transaction, (b) all of the entity’s debt
- To undergo an annual audit.
meets Standard & Poor’s segregation of assets
♦ The entity should be bound not to create or
criteria, or (c) the additional debt:
permit to subsist any encumbrances over any of
- Is fully subordinated to the rated securities;
the underlying security except the trustee’s and in
- Is nonrecourse to the entity or any of its assets certain other circumstances.
other than cash flow in excess of amounts
♦ The entity should be bound not to pay any
necessary to pay holders of the rated securities;
dividend or make any other distributions except
and
in certain circumstances.
- Does not constitute a claim against the entity
♦ The entity should be bound not to discharge or
to the extent that funds are insufficient to pay
release any person from his obligations under any
such additional debt.
of the agreements that form part of the trustee’s
♦ The entity should be qualified to do business
security except in certain circumstances.
under applicable law in the state in which any
♦ The entity should be bound not to open and
assets are located.
operate any bank accounts except on the terms
♦ The entity (and, if applicable, the entity’s mem-
set out in the transaction documents.
bers and affiliates) should agree to abide by the
♦ The entity should be bound not to have any
following separateness covenants:
subsidiaries other than as contemplated by the
- To maintain books and records separate from transaction documents.
any other person or entity;
- To maintain its accounts separate from any SPE Corporations
other person or entity; In addition to the general SPE criteria set forth
- Not to commingle assets with those of any above, a SPE corporation should conform to the
other entity; following additional criteria:
- To conduct its own business in its own name; ♦ The corporation should have at least one inde-
- To maintain separate financial statements; pendent director.
- To pay its own liabilities out of its own funds; ♦ The unanimous consent of the directors, includ-
ing that of the independent director(s), should be
- To observe all corporate or partnership
required to:
formalities and other formalities required by
the organic documents; - Institute insolvency proceedings;
- To maintain an arms-length relationship with - Dissolve, liquidate, consolidate, merge, or sell
its affiliates; all or substantially all of the assets of the
corporation;
- Not to guarantee or become obligated for the
debts of any other entity or hold out its credit - Engage in any other business activity; and
as being available to satisfy the obligations of - Amend the articles of incorporation of the
others; corporation.
- Not to acquire obligations or securities of its ♦ The directors should be required to consider the
members, or shareholders; interests of the corporation’s creditors when
making decisions.

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 Structured Finance Australia & New Zealand ¨ April 1999

Swaps And Structured Finance (d) Deduction or withholding for tax The ISDA
agreement requires a party to gross up its swap
Swaps have become an integral part of many payment if an indemnifiable tax is imposed on the
structured finance securities. They are important payment. This definition should not be limited to an
because they transform asset cash flows into flows indemnifiable tax, but should include any withhold-
that match the cash flows due to investors, under ing taxes.
the terms of mortgage-backed or asset-backed
If no withholding tax currently applies to swap
securities.
payments, Standard & Poor’s will require legal
This article explains Standard & Poor’s swap criteria opinions from the issuer’s legal counsel confirming
for structured financings. A structured finance rating that under current law no such tax applies. Standard
addresses the issuer’s ability to make full and timely & Poor’s ratings do not address change in law risk,
payment, according to the terms of the issue. The and its criteria recognises that it is up to the parties
issuer, usually a special-purpose entity with a limited to fashion the remedies for the potential imposition
cash flow stream, cannot risk an early termination of taxes.
of the swap.
Standard & Poor’s will accept two remedies,
In most structured financings, the rating of the swap provided the risks are properly disclosed in the
counterparty, or its guarantor, is a supporting rating information memorandum to investors. To address
and may be the rating assigned to the transaction if future imposition of withholding taxes on swap
the swap counterparty rating is the lowest of all the payments made by itself or the issuer, and before a
supporting ratings. A supporting rating is the rating rating is assigned to a transaction, the swap
of a counterparty on which an issuer relies for counterparty may elect to:
monetary support.
♦ Gross up payments made to the issuer to take
This swap criteria refers to the 1992 International into account withholding tax and accept pay-
Swap Dealers Association Inc. (ISDA) ments from the issuer net of tax; or
Multicurrency-Cross Border Master Agreement. ♦ Make payments to the issuer net of withholding
There are three parts to the ISDA agreement: the tax and accept payments from the issuer net of
master agreement, a schedule, and a confirmation. withholding tax, subject to a legal opinion given
The schedule and/or confirmation should include by the issuer’s counsel that no withholding tax is
modifications to the master agreement, so that the currently imposed in the relevant jurisdiction.
entire agreement conforms to the criteria for the
Standard & Poor’s will request that the transaction
specific type of transaction.
documents adequately disclose that investors’
Standard & Poor’s swap criteria are cross-referenced payments from the issuer may be affected if a
to the appropriate section of the 1992 ISDA agree- withholding tax is imposed on swap payments, and
ment. The provisions of the ISDA agreement not that the counterparty is not obligated to gross up
referenced below are acceptable, provided they are payments to the issuer.
not modified.
Section 3: Representations
ISDA CROSS REFERENCES To help parties standardise the agreement, and to
Section 2: Payments allow for proper due diligence, representations may
be included in the swap agreement. However,
(c) Netting The master agreement allows for the
Standard & Poor’s believes that breach of these
party that owes a higher swap payment to the other
representations by the issuer should not, in most
party to make a net payment to that party. It does
circumstances, constitute an event of default or give
not apply to swapped currency payments. The
the counterparty the right to terminate the swap.
parties should elect that netting across different
series will not apply to vehicles that can issue Section 4: Agreements
multiple classes or series of securities, to avoid In general, the issuer’s failure to comply with Section
netting across different classes or series. For a given 4 should not constitute an event of default or give
series, payment netting for that series is acceptable. the swap counterparty the right to terminate.
Further, the swap agreement for each class or series
must be written as a separate agreement. If not, Section 5: Events Of Default And Termination Events
there must be a provision in the swap agreement The ISDA master agreement contains a number of
stating clearly that swaps in different series are default and termination events that apply to both
segregated. the issuer and the swap counterparty. Standard &

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 Structured Finance Australia & New Zealand ¨ April 1999

Poor’s seeks to limit the circumstances under which enables a party to declare the swap in default, if the
the swap counterparty may terminate the swap other party or its credit support provider defaults on
agreement. Each of the events of default and obligations in excess of an agreed-upon threshold
termination events are discussed more fully below. amount. Because Standard & Poors can rate
For ease of reference, the box below lists the events particular categories of debt of an entity differently
that Standard & Poor’s views as acceptable for the (for example, senior debt, subordinated debt etc.)
swap counterparty. and structured transactions rely on the credit quality
of particular assets, this provision should be re-
(a) Events Of Default
moved from the swap agreement.
(ii) Breach of agreement. The issuer’s breach of
The risk of different ratings on different categories
identified agreements will not be an acceptable event
of debt also applies to an issuer with deeply subordi-
that gives the swap counterparty the option to
nated instruments outstanding, on which the
terminate the swap agreement.
relevant creditor has agreed not to enforce its claim
(iii) Credit support default. The master agreement upon a default. Nonetheless, this arrangement could
provides that a credit support default can lead to an inadvertently trigger the cross-default provision.
event of default under the swap agreement. This
(vii) Bankruptcy. Under this provision, if a party
provision should be removed from the agreement
becomes bankrupt, the other party can declare the
when the swap counterparty’s obligations under the
swap in default. This provision generally is accept-
swap agreement are not supported by, or guaranteed
able, as the issuer usually is structured to be bank-
by, another entity.
ruptcy remote. A downgrade of the swap
(iv) Misrepresentation. Under this provision, a counterparty, on the other hand, would cause the
misrepresentation by either party or its credit transaction’s rating to be lowered accordingly.
support provider, other than a misrepresentation
relating to payer or payee tax representations under (b) Termination Events
sections 3(e) or 3(f), would enable the other party to (ii) Tax event. Under this provision, the affected
declare the swap in default. This provision should be party has the right to terminate the swap. The
removed. affected party is the party obligated to pay tax or
(v) Default under specified transaction. This provi- receive a payment net of tax, if an indemnifiable tax
sion allows the nondefaulting party to terminate the is imposed on a party’s swap payments, or if the
swap if the other party defaults under a specified party will receive swap payments net of this tax
swap or transaction, whether or not the swap or from the other party because a tax is imposed and
transaction is a part of the current swap agreement. neither party is obligated to gross up its payments
Allowing the swap to default for this reason can be under the master agreement. This right to terminate
used to create a cross default. As noted below, cross- the swap should be removed.
default provisions are not appropriate in structured (iii) Tax event upon merger. Under this provision,
finance transactions. the burdened party has the right to terminate the
(vi) Cross default. The cross-default provision swap. The burdened party is the party required to
pay an amount relating to an indemnifiable tax or
receive a payment net of this tax, which the other
EVENTS OF DEFAULT AND TERMINATION party is not required to gross up other than by
EVENTS reason of section (2)(d) (i) (4) (A) or (B) because the
The following are acceptable default and termination burdoned party or the other party merged. In most
events that would enable the swap counterparty to cases, this provision must be removed.
terminate the swap agreement in securities in which the (iv) Credit event upon merger. This provision may be
collateral and swap counterparty are supporting ratings: retained if the issuer is the only party with the right
to terminate. The counterparty should not be
Events Of Default
concerned with its inability to terminate the swap in
♦ Failure to pay or deliver. Section 5(a) (i)
♦ Bankruptcy. Section 5(a) (vii)
an issuer merger. This issuer, as a bankruptcy-
♦ Merger without assumption. Section 5(a) (viii) remote, special-purpose entity, is usually prohibited
from merging, when doing so would materially
Termination Events prejudice investors.
♦ Illegality. Section 5(b) (i)
(v) Additional termination events. Standard &
Poor’s will review any additional termination events

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 Structured Finance Australia & New Zealand ¨ April 1999

to ensure that they comply with criteria within the SECTION 9: MISCELLANEOUS
context of the transaction. In general, Standard &
(b) Amendments
Poor’s considers that there will be very few transac-
tions in which additional termination events would Any amendments to the swap agreement must be
be appropriate. approved in advance and in writing by Standard &
Poor’s.
SECTION 6: EARLY TERMINATION
SECTION 10: MULTIBRANCH PARTIES
(a) Right To Terminate Following Event Of Default
Each party should represent that it is not a
The master agreement allows the nondefaulting multibranch party for purposes of the swap agree-
party to terminate the swap following an event of ment.
default by the other party. The ability to terminate
the swap immediately or automatically after such RANKING
default should be removed from the agreement in Although the ISDA agreement does not stipulate any
certain circumstances. This provision generally is sharing of proceeds resulting from selling or liqui-
included to buttress netting in several jurisdictions. dating the underlying collateral upon a swap
Because most transactions will waive netting across termination, Standard & Poor’s continues to be
different swap agreements, this provision should not concerned with the relative rights of the swap
be necessary. counterparty and investors in the event of termina-
(b) Right To Terminate Following Termination Event tion. Standard & Poor’s view is that the swap
counterparty should share pari passu and pro rata in
(ii) Transfer to avoid termination event. This
all proceeds from selling or liquidating the underly-
provision is acceptable as long as both parties have
ing collateral.
the right to transfer and as long as any successor
counterparty to which the counterparty has trans- Like other modifications to the master agreement,
ferred its obligations under the swap agreement has provisions for ranking must be addressed in the
a rating at least equal to the current rating on the schedule and confirmation.
issue.
LIMITED RECOURSE AND NONPETITION
(e) Payments On Early Termination To ensure that the swap counterparty does not cause
Provided that the swap counterparty is not other- an event of default and thereby terminate the facility,
wise obligated to pay a different amount when the the following limited recourse language typically is
swap terminates (for example, as a result of tax included in the facility agreement.
events), Standard & Poor’s will accept the termina-
Limited Recourse
tion payment agreed upon by the issuer and the
counterparty. Market quotation should be the first The swap counterparty may enforce its rights
alternative for payment measure, with a provision against the issuer only to the extent of its rights
for loss if market quotation is not available. Either under the security of the transaction.
method is acceptable. Nonpetition
SECTION 7: TRANSFER In the case of company special-purpose entities, in
addition to the limited recourse provisions, the swap
This section prevents the parties from transferring
counterparty usually covenants not to appoint, or
their rights under the swap agreement to another
agree to the appointment of, an administrator to the
party without the other party’s prior written
issuer; or apply for the winding up, or dissolution
consent. This section must be modified, so that the
of, the issuer.
issuer can assign or mortgage all of its benefits and
interest in the swap agreement to a trustee in the The nonpetition language may incorporate a
context of the structured transaction, and so that the minimum period of time during which a petition is
issuer can transfer its interest in the swap agreement prevented from occurring. Typically, the minimum
to avoid a tax event or illegality in its current period of time is two years and one day after the
jurisdiction. Standard & Poor’s will allow swap payment of the last securities issued by the issuer,
counterparties to be released from their obligations reflecting the preference period of the Australian and
under the swap agreement only after they assign the New Zealand jurisdictions, to ensure that payments
agreement to an entity with a rating at least as high made by the issuer to securities holders cannot be
as that currently assigned to the transaction. clawed back from them.

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 Structured Finance Australia & New Zealand ¨ April 1999

New Interest Rate And Table 2 Volatility Buffer For AAA Rated
Currency Swap Criteria Broaden Transactions In Group 2 Currencies (%)*

Allowable Counterparties Counterparty

Maturities
up to
Maturities
up to
Maturities
more than
New interest rate and currency swap criteria allow rating 5 years 10 years 10 years
‘A-1’ and ‘A’ rated counterparties with collateral to A+ 1.05 1.75 3.0
A 1.35 2.45 4.5
participate in structured financings. The criteria
A-1 1.5 3.15 6.0
combine a blend of market risk protection, eco-
nomic incentives, counterparty credit strength, and *Group 2 currencies are: Australian dollars, British pounds,
Canadian dollars, Danish kroner, New Zealand dollars, and
the ability to substitute. Together, these factors
Swedish kronor. The ‘A-’ category is limited to ‘A-’ rated credits or
provide the credit strength necessary to maintain the ‘A-/A-1’ rated credits. If an ‘A-’ counterparty has an ‘A-2’
quality associated with the highest ratings. commercial paper rating, it must find an eligible replacement.
Under the new criteria:
♦ ‘A-1+’ rated entities can now provide swaps in
‘AAA’ rated transactions if they agree to For interest rate and currency swaps in these
collateralise or find a suitable replacement currencies, ‘A-1+’ rated counterparties do not have
counterparty upon downgrade to ‘A-1’. to post collateral. The new collateral levels will
♦ ‘A-/A-1’ rated entities, together with a pledge of equal greater of zero or the mark to market of the
collateral, can also participate in ‘AAA’ rated swap, plus the amount equal to the appropriate
transactions subject to the conditions detailed in value as a percentage of the swap’s notional value.
this article. All collateral should be pledged to the trustee or
♦ Basis risk swaps, caps, and floors are also eligible other independent third party acting as agent for
in this expanded criteria. Caps and floors investors. An enforceability opinion indicating that
collateral levels will need to be developed and are security holders have full rights in the collateral,
not available at this time. notwithstanding the insolvency of the swap
♦ Total return swaps do not qualify for this criteria. counterparty, should be delivered at closing.
Entities whose ratings fall below ‘A-1’ commercial
LIMITED TO ISDA-RECOGNISED CURRENCIES
paper or ‘A-’ long-term will have to be substituted.
The new criteria is limited to those currencies
recognised by the International Swap Dealers CALCULATING SWAP COLLATERAL
Association (ISDA). These include: Australian The collateral formula for interest rate (other than
dollars, Belgian francs, British pounds, Canadian basis risk) swaps equals the greater of:
dollars, Danish kroner, deutschemarks, Dutch 1. MTM + VB = CR
guilder, the euro, European Currency Units, French
2. 0
francs, Hong Kong dollars, Italian lire, yen, New
Zealand dollars, Spanish pesetas, Swedish kronor, The collateral formula for basis risk swaps equals
Swiss francs, and U.S. dollars. the greater of:
1. MTM + (VB x 0.1) = BRCR
2. 0
Table 1 Volatility Buffer For AAA Rated Currency swaps will be calculated as:
Transactions In Group 1 Currencies (%)*
CR x CM1 x CM2 = CCR
Maturities Maturities Maturities Where:
Counterparty up to up to more than ♦ MTM = Mark-to-market of the swap.
rating 5 years 10 years 10 years
♦ VB = Volatility buffer that equals the amount of
A+ 0.6 1.05 1.5
A 0.9 1.10 1.9 any given currency derived by taking the appro-
A-1 1.2 2.25 4.45 priate percentage of the swap’s notional balance
(see tables 1, 2, and 3). If two currencies are in
*Group 1 currencies are: Belgian francs, deutschemarks, Dutch
guilders, euro, European Currency Units, French francs, yen, Swiss different groups, use the higher of the two
francs, and U.S. dollars. The ‘A-’ category is limited to ‘A-’ rated buffers.
credits or ‘A-/A-1’ rated credits. If an ‘A-’ counterparty has an ‘A-2’ ♦ CR = Collateral requirement for interest rate
commercial paper rating, it must find an eligible replacement.
swaps.

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 Structured Finance Australia & New Zealand ¨ April 1999

Swap providers will have to mark the swap to

Table 3 Volatility Buffer For AAA Rated market, and post collateral on a weekly basis, with a
Transactions In Group 3 Currencies (%)*
cure period of three days. The mark-to-market
Maturities Maturities Maturities valuation should reflect the higher of two bids from
Counterparty up to up to more than counterparties eligible and willing to provide the
rating 5 years 10 years 10 years
swap in the absence of the current provider. Annual
A+ 1.5 2.45 4.5
A 1.8 3.15 8.0 audits should be amended to specifically verify a
A-1 2.1 3.85 7.5 sample of swap calculations and collateral postings.
*Group 3 currencies are: Hong Kong dollars, Italian lire, and First loss classes should take any loss arising to
Spanish pesetas. The ‘A-’ category is limited to ‘A-’ rated credits senior classes because of the failure of a swap
or ‘A-/A-1’ rated credits. If an ‘A-’ counterparty has an ‘A-2’ counterparty. Transactions should explicitly state
commercial paper rating, it must find an eligible replacement.
that all subordinated cash flows will be diverted to
make up any shortfalls. Claims resulting from
insufficient swap payments, a counterparty default,
♦ BRCR = Basis risk swap collateral requirement
or insufficient collateral necessary to find a replace-
ment counterparty will be the obligation of the first
♦ CM1 = Currency multiplier 1
loss class.
♦ CM2 = Currency multiplier 2
Swap collateral terms may be individually tailored to
♦ CCR = Collateral requirement for currency swaps
a transaction, provided that they have been reviewed
♦ Basis swap = Single currency, floating-to-floating,
and approved by Standard & Poor’s Structured
basis risk swaps.
Finance Ratings derivatives group.
For currency swaps, the derived collateral require-
ment needs to multiplied by a factor for the appro-
priate currency (see table 4). Table 4 Multiplication Factors For Currency
The accompanying chart demonstrates some sample Swaps
currency swap calculations. U.S. dollars 1.000
In the event of a downgrade of the swap Canadian dollars 1.020
New Zealand dollars 1.020
counterparty, a new required amount of collateral
Australian dollars 1.030
should be calculated and posted within 30 days to Hong Kong dollars 1.030
ensure the transaction rating remains unaffected. Belgian francs 1.040
Guarantees or third-party credit support may be British pounds 1.040
substituted for collateral at any time. Danish kroner 1.040
Dutch guilders 1.040
The collateral should be segregated and pledged European Currency Units 1.040
under normal ISDA requirements, and in the Euro 1.040
possession of the trustee or some other third party. French francs 1.040
Deutschemarks 1.040
Collateral is to be invested in eligible investments Yen 1.040
(other than the counterparty’s debt) in the currency Italian lire 1.045
of the rated securities and should be deposited in an Spanish pesetas 1.045
account in the name of the trustee or issuer. The Swedish kronor 1.045
Swiss francs 1.045
funds should be invested with an eligible institution
other than the swap provider collateralising its
obligations. If the funds do not mature before the
next interest payment due on the rated securities,
additional collateral may be required.
Costs associated with posting the collateral should
be borne by the swap provider.

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 Structured Finance Australia & New Zealand ¨ April 1999

Currency Swap Providers servicer, irrespective of whether the servicer is then

able to pay those moneys to a local account in the
Absorb Currency Convertability name of the nonresident currency swap provider.
And Transfer Risks Future imposition of withholding tax on the swap
agreement. To achieve a rating above the local
Issuers can now issue foreign currency debt that may
currency sovereign rating, typically the risk of a
be assigned a rating as high as the local currency
future imposition of withholding tax should be
sovereign rating, if highly rated swap providers
borne by the swap provider. Usually the swap
domiciled outside the country take local currency
provider should agree to make payments free of any
transfer and convertibility risk through cross-
set-off, counterclaim, deduction, or withholding.
currency swap agreements.
The SPE usually should be obligated to only make
A company’s local currency rating is often higher its payments net of any withholding tax.
than its foreign currency rating, as the foreign
Legal opinions required. A legal opinion, usually
currency rating includes factors such as transfer and
from a law firm eligible to practice law in the
other risks related to sovereign actions that may
jurisdiction governing the swap contract, should be
directly affect a company’s access to the foreign
provided that specifically addresses the enforceabil-
exchange needed for timely servicing of the rated
ity of the swap agreement and in particular:
obligation. Transfer and other direct sovereign risks
♦ That the payment of local currency according to
addressed in such ratings include the likelihood of
the terms of swap agreement constitutes full
foreign exchange controls and the imposition of
performance of the issuer’s payment obligations
other restrictions on the repayment of foreign debt.
under the swap agreement;
Generally, the terms that should be included in the
♦ That the imposition of exchange controls or
cross-currency swap agreement in addition to
other restrictions on currency exchange will not
Standard & Poor’s general criteria for swap agree-
be grounds for the swap counterparty to termi-
ments participating in rated structured finance
nate the swap, nor will such controls or restric-
transactions are as follows:
tions constitute an illegality for purposes of the
The definition of illegality under the swap agreement swap agreement; and
should explicitly exclude any currency exchange
♦ That the swap counterparty’s agreement to gross
controls, restrictions, or prohibitions. The swap
up for any withholding tax under the swap (and
provider should agree that imposition by any
the agreement to receive payments from the SPE
regulatory agency of the local jurisdiction of any
net of withholding tax) is enforceable.
currency exchange controls, restrictions or prohibi-
tions will not be deemed to be an illegality under the APPLYING STANDARD & POOR’S PROBABILISTIC
swap agreement, or entitle the swap provider to APPROACH TO JOINT SUPPORT
terminate the swap. Also, proper payment by the Issuers with high local currency ratings may find a
special-purpose entity (SPE) according to the terms very limited number of highly rated swap providers
of the swap agreement should continue to be proper who can be used to exceed the foreign currency
performance by the SPE of its payment obligations sovereign rating. Standard & Poor’s probabilistic
and the swap provider’s obligations should be approach to joint support allows issuers of struc-
unaffected. tured finance securities the flexibility to:
Proper payment. An acceptable definition of ♦ Increase the number of available counterparties
“proper payment” in the local currency for purposes by using counterparties with ratings that are
of the cross currency swap will depend on Standard lower than the ratings sought on the securities;
& Poor’s assessment of the magnitude of exchange and
control risk for any given country. For instance, in ♦ Partially insulate the ratings assigned to securities
Australia, proper payment typically is defined as from counterparty downgrade risk.
delivery of Australian dollars by the SPE to an
This probabilistic approach to jointly supported
Australian bank account in the name of the swap
obligations in structured finance ratings recognises
provider. Standard & Poor’s envisages that this may
that default risk is reduced where two companies
not be sufficient in some countries, and that proper
guarantee the same obligation. For example, if two
payment may need to be linked to the asset perform-
entities rated ‘AA’ support a single obligation,
ance and payment by the underlying obligors to the
Standard & Poor’s believes that the likelihood of the

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 Structured Finance Australia & New Zealand ¨ April 1999

obligation defaulting is commensurate with a ‘AAA’ ♦ The jointly supported foreign currency sovereign
rating. rating implied from the jurisdictions of the two
To obtain a rating on securities that is above the counterparties should be equivalent to the rating
foreign currency sovereign rating where the joint sought on the securities. Economic performance
swap providers are not rated as highly as the rating in the two countries should not be highly corre-
sought on the foreign currency securities, there lated. (Both swap providers may be located in the
typically are two factors that should independently same country if the foreign currency rating
achieve a level of comfort consistent with the rating assigned to the sovereign is at least equivalent to
sought on the securities: the rating sought on the securities).
♦ The jointly supported counterparty rating implied
from the two individual swap provider ratings
should be equivalent to the rating sought on the
securities; and

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 Structured Finance Australia & New Zealand ¨ April 1999

‘AAAt’ Swaps Approved In Struc- Collateral is to be invested in eligible investments

(other than counterparty debt) in the currency of the
tured Finance Transactions rated securities and held in the name of the trustee
As a result of the growing and increasingly liquid or issuer. The funds should be invested with an
market for swaps, Standard & Poor’s will rate eligible institution other than the swap provider
structured finance transactions with swaps from collateralising its obligations. If the funds do not
‘AAAt’ rated derivative product companies. The mature before the next interest payment due on the
company will have to post additional collateral with rated securities, additional collateral may be re-
the trustee, to ensure sufficient funds are available to quired.
replace the swap during market swings. The costs associated with posting the collateral
should be borne by the swap provider.
Terminating derivative product companies are rated
on their ability to pay the mark to market at Derivative product companies will have to post
termination. Structured financings, however, need collateral on a weekly basis, with a cure period of
additional protection against movement in swap three days. Annual audits should be amended to
values between termination and replacement. specifically verify a sample of swap calculations and
collateral postings. All swaps will be reviewed to
Volatility buffers for ‘AAA’ rated transactions are:
ensure the swap is consistent with the overall risk
♦ Maturities up to five years: 0.60%
profile of the derivative product company. Guaran-
♦ Maturities up to 10 years: 1.05% tees or third-party credit support may be substituted
♦ Maturities more than 10 years: 1.50% for collateral at any time.
Collateral will be expressed as a percentage of the First loss classes should take any loss arising to
notional amount. senior classes because of the failure of a swap
These amounts were derived from data and research counterparty. Transactions will need to explicitly
pertaining to interest rate and currency fluctuations state that all subordinated cash flows will be
in the past 7-10 years. They will be updated when diverted to make up any shortfalls. Claims resulting
currency regimes change. from insufficient swap payments, a counterparty
Single currency, floating-to-floating, basis risk swaps default, or insufficient collateral necessary to find a
will require only 10% of the above amounts. For replacement counterparty, will be the obligation of
currency swaps, the volatility buffer needs to be the first loss class.
multiplied by a factor for the appropriate currency
(see table 1).
Table 1 Multiplication Factors For Currency
CALCULATING SWAP COLLATERAL Swaps
Currency swaps will be calculated as: U.S. dollars 1.000
VB x CM1 x CM2 = CCR Canadian dollars 1.020
New Zealand dollars 1.020
Where: Australian dollars 1.030
♦ VB = Volatility buffer that equals the amount of Hong Kong dollars 1.030
Belgian francs 1.040
any given currency derived by taking the appro-
British pounds 1.040
priate percentage of the swap’s notional balance. Danish kroner 1.040
♦ CM1 = Currency multiplier 1. Dutch guilders 1.040
♦ CM2 = Currency multiplier 2. European Currency Units 1.040
Euro 1.040
♦ CCR = Collateral requirement for currency French francs 1.040
swaps. Deutschemarks 1.040
The collateral should be segregated and pledged Yen 1.040
Italian lire 1.045
under normal International Swap Dealers Associa- Spanish pesetas 1.045
tion Inc. (ISDA) requirements and in the possession Swedish kronor 1.045
of the trustee or some other third party. Swiss francs 1.045

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 Structured Finance Australia & New Zealand ¨ April 1999

Uniform Consumer Credit Code— Mortgages for residential owner occupation ex-
ecuted after Nov. 1, 1996 and mortgages containing
Implications For The Rating Proc- continuing credit (this includes revolving home
ess equity loans but excludes mortgages incorporating
redraw facilities) provisions executed before
OVERVIEW Nov. 1, 1996 are regulated under the code. Further,
certain provisions of the code do not apply to
The Uniform Consumer Credit Code regulates all
residential, owner-occupied loans with an initial
contracts entered into by credit providers with
loan balance exceeding A$125,000.
individuals where the credit is wholly or predomi-
nantly for personal, domestic, or household pur- Code Regulations
poses. The code, which is state-based legislation The code requires credit providers to make detailed
introduced across Australia on Nov. 1, 1996, disclosure in their contract documents and to
replaces a maze of individual state credit acts which provide these disclosures before the debtor enters
previously governed the provision of consumer the contract. Credit providers are obliged to comply
credit in Australia. with certain requirements as to procedures and form
Application Of The Code in relation to supporting securities and guarantees.
There also are general restrictions on the way in
The code regulates credit if:
which interest may be charged and adjusted and on
♦ The debtor is a natural person (or strata corpora-
additional fees that may be imposed.
tion);
Procedures for enforcement and repossession will be
♦ It is provided, or intended to be provided, wholly
regulated. For example, lenders will not be able to
or predominantly for personal, domestic, or
repossess mortgaged goods if the amount owing is
household purposes;
less than 25% of the amount financed or A$10,000,
♦ A charge is, or may be, made for providing the
whichever is the lesser.
credit; and
The code also regulates the way in which the terms
♦ It is provided in the course of, or incidentally to,
and operation of credit contracts can be varied,
any business.
particularly where the variation is unilaterally made
The types of facilities covered by the code are: by the credit provider. The code gives debtors,
♦ Personal loans; mortgagors, and guarantors the right to re-open
♦ Bank term loans; contracts, mortgages, and guarantees on grounds of
♦ Overdraft facilities, and other continuing credit “hardship” (sections 66 and 68) or where the
contracts; contract is deemed to be “unjust” (section 70).
♦ Credit card facilities; Requirements For Commissions
♦ Credit and debit facilities to the extent that credit
Commissions on consumer credit must not exceed
is provided;
20% of the premium. Insurance commissions and
♦ Housing loans; any commissions paid by, or to, a credit provider
♦ Consumer leases; must be disclosed if they are ascertainable. The code
♦ Hire purchase agreements; and also requires the production of a statement that a
♦ Retail credit commission is payable, and a statement as to who is
The code does not apply to a number of financial paying the commission and who is receiving it.
assets, including: Marketing And Advertising
♦ Charge card receivables;
The code also contains limits on the way credit
♦ Trade receivables; contracts can be marketed, and prohibitions on
♦ Government car leases; making false or misleading representations in
♦ Leases that are for an indefinite period; relation to the inducement of a person to enter into
♦ Loans made wholly or predominantly for a credit contract. The code demands that the annual
business or investment purposes; percentage rate is stated in advertising material, and
♦ Bill discount facilities; and any fees and charges must be stated if applicable.
♦ Short-term credit (less than 62 days).

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 Structured Finance Australia & New Zealand ¨ April 1999

Penalties provider to the trustee, for any civil penalties that

For a breach of the code’s “key requirements” the may arise. The deed of indemnity and the trust deed
court can impose a civil penalty, which might be the should state that the trustee must seek relief initially
loss of interest charges, up to a maximum of under the indemnity before exercising its statutory
A$500,000 per breach. Loss of interest charges is no right to recover against the assets of the trust.
longer automatic and will be at the discretion of the For MBS transactions where third-party mortgage
court. (The court will be influenced by which party originators introduce loans to a program, an
makes the application of the breach.) indemnity pursuant to regulation 76 should be
There also are provisions for other breaches that will provided by each originator to the credit provider
result in criminal liability and fines of up to for any civil penalties as a result of any breach of the
A$10,000. “key requirements” under the code.
Mitigation Of “Hardship” Risk (Sections 66 And 68)
STANDARD & POOR’S RATING REQUIREMENTS
FOR CODE REGULATED ASSETS Additional risk could be introduced to MBS and
ABS programs as a result of the application of
The sections below describe the approach Standard
section 66 or section 68 of the code, which deals
& Poor’s takes in rating mortgage-backed securities
with borrower hardship. Most mortgage insurance
(MBS) and asset-backed securities (ABS). In sum-
explicitly covers this risk. Should a mortgage insurer
mary, Standard & Poor’s sees the need for:
not cover this risk, Standard & Poor’s will seek to
♦ Additional structural enhancement in some
have additional credit enhancement incorporated
programs;
into the structure and to have the final rated
♦ Legal sign-off for documentation compliance; maturity date of MBS extended significantly beyond
♦ Specific due diligence in relation to code compli- the maturity date of the underlying assets.
ance; and
Mitigation Of “Unjust Contract” Risk (Section 70)
♦ Annual compliance audits.
The code gives the credit tribunal the power to re-
STRUCTURAL ENHANCEMENTS open unjust credit contracts, mortgages, and
guarantees where:
Mitigation Of Civil Penalty Risk
♦ Unfair tactics have been employed in the origina-
The code imposes civil penalties on credit providers
tion of the contract, mortgage, or guarantee;
who fail to comply with “key requirements” of the
♦ The credit provider should have known that the
code. To protect against this potential liability,
borrower could not afford the loan; or
Standard & Poor’s may require that additional
credit support of up to A$500,000 be available to ♦ Where the terms of the contract could only be
the issuer to provide a degree of protection against met with some financial hardship.
these penalties. To mitigate the credit risk as a result of the opera-
Consideration will be given to the nature of the tion of this clause, additional credit support may
organisation of which the credit provider is part. need to be included in MBS and ABS programs. This
Standard & Poor’s also will consider the style of risk may be covered by the professional indemnity
loan origination and the policies and procedures of insurance of the credit provider. However, Standard
the credit provider. & Poor’s will only give credit to this insurance
coverage if the policy is restructured to explicitly
Credit providers that are wholly owned subsidiaries
cover the liability created by a breach of section 70.
of financial institutions may not need to provide this
It will also be necessary for the insured to be able to
element of additional support. This may be the case
make a claim against the policy in a timely manner.
where the institution has a highly developed culture
of risk management and is assessed to have the As a minimum, the priority of payments set out in
organisational and financial capacity to maintain the transaction documents should require excess
compliance with the code. spread to be used to offset any principal or interest
loss incurred that cannot be claimed under any
Trust Structures insurance policy (mortgage insurance for MBS) or
Where a trust structure, rather than a corporate other form of credit enhancement. Where the seller
structure, is used for the issue of MBS or ABS, and the servicer have not completed the audit
Standard & Poor’s expects an indemnity pursuant to compliance certification, or the audit highlighted
regulation 75 (1) and (2) to be given by the credit code compliance deficiencies, the yield on the assets

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 Structured Finance Australia & New Zealand ¨ April 1999

and other authorised investments should exceed the ♦ Loan underwriting criteria;
issuer’s interest costs and other expenses by a margin ♦ Comprehensive review of policy and procedures
of up to 25 basis points. manuals;
♦ Scope of staff training, including training relating
LEGAL CERTIFICATION OF LOAN AND ANCILLARY
to the code;
DOCUMENTATION
♦ Historical data on loan application accept/reject
Standard & Poor’s expects the assets backing the
rates;
issue of MBS and ABS will be documented using
♦ Historical record of defaults and claims made
uniform, plain English loan and mortgage documen-
under mortgage insurance policies (if applicable);
tation drafted by qualified legal practitioners. Credit
♦ Nature and capacity of computer software and
providers also should have staff training manuals on
the code drafted by qualified legal practitioners. It is hardware;
further expected that MBS and ABS issuers will have ♦ Information reporting capability; and
marketing material vetted by their legal counsel. ♦ Professional indemnity insurance.
Standard & Poor’s will seek from the legal counsel AUDIT COMPLIANCE CERTIFICATION
of MBS and ABS issuers, a legal opinion stating that
To verify that the code’s operational standards are
the terms and conditions of the loan and/or asset
being met, an audit compliance letter from the
documentation comply with the provisions of the
issuer’s auditor should be provided to Standard &
code. In addition, Standard & Poor’s expects that
Poor’s. This must be provided at the time of the
the issuer’s counsel also will certify that training and
initial issue of MBS and ABS and, thereafter, on an
policy procedures manuals developed for the
annual basis. The letter should state that the
introduction of the code meet the code’s standards.
operations of the credit provider comply with key
Should the loan or asset documentation change in
aspects of the code. It is expected by Standard &
the future, a further opinion will be necessary to
Poor’s that this certification will focus on specific
certify that the amended document complies with
operational areas, including:
the code.
♦ The credit provider’s compliance with loan
In addition, for MBS transactions, the credit
origination guidelines;
provider should provide representations to Standard
♦ The appropriateness of tests employed to ascer-
& Poor’s that the loans initially included or subse-
tain loan affordability;
quently substituted into the mortgage pools have
been originated and settled in accordance with the ♦ Evidence of borrower income;
requirements of the code. ♦ Full disclosure of all fees and interest expenses to
borrowers;
EXPANDED DUE DILIGENCE ♦ Calculation of interest (and default interest) and
Credit providers will need to satisfy Standard & principal payments;
Poor’s that their policies, procedures, systems, and ♦ Allocation of principal against the outstanding
staff training meet the standards necessary to loan balance;
conform with the code. This will involve the ♦ Timely and accurate production of borrower
completion of a more specific and frequent due statements;
diligence review. General topics covered will include: ♦ Adequacy of the credit code staff training
♦ Origination practices; programs; and
♦ Details of any third-party originators; ♦ Maintenance of a credit code complaints register.
♦ Product promotion and advertising material;
♦ Details of valuers and solicitors used in the
program;

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 Structured Finance Australia & New Zealand ¨ April 1999

Ratings Index Rating

The following is a comprehensive list of structured finance ratings in Australia and New Zealand at March
1999. The listing is organised alphabetically by the name of the transaction.

Rating
Abel Funding Pty. Ltd.
Australian CP prog auth amt A$2 bil: asset-backd A-1+
ACE Overseas Corp.*
CP prog auth amt US$2.5 bil: asset-backd A-1+
ACE Overseas Ltd.*
Euro CP prog auth amt US$1 bil: asset-backd A-1+
Asset Based Financing Trust
A$683.2 mil sr fltg-rate class A nts due 2005 AA-
A$17.5 mil sub fltg-rate class B nts due 2008 BBB
Asset Collateralised Entity Ltd.
Australian CP prog auth amt A$1.5 bil: ser 2 asset-backd A-1+
Euro CP prog auth amt US$1 bil: ser 2 asset-backd A-1+
Australian Barley Board
CP prog nts auth amt A$400 mil: fully supported A-1+
Australian Mortgage Securities Ltd. AMS-ARMS II Fund I
A$112 mil tranche 1 pass-thru bnds 1 mth BBR + 0.36% due 2020 AAA
A$32 mil tranche 2 pass-thru bnds 1 mth BBR + 0.63% due 2020 AAA
A$6 mil tranche 3 pass-thru bnds 1 mth BBR + 1.18% due 2020 AA-
Australian Mortgage Securities Ltd. AMS-ARMS II Fund II
A$485 mil tranche 1 pass-thru bnds 1 mth BBR + 0.19% due 2029 AAA
A$15 mil tranche 2 pass-thru bnds 1 mth BBR + 0.48% due 2029 AA-
Australian Securitisation Corp. No. 1 Ltd.
A$50 mil prom nts A-1+
Banksia Series 1 Trust
A$122 mil mtg-backd bnds 1 mth BBSW + 0.27% due 2025 AAA
Brentwood (Australis) Ltd.
A$39.5 mil zero cpn bnds due 2008 AA
A$28.6 mil scheduled indexed bnds due 2008 AA
BSF Bonds No. 1 Ltd.
A$30 mil CPI indexed fxd principal repayment bnds due 2017 AAA
BSF Bonds No. 2 Ltd.
A$28 mil CPI indexed fxd principal repayment bnds due 2014 AAA
Burnie Hospital Ltd.
Tranche A A$28.7 mil CPI indexed annuity bnds due 2010 AAA
Tranche B A$2.6 mil CPI indexed annuity bnds due 2000 AAA
Construction and Development Co. Ltd.
A$166 mil CDC 4% capital indexed bnds due 2008 AAA

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

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 Structured Finance Australia & New Zealand ¨ April 1999

Rating
Corporate Asset Securitisation Australia Ltd. Inc.*
Australian CP prog auth amt US$1.5 bil: asset-backd A-1+
Corporate Australasian Securitisation Transactions Pty. Ltd.*
CP prog auth amt A$1 bil: asset-backd A-1+
Crusade CP No. 1 Pty. Ltd.
CP prog auth amt A$500 mil: asset-backd A-1
Crusade Euro Trust No. 1 of 1998
US$496 mil class A mtg-bckd pass-thru nts 3 mth LIBOR + 0.18% due 2029 AAA
US$4 mil class B mtg-bckd pass-thru nts 3 mth LIBOR + 0.30% due 2029 AA+
Crusade Euro Trust No. 2 of 1998
US$314 mil class A mtg-bckd pass-thru nts AAA
US$11 mil class B mtg-bckd pass-thru nts AA-
Crusade Trust No. 1 of 1997
A$500 mil mtg-backd pass-thru bnds 90 day BBSW + 0.23% due 2029 AAA
Diners Club Master Trust
A$10 mil ser 1995-5-A 8.37% due 2000 AAA
A$2.05 mil ser 1995-5-B 10.06% due 2000 N.R.
A$30 mil ser 1996-2-A 1 mth BBR + 0.18% due 2000 AAA
A$4.5 mil ser 1996-2-B 1 mth BBR + 2% due 2000 N.R.
A$20 mil ser 1996-3-A 1 mth BBR + 0.18% due 2000 AAA
A$3 mil ser 1996-3-B 1 mth BBR + 2% due 2000 N.R.
A$20 mil ser 1996-4-A 1 mth BBR + 0.18% due 2000 AAA
A$3 mil ser 1996-4-B 1 mth BBR + 2% due 2000 N.R.
A$10 mil ser 1996-5-A 1mth BBR + 0.15% due 2000 AAA
A$1.5 mil ser 1996-5-B 1 mth BBR + 2% due 2000 N.R.
A$5 mil ser 1996-6-A 1 mth BBR + 0.15% due 2000 AAA
A$0.75 mil ser 1996-6-B 1 mth BBR + 2% due 2000 N.R.
A$5 mil ser 1996-7-A 1 mth BBR + 0.15% due 2000 AAA
A$0.75 mil ser 1996-7-B 1 mth BBR + 2% due 2000 N.R.
A$5 mil ser 1996-8-A 1 mth BBR + 0.15% due 2000 AAA
A$0.75 mil ser 1996-8-B 1 mth BBR + 2% due 2000 N.R.
A$15 mil ser 1997-1-A 1 mth BBR + 0.17% due 2000 AAA
A$2.25 mil ser 1997-1-B 1 mth BBR + 2% due 2000 N.R.
A$15 mil ser 1997-2-A 1 mth BBR + 0.17% due 2000 AAA
A$2.25 mil ser 1997-2-B 1 mth BBR + 2% due 2000 N.R.
A$10 mil ser 1997-3-A 1 mth BBR + 0.17% due 2000 AAA
A$1.5 mil ser 1997-3-B 1 mth BBR + 2% due 2000 N.R.
A$10 mil ser 1997-4-A 1 mth BBR + 0.19% due 2001 AAA
A$1.5 mil ser 1997-4-B 1 mth BBR + 2% due 2001 N.R.
A$10 mil ser 1997-5-A 1 mth BBR + 0.19% due 2001 AAA
A$1.5 mil ser 1997-5-B 1 mth BBR + 2% due 2001 N.R.
A$5 mil ser 1997-6-A 1 mth BBR + 0.19% due 2001 AAA
A$0.75 mil ser 1997-6-B 1 mth BBR + 2% due 2001 N.R.
A$5 mil series 1998-1-A 1 mth BBSW + 0.23% due 2001 AAA
A$0.75 mil series 1998-1-B 1 mth BBSW + 2.00% due 2001 N.R.
A$15 mil series 1998-2-A 1 mth BBSW + 0.23% due 2001 AAA
A$2.25 mil series 1998-2-B 1 mth BBSW + 2.00% due 2001 N.R.
A$10 mil series 1998-3-A 1 mth BBSW + 0.23% due 2001 AAA
A$1.5 mil series 1998-3-B 1 mth BBSW + 2.00% due 2001 N.R.
A$15 mil series 1998-4-A 1 mth BBSW + 0.23% due 2001 AAA

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 109

 Structured Finance Australia & New Zealand ¨ April 1999

Rating
A$2.25 mil series 1998-4-B 1 mth BBSW + 2.00% due 2001 N.R.
A$10 mil series 1998-5-A 1 mth BBSW + 0.23% due 2001 AAA
A$1.5 mil series 1998-5-B 1 mth BBSW + 2.00% due 2001 N.R.
A$15 mil series 1998-6-A 1 mth BBSW + 0.23% due 2001 AAA
A$2.25 mil series 1998-6-B 1 mth BBSW + 2.00% due 2001 N.R.
A$10 mil series 1998-7-A 1 mth BBSW + 0.23% due 2001 AAA
A$1.5 mil series 1998-7-B 1 mth BBSW + 2.00% due 2001 N.R.
A$5 mil series 1998-8-A 1 mth BBSW + 0.23% due 2001 AAA
A$0.75 mil series 1998-8-B 1 mth BBSW + 2.00% due 2001 N.R.
A$10 mil series 1998-9-A 1 mth BBSW + 0.23% due 2001 AAA
A$1.5 mil series 1998-9-B 1 mth BBSW + 2.00% due 2001 N.R.
A$5 mil series 1998-10-A 1 mth BBSW + 0.23% due 2001 AAA
A$0.75 mil series 1998-10-B 1 mth BBSW + 2.00% due 2001 N.R.
A$5.0 mil series 1998-11-A 1 mth BBSW + 0.23% due 2001 AAA
A$0.75 mil series 1998-11-B 1 mth BBSW + 2.00% due 2001 N.R.
A$8.0 mil series 1998-12-A 1 mth BBSW + 0.23% due 2001 AAA
A$1.2 mil series 1998-12-B 1 mth BBSW + 2.00% due 2001 N.R.
A$7.0 mil series 1998-13-A 1 mth BBSW + 0.23% due 2001 AAA
A$1.05 mil series 1998-13-B 1 mth BBSW + 2.00% due 2001 N.R.
Eden Park Trust #1
A$97 mil sr fltg-rate class A1 nts due 2001 AAA
A$97 mil sr fltg-rate class A2 nts due 2003 AAA
A$6 mil sub fltg-rate class B nts due 2003 A
Endeavour Mortgage Trust Funds
NZ$2.998 mil GIF 4004 9% due 1999 AA-
NZ$3.886 mil GIF 4005 9% due 1999 AA-
FANMAC Ltd.
Premier Trust No. 17 A$500 mil 15% due 2002 AAA
Premier Trust No. 18 A$300 mil 14.7% due 1999 AAA
Premier Trust No. 19/A AAA
Premier Trust No. 19/B A$330 mil 13.95% due 2006 AAA
Premier Trust No. 19/C A$150 mil 13.8% due 2006 AAA
Premier Trust No. 20/A AAA
Premier Trust No. 20/B A$180 mil 12.5% due 2007 AAA
Premier Trust No. 20/C A$100 mil 12.3% due 2007 AAA
Premier Trust No. 21/A AAA
Premier Trust No. 21/B AAA
Premier Trust No. 21/C A$150 mil 11.75% due 2001 AAA
Premier Trust No. 22 A$160 mil 11.4% due 2001 AAA
Premier Trust No. 23 A$90 mil 10.82% due 2002 AAA
Premier Trust No. 25 A$60 mil 10.33% due 2002 AAA
Premier Trust No. 26/A AAA
Premier Trust No. 26/B A$110 mil fltg rate bnds due 2002 AAA
Premier Trust No. 26/C A$50 mil fltg rate bnds due 2002 AAA
Premier Trust No. 27 A$100 mil 10.31% due 2002 AAA
FATO Ltd.
A$41 mil 11.19% amortizing bnds due 2003 AAA
Financial Assets Specialised Trust No. 1 (FAST Trust No. 1)
CP prog auth amt A$100 mil: asset-backd A-1
Financial Assets Specialised Trust No. 2 (FAST Trust No. 2)
CP prog auth amt A$100 mil: asset-backd A-1

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 110

 Structured Finance Australia & New Zealand ¨ April 1999

Rating
Financial Assets Specialised Trust No. 3 (FAST Trust No. 3)
CP prog auth amt A$100 mil: asset-backd A-1+
Ford Credit Receivables Trust 1998-1
A$58.841 mil 5.355% 1998-1-A1 fixed-rate pass thru bonds due 2004 AAA
A$43.577 mil 5.590% 1998-1-A2 fixed-rate pass thru bonds due 2004 AAA
A$28.089 mil 5.620% 1998-1-A3 fixed-rate pass thru bonds due 2004 AAA
Generic Loan Asset Securitisation Structures Ltd.
Australian CP prog auth amt A$600 mil: ser 1 A-1+
Home Owner Mortgage Enhanced Securities Ltd. (HOMES)
CP prog auth amt A$1 bil: ser 1 residential mtg-backd A-1+
A$30 mil class A2 (a) ser 1998-1 fltg rate MTN prog BBSW + 0.11% due 2028 AAA
A$130 mil class A2 (b) ser 1998-1 fltg rate MTN prog BBSW + 0.11% due 2028 AAA
A$59.9 mil series 1998-2 class A1(a) fltg-rate MTNs BBSW + 0.13% due 2026 AA
A$42 mil series 1998-2 class A1(b) fltg-rate MTNs BBSW + 0.13% due 2026 AA
A$59.9 mil series 1998-2 class A2(a) fltg-rate MTNs BBSW + 0.13% due 2026 AA
A$42 mil series 1998-2 class A2(b) fltg-rate MTNs BBSW + 0.13% due 2026 AA
A$58 mil series 1998-2 class A3(a) fltg-rate MTNs BBSW + 0.13% due 2031 AA
A$42 mil series 1998-2 class A3(b) fltg-rate MTNs BBSW + 0.13% due 2031 AA
Initial Corporate Obligation Notes Pty. Ltd.
CP prog auth amt A$400 mil: asset-backd A-1+
Initial Corporate Obligation Notes Trust
A$310.5 mil ser A1 nts 3 mth BBSW + 0.17% due 2003 AAA
A$200 mil ser A2 nts 3 mth BBSW + 0.25% due 2003 AAA
A$40 mil ser B1 nts 3 mth BBSW + 0.65% due 2003 N.R.
A$35.5 mil ser B2 nts 3 mth BBSW + 0.65% due 2003 N.R.
Interstar Pool AC41 Trust
A$50 mil class A sr certificates 9% due 2001 AAA
A$16 mil class B companion certificates 9% due 2001 AA-
Interstar Pool DD12 Trust
A$128 mil class A sr fltg rate certificates due 2012 AAA
Interstar Pool DD14 Trust
A$156 mil class A sr fltg rate certificates due 2014 AAA
A$27 mil class B1 companion fltg rate certificates due 2014 AA-
A$12 mil class B2 companion fltg rate certificates due 2014 AA-
Interstar RD25 Master Trust
A$720 mil class A sr certificates due 2025 AAA
A$80 mil class B sub certificates due 2025 AA-
Jem Bonds Ltd.
A$150 mil interest only bnds 9% due 2006 AAA
JEMstone Fund
A$130 mil tranche 1 pass-thru CMBS 30 day BBSW + 0.27% AAA
A$14.1 mil tranche 2 pass-thru CMBS 30 day BBSW + a margin AA
A$11.9 mil tranche 3 pass-thru CMBS 30 day BBSW + a margin BBB
A$13 mil tranche 4 pass-thru CMBS 30 day BBSW + a margin N.R.
JEM Warehouse Bonds Pty. Ltd.
A$58.34 mil fixed-rate bnds A-

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 111

 Structured Finance Australia & New Zealand ¨ April 1999

Rating
Keystart Bonds Ltd.
2M (Keystart Bonds)
Ser 1 A$156 mil 90 day BBR rate + 0.5% due 2024 AA+
Ser 2 A$78 mil 18 mth swap rate + 0.77% due 2024 AA+
Ser 3 A$78 mil 18 mth swap rate + 0.77% due 2024 AA+
Ser 4 A$78 mil 18 mth swap rate + 0.77% due 2024 AA+
Ser 5 A$78 mil 18 mth swap rate + 0.77% due 2024 AA+
Ser 6 A$78 mil 18 mth swap rate + 0.77% due 2024 AA+
Ser 7 A$78 mil 18 mth swap rate + 0.77% due 2024 AA+
Ser 1 A$26 mil 90 day BBR rate + 0.31% due 2024 AA+
Ser 2 A$13 mil 18 mth swap rate + 0.43% due 2024 AA+
Ser 3 A$13 mil 18 mth swap rate + 0.43% due 2024 AA+
Ser 4 A$13 mil 18 mth swap rate + 0.43% due 2024 AA+
Ser 5 A$13 mil 18 mth swap rate + 0.43% due 2024 AA+
Ser 6 A$13 mil 18 mth swap rate + 0.43% due 2024 AA+
Ser 7 A$13 mil 18 mth swap rate + 0.43% due 2024 AA+
Australian CP prog auth amt A$750 mil A-1+
A$1 bil government supported residential mtg-backd MTN prog AA+
Longreach CP Ltd.
A$600 mil series 1 CP prog A-1+
MBS New Zealand No. 1 Ltd.
NZ$75 mil tranche 1 mtg-backd securities due 2029 AAA
NZ$63.75 mil tranche 2 mtg-backd securities due 2029 AAA
NZ$11.25 mil tranche 3 mtg-backd securities due 2029 AA-
MBS New Zealand No. 2 Ltd.
NZ$75 mil tranche 1 mtg-backd securities due 2030 AAA
NZ$63.75 mil tranche 2 mtg-backd securities due 2030 AAA
NZ$11.25 mil tranche 3 mtg-backd securities due 2030 AA-
Medical Mortgages Ltd.
CP prog auth amt NZ$100 mil: residential mtg-backd A-1+
MI Trust
A$169.1 mil pass-thru MBS class A-1 due 2026 AA
A$169.1 mil pass-thru MBS class A-2 due 2026 AA
A$2.7 mil sub pass-thru MBS class B due 2026 AA-
Mortgage Corp. of New Zealand No. 2 Ltd.
NZ$70 mil ser 4 bnds 8% due 2000 AA-
Mount Gambier Hospital Ltd.
A$23.75 mil CPI indexed annuity bnds due 2022 AA
MTF Securities Ltd.
Euro CP prog auth amt US$500 mil: asset-backd A-1+
Mustang No. 1 Trust
A$1 bil residential mtg-bckd CP prog A-1+
National Mutual Home Loans Securitisation Fund No. 1
A$110 mil mtg-backd pass-thru bnds 90 day BBR + 0.26% due 2023 AAA
National Mutual Home Loan Securitisation Fund No. 2
A$110 mil mtg-backd pass-thru bnds 90 day BBSW + 0.24% due 2023 AAA
National Mutual Home Loan Securitisation Fund No. 3
A$110 mil mtg-backd pass-thru bnds 90 day BBSW + 0.27% due 2024 AAA
*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 112

 Structured Finance Australia & New Zealand ¨ April 1999

Rating
New Zealand Receivables Corp. Ltd.
CP prog auth amt NZ$250 mil: asset-backd A-1+
NSW (Jersey) Ltd.
A$4,208,750 zero cpn interest bnds due 1999 AAA
A$4,208,750 zero cpn interest bnds due 1999 AAA
A$4,208,750 zero cpn interest bnds due 2000 AAA
A$4,208,750 zero cpn interest bnds due 2000 AAA
A$4,208,750 zero cpn interest bnds due 2001 AAA
A$4,208,750 zero cpn interest bnds due 2001 AAA
A$4,208,750 zero cpn interest bnds due 2002 AAA
A$4,208,750 zero cpn interest bnds due 2002 AAA
A$4,208,750 zero cpn interest bnds due 2003 AAA
A$4,208,750 zero cpn interest bnds due 2003 AAA
A$4,208,750 zero cpn interest bnds due 2004 AAA
A$4,208,750 zero cpn interest bnds due 2004 AAA
A$4,208,750 zero cpn interest bnds due 2005 AAA
A$4,208,750 zero cpn interest bnds due 2005 AAA
A$4,208,750 zero cpn interest bnds due 2006 AAA
A$129,500,000 zero cpn principal bnds due 2006 AAA
Orion Funding Pty. Ltd.
A$500 mil asset-bckd CP prog A-2
Pacific Retail Securities Ltd.
New Zealand CP prog auth amt NZ$250 mil A-1+
Paper Bond Ltd.
A$105.8 mil class A CPI indexed bnds due 2000 AAA
PAV Hospital Funding Ltd.
A$14 mil MTN prog 3 mth BBSW + 0.18% due 2006 AAA
Port Augusta Hospital Ltd.
A$21 mil CPI bnds due 2022 AA
POLAR Finance Ltd.
CP prog auth amt A$1 bil: ser 1 asset-backd A-1+
Prime Asset Vehicle Ltd.
CP prog auth amt US$1 bil: ser 2 A-1+
CP prog auth amt A$500 mil: ser 4 A-1+
Prime Asset Vehicle No. 2 Ltd.
A$88.7 mil MBIA ser 1 MTN 90 day BBR + 0.3% due 2006 AAA
CP prog auth amt US$500 mil: BHP ser A-1
CP prog auth amt A$150 mil: MBIA (Loy Yang B) ser A-1+
Prime Investment Entity Ltd.
CP prog auth amt A$500 mil: asset-backd A-1+
Progress 1997-1 Trust
A$200 mil class A1 sr mtg-backd fltg rate nts 30 day BBSW + 0.14% due 2030 AAA
A$160 mil class A2 sr mtg-backd semiannual fxd-rate nts 6% (fxd until 2002) due 2030 AAA
A$125 mil class A3 sr mtg-backd fltg rate pass-thru nts 30 day BBSW + 0.25% due 2030 AAA
A$15 mil class B sub mtg-backd fltg rate pass-thru nts 30 day BBSW + 0.37% due 2030 AA-

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 113

 Structured Finance Australia & New Zealand ¨ April 1999

Rating
Property Income Investment Trust
A$30 mil tranche 4 MTN 90 day BBR + 0.2% due 2000 AA
A$30 mil tranche 6 ser 1 MTN 90 day BBR + 0.2% due 2000 AA
A$8 mil tranche 6 ser 2 MTN 90 day BBR + 0.2% due 2000 AA
A$17 mil tranche 7 MTN 90 day BBR + 0.16% due 2000 AA
A$18 mil tranche 9 MTN 90 day BBSW + 0.10% due 2000 AA
A$46.5 mil tranche 10 MTN 90 day BBSW + 0.13% due 2000 AA
A$16.5 mil tranche 11 MTN 90 day BBSW + 0.20% due 2001 AA
PUMA Finance Ltd.
US$105 mil class A1 ser E-1 (1a) pass-thru nts LIBOR + 0.08% due 2029 AAA
US$560 mil class A2 ser E-1 (1a) pass-thru nts LIBOR + 0.13% due 2029 AAA
US$35 mil class B ser E-1 (1b) pass-thru nts LIBOR +0.27% due 2029 AA-
US$180 mil class A1 ser E-2 (1a) pass-thru nts LIBOR + 0.13% due 2031 AAA
US$666 mil class A2 ser E-2 (1a) pass-thru nts LIBOR + 0.19% due 2031 AAA
US$54 mil class B ser E-2 (1b) pass-thru nts LIBOR + 0.375% due 2031 AA-
US$120mil class A1 ser E-2 (2a) pass-thru notes due 2031 AAA
US$330mil class A2 ser E-2 (2a) pass-thru notes due 2031 AAA
PUMA Masterfund E-1
A$866.23 mil ser A sr mtg-backd pass-thru certificates due 2029 AAA
A$45.59 mil ser A sub mtg-backd pass-thru certificates due 2029 AA-
PUMA Masterfund E-2
A$1.2 bil ser 1 sr mtg-backd pass-thru certificates due 2031 AAA
A$79.3 mil ser 1 sub mtg-backd pass-thru certificates due 2031 AA-
A$725.8 mil ser 2 mtg-backed pass-thru certificates AAA
PUMA Masterfund P-5
A$720 mil ser A tranche 1 pass-thru bnds 90 day BBR + 0.3% due 2028 AAA
A$36 mil ser A tranche 2 pass-thru bnds 90 day BBR + 0.39% due 2028 AAA
A$44 mil ser A tranche 3 pass-thru bnds 90 day BBR + 0.85% due 2028 AA-
A$300 mil ser B tranche 1F 7.5% s.a. to 2000 then fltg rate pass-thru bnds due 2028 AAA
A$150 mil ser B tranche 2 pass-thru bnds 90 day BBR + 0.24% due 2028 AAA
A$25 mil ser B tranche 3 pass-thru bnds 90 day BBR + 0.25% due 2028 AAA
A$25 mil ser B tranche 4 pass-thru bnds 90 day BBR + 0.56% due 2028 AA-
PUMA Masterfund P-6
A$315 mil ser A tranche 1F 6.9% s.a. to 2000 then fltg rate pass-thru bnds due 2030 AAA
A$135 mil ser A tranche 2 pass-thru bnds 90 day BBR + 0.19% due 2030 AAA
A$25 mil ser A tranche 3 pass-thru bnds 90 day BBR + 0.21% due 2030 AAA
A$25 mil ser A tranche 4 pass-thru bnds 90 day BBR + 0.37% due 2030 AA-
A$315 mil ser B tranche 1F 6.9% s.a. to 2000 then fltg rate pass-thru bnds due 2030 AAA
A$135 mil ser B tranche 2 pass-thru bnds 90 day BBR+ 0.21% due 2030 AAA
A$23 mil ser B tranche 3 pass-thru bnds 90 day BBR+ 0.22% due 2030 AAA
A$27 mil sub pass-thru bnds 90 day BBR+ 0.34% due 2030 AA-
PUMA Sub-Fund No. 2
A$34 mil class A registered stock 180 day BBR + 0.38% due 2000 AAA
A$8 mil class B registered stock 180 day BBR + 0.67% due 2000 AA-
PUMA Sub-Fund P-1
A$100 mil class A1 pass-thru bnds 90 day BBR + 0.36% due 2015 AAA
A$50 mil class A2 pass-thru bnds 90 day BBR + 0.49% due 2018 AAA
A$36 mil class A3 pass-thru bnds 90 day BBR + 0.8% due 2020 AAA
A$14 mil class B pass-thru bnds 90 day BBR + 1.25% due 2020 AA-

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 114

 Structured Finance Australia & New Zealand ¨ April 1999

Rating
PUMA Sub-Fund P-2
A$165 mil tranche 1 pass-thru bnds 90 day BBR + 0.34% due 2016 AAA
A$60 mil tranche 2 pass-thru bnds 90 day BBR + 0.49% due 2018 AAA
A$55 mil tranche 3 pass-thru bnds 90 day BBR + 0.72% due 2020 AAA
A$20 mil tranche 4 pass-thru bnds 90 day BBR + 1.23% due 2020 AA-
PUMA Sub-Fund P-3
A$345 mil tranche 1F 8.07% s.a. 3 year fxd then fltg rate pass-thru bnds due 2020 AAA
A$285 mil tranche 2 pass-thru bnds 90 day BBR + 0.48% due 2020 AAA
A$30 mil tranche 3 pass-thru bnds 90 day BBR + 0.65% due 2020 AAA
A$40 mil tranche 4 pass-thru bnds 90 day BBR + 1.15% due 2020 AA-
PUMA Sub-Fund P-4
A$561 mil tranche 1F 8.07% s.a. to 1999 then fltg rate pass-thru bnds due 2028 AAA
A$204 mil tranche 2 pass-thru bnds 90 day BBR + 0.4% due 2028 AAA
A$38.25 mil tranche 3 pass-thru bnds 90 day BBR + 0.45% due 2028 AAA
A$46.75 mil tranche 4 pass-thru bnds 90 day BBR + 0.93% due 2028 AA-
RAMS Mortgage Corp. Ltd.
A$160 mil ser 1 class A1 pass-thru bnds 90 day BBR + 0.22% due 2021 AAA
A$120 mil ser 1 class A2 pass-thru bnds 90 day BBR + 0.42% due 2021 AAA
A$80 mil ser 1 class A3 pass-thru bnds 90 day BBR + 0.72% due 2021 AAA
A$10 mil ser 1 class B pass-thru bnds 90 day BBR + 1.56% due 2021 AA-
A$30 mil ser 1 class B1 pass-thru bnds 90 day BBR + 1.36% due 2021 AA-
A$400 mil ser 2 class A1 pass-thru bnds 30 day BBR + 0.17% due 2025 AAA
A$550 mil ser 2 class A2 pass-thru bnds 30 day BBR + 0.32% due 2025 AAA
A$50 mil ser 2 class B pass-thru bnds 30 day BBR + 0.83% due 2025 AA-
A$300 mil ser 3 class A1 bnds 30 day BBR + 0.17% due 2031 AAA
A$276 mil ser 3 class A2 bnds 30 day BBR + 0.26% due 2031 AAA
A$24 mil ser 3 class B bnds 30 day BBR + 0.4% due 2031 AA-
A$100 mil ser 4 class A1 bnds 90 day BBR + 0.17% due 2032 AAA
A$92 mil ser 4 class A2 bnds 90 day BBR + 0.28% due 2032 AAA
A$8 mil ser 4 class B sub bnds 90 day BBR + 0.54% due 2032 AA-
US$100 mil ser 5E class A1 sr nts 90 day LIBOR + 0.14% due 2032 AAA
US$284 mil ser 5E class A2 sr nts 90 day LIBOR + 0.18% due 2032 AAA
US$16 mil ser 5E class B sub nts 90 day LIBOR + 0.43% due 2032 AA-
RAMS Net Interest Margin Ltd.
A$28.6 mil net interest margin fltg rate pass-thru bnds 30 day BBSW + 0.65% due 2006 A-
Registered Australian Mortgage Securities Trust No. 4
A$18 mil ser A sr bnds 90 day BBR + 0.6% due 2014 AAA
A$2 mil ser B sub bnds 90 day BBR + 1.5% due 2014 AA-
Resimac Series 1998-1 Fund
A$193.2 mil class A pass-thru bnds 3 mth BBSW + 0.29% due 2029 AAA
A$8.8 mil class B pass-thru bnds 3 mth BBSW + 0.53% due 2029 AA-
Retail Financial Services Ltd.
New Zealand CP prog auth amt NZ$600 mil: asset-backd A-1+
RMT Securitisation Trust No. 1
A$187 mil class A pass-thru bnds 30 day BBR + 0.27% due 2022 AAA
A$13 mil class B pass-thru bnds 30 day BBR + 0.65% due 2022 AA-
RMT Securitisation Trust No. 2
A$228 mil class A pass-thru bnds 30 day BBR + 0.25% due 2023 AAA
A$12 mil class B pass-thru bnds 30 day BBR + 0.34% due 2023 AA-

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

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 Structured Finance Australia & New Zealand ¨ April 1999

Rating
RMT Securitisation Trust No. 3
A$28 mil class A1 pass-thru nts 90 day BBSW + 0.19% due 2024 AAA
A$40 mil class A2 pass-thru nts 30 days BBSW + 0.33% AAA
A$127 mil class A3 pass-thru nts 30 day BBSW + 0.34% AAA
A$3 mil class B 30 day BBSW + 0.70% AA-
Rock Trust
A$88.04 mil class A sr mtg-backd nts AAA
A$1.96 mil class B mtg-backd sub nts AA-
SABRE New Zealand Ltd.
CP prog auth amt NZ$500 mil: asset-backd A-1
SABRE Securitisation Ltd.
CP prog auth amt A$700 mil: asset-backd A-1
SBC Warburg Australia Securities Trust No. 1
CPI indexed annuity nts
R1 ser due 2005 AA+
R2 ser due 2006 AA+
R3 ser due 2007 AA+
R4 ser due 2008 AA+
R5 ser due 2009 AA+
R6 ser due 2010 AA+
R7 ser due 2011 AA+
R8 ser due 2012 AA+
R9 ser due 2013 AA+
R10 ser due 2014 AA+
R11 ser due 2015 AA+
R12 ser due 2016 AA+
R13 ser due 2017 AA+
R14 ser due 2018 AA+
R15 ser due 2019 AA+
R16 ser due 2020 AA+
R17 ser due 2021 AA+
Schooner Capital Pty. Ltd.
CP prog auth amt A$500 mil: asset-backd A-1
SECURE Australia Ltd.
Government fleet lease ser bnds AAA
Secured Asset Funding Entity No. 1 Ltd.
CP prog auth amt A$1 bil: asset-backd A-1
Securitised Australian Mortgage Trust 1995-1 (SAM Trust 1995-1)
A$306.3 mil class A nts 90 day BBR + 0.42% due 2025 AAA
A$9.5 mil class B units 90 day BBR + 0.95% due 2025 AA
Securitised Australian Mortgage Trust 1996-1 (SAM Trust 1996-1)
A$310.3 mil class A nts 30 day BBR + 0.28% due 2026 AAA
A$10 mil class B units 30 day BBR + 0.85% due 2026 AA-
Securitised Australian Mortgage Trust 1997-1 (SAM Trust 1997-1)
A$225.1 mil class A nts 30 day BBSW + 0.21% due 2027 AAA
A$7 mil class B units 30 day BBSW + 0.36% due 2027 AA-

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 116

 Structured Finance Australia & New Zealand ¨ April 1999

Rating
Securitised Australian Mortgage Trust 1997-2 (SAM Trust 1997-2)
A$163 mil class A nts 30 day BBSW 0.26% due 2028 AAA
A$5.2 mil class B units 30 day BBSW 0.43% due 2028 AA-
Securitised Australian Mortgage Trust 1998-1 (SAM Trust 1998-1)
A$214.8 mil class A sr nts 30 day BBSW + 0.27% due 2028 AAA
A$2.4 mil class B sub units 30 day BBSW + a margin due 2028 AA-
Series 1996-1 Torrens Trust
A$182.2 mil class A mtg-backd pass-thru nts 30 day BBR + 0.35% due 2026 AAA
A$13.2 mil class B mtg-backd pass-thru nts 30 day BBR + 0.95% due 2026 AA-
Series 1998-1 Torrens Trust
A$243.0 mil class A mtg-backd pass-thru nts 30 day BBSW + 0.27% due 2029 AAA
A$3.7 mil class B mtg-backd pass-thru nts 30 day BBSW + 0.55% due 2029 AA-
Series 1998-2 Torrens Trust
A$197.00 mil class A mortgage-backed pass-thru notes 30 day BBSW + 0.41% due 2030 AAA
A$3.35 mil class B mortgage-backed pass-thru notes 30 day BBSW + 0.70% due 2030 AA-
Series 1997-1 CATS Trust
A$202 mil mtg-backd bnds 30-day BBSW + 0.25% due 2028 AAA
Series 1998-1 CATS Trust
A$248 mil class A-1 mtg-bckd notes AAA
A$245 mil class A-2 mtg-bckd notes AAA
Series 1997-1 Medallion Trust
A$277.2 mil residential mtg-backd pass-thru bnds 30 day BBR + 0.25% due 2028 AAA
Series 1998-1 Medallion Trust
A$300 mil class A residential mtg-bckd pass-thru nts AAA
A$3 mil class B residential mtg-bckd pass-thru nts AA+
Series 1997-2 WST Trust
A$591.1 mil class A mtg-backd pass-thru sr nts 30 day BBSW + 0.18% due 2028 AAA
A$13.3 mil class B mtg-backd pass-thru sub nts 30 day BBSW + 0.34% due 2028 AA-
Series 1997-3 WST Trust
A$204 mil class A1 mtg-backd pass-thru sr nts 30 day BBSW + 0.12 % due 2028 AAA
A$190 mil class A2 mtg-backd pass-thru sr nts 30 day BBSW + 0.20 % due 2028 AAA
A$287.1 mil class A3 mtg-backd pass-thru sr nts 30 day BBSW + 0.24% due 2028 AAA
A$13.9 mil class B mtg-backd pass-thru sub nts 30 day BBSW + 0.34% due 2028 AA-
Series 1997-4E WST Trust
US$499 mil class A sr fltg rate pass-thru Euro nts LIBOR + 0.13% due 2028 AAA
US$17.6 mil class B sub fltg rate pass-thru Euro nts 90 day LIBOR + 0.26% due 2028 AA-
Series 1998-1G WST Trust
US$1.37 bil class A mtg-backd fltg rate pass-thru nts 3 mth LIBOR + a margin due 2029 AAA
US$32.3 mil class B fltg rate pass-thru nts 3 mth LIBOR + a margin due 2029 AA-
Series 1998-1 REDS Trust
A$189.4 mil class A mtg-backd nts 30 day BBSW + 0.28% AAA
A$10.6 mil sub class B mtg-backed nts 30 day BBSW + 0.42% AA-
Series 1999-1 Apollo Trust
A$66 mil class A-1 mortgage-backed bonds AAA
A$154 mil class A-2 mortgage-backed bonds AAA

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 117

 Structured Finance Australia & New Zealand ¨ April 1999

Rating
Speirs Securities Ltd.
CP prog auth amt NZ$250 mil: asset-backd A-1+
Structured Prime Asset Receivables (SPARS 2) No. 2 Ltd.
CP prog auth amt A$236 mil A-1
Superannuation Members’ Home Loans Securitisation Fund No. 1 (The) (SMHL Fund No. 1)
A$150 mil mtg-backd pass-thru bnds 90 day BBR + 0.39% due 2021 AAA
Superannuation Members’ Home Loans Securitisation Fund No. 2 (The) (SMHL Fund No. 2)
A$150 mil mtg-backd pass-thru bnds 90 day BBR + 0.29% due 2022 AAA
Superannuation Members’ Home Loans Securitisation Fund No. 3 (The) (SMHL Fund No. 3)
A$150 mil mtg-backd pass-thru bnds 90 day BBR + 0.27% due 2022 AAA
Superannuation Members’ Home Loans Securitisation Fund No. 4 (The) (SMHL Fund No. 4)
A$180 mil mtg-backd pass-thru bnds 90 day BBR + 0.18% due 2023 AAA
Superannuation Members’ Home Loans Securitisation Fund No. 5 (The) (SMHL Fund No. 5)
A$180 mil mtg-backd pass-thru bnds 90 day BBR + 0.18% due 2023 AAA
Superannuation Members’ Home Loans Securitisation Fund No. 6 (The) (SMHL Fund No. 6)
A$150 mil mtg-backd pass-thru bnds 90 day BBR + 0.29% due 2024 AAA
Superannuation Members’ Home Loans Securitisation Fund No. 7 (The) (SMHL Fund No. 7)
A$180 mil residential mtg-backed pass-thru bnds 90 day BBR + 0.27% due 2024 AAA
SWORD Securitisation Ltd.
A$1 bil CP Prog A-1+
Sydney Capital Corp. Inc.*
Australian CP prog auth amt US$1.6 bil: asset-backd A-1+
Symphony Trust No. 1
A$144 mil unsecd bnds due 2003: Class A AAA
A$6 mil unsecd bnds due 2003: Class B BBB
Tasman Funding Inc.
US$1 bil asset-backed CP prog A-1+
Titan Securitisation Ltd.
A$1 bil asset-backd CP/MTN prog A-1+/AA-
Transferable Investment Certificates (TICs)
Category 1 (Secured by ‘A-1+’ and ‘AA’ paper) AA-/A-1+
Category 2 N.R.
Category 3 (Secured by paper issued by CBA) AA-/A-1+
Cpn TICs (Secured by ‘A-1+’ and ‘AA’ paper) AA-/A-1+
Universal Mirror Trust
Program for the issue of index replications nts AA+r
Waratah Securities Australia Ltd.
Australian CP prog auth amt A$2 bil: asset-backd A-1+
CP prog auth amt NZ$500 mil A-1+
WB Trust - 1998
A$141.3 mil pass-thru class A sr nts 3 mth BBSW + 0.29% due 2031 AA
WB Trust
A$50 mil pass-thru class A sr nts 3 mth BBSW + 0.26% due 2027 AA

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 118

 Structured Finance Australia & New Zealand ¨ April 1999

Rating
WISDOM Prime Asset Trust No. 1
CP prog auth amt A$500 mil: asset-backd A-1+
WST Funding Trust New Zealand Sub-Series 1
A$243.69 mil class A nts due 2024 AAA
A$16.95 mil class B nts due 2024 AA
WST-NZ Series 1998-1 Trust
NZ$278.82 mil class A nts 3 mth NZD bank rate + 0.39% due 2024 AAA
NZ$19.393 mil class B nts 3 mth NZD bank rate + 0.62% due 2024 AA
Zenith Funding Pty. Ltd.
CP prog auth amt A$200 mil: asset-backd A-3

*Non-Australian and non-New Zealand issuers. N.R.—Not rated.

Standard & Poor’s 119

 Structured Finance Australia & New Zealand ¨ April 1999

Rating Rationales
The following is a summary of each of the transac- underlying securities, which are rated at least
tions remaining outstanding which have been rated ‘AA-/A-1+’, and the matching of obligations due
by Standard & Poor’s. from underlying assets and those ultimately due to
commercial paper holders via liquidity facilities and
risk management agreements with entities having, or
Abel Funding Pty. Ltd. supported by an entity having, a rating of ‘A-1+’.

Rating AOL is a special-purpose entity incorporated in

A$2 billion commercial paper program A-1+ Jersey, Channel Islands, for the purpose of issuing
discounted commercial paper in the Euro market.
RATIONALE The proceeds of the commercial paper are used by
The rating on the commercial paper notes issued by AOL to fund its subscriptions in an investor unit in
Abel Funding Pty. Ltd. reflects: a master trust. The master trust, in turn, will invest
♦ The quality of the receivables; the proceeds in a unit in a series of subtrusts. Each
subtrust will invest the proceeds in fixed- or float-
♦ The ongoing portfolio monitoring process;
ing-rate securities rated at least ‘AA-/A-1+’ and will
♦ The liquidity support provided to the program by
be restricted to holding securities of a single entity.
an asset purchase agreement in which ABN
AMRO Australia Ltd. (AA/Stable/A-1+) agrees to
purchase all or a portion of the receivables if the
issuer has insufficient funds to pay maturing ACE Overseas Corp.
notes; and Rating
♦ The 10% programwide credit enhancement US$2.5 billion U.S. commercial paper program A-1+
provided by ABN AMRO Australia Ltd. under a
RATIONALE
letter of credit that forms a second level of loss
support in addition to any support provided by The rating on the commercial paper issued by ACE
the seller of purchased receivables and for pools Overseas Corp. reflects the credit quality of the
of debt securities exceeding 10 in number. underlying securities, which are rated at least ‘AA-/
A-1+’. The rating also reflects the matching of
Abel Tasman Holdings Pty. Ltd. and its wholly
obligations due from underlying assets and those
owned subsidiary, Abel Funding Pty. Ltd., are
ultimately due to commercial paper holders via
limited-purpose entities incorporated in the Austral-
liquidity facilities and risk management agreements
ian Capital Territory. Abel Funding Pty. Ltd. lends
with entities having, or supported by an entity
the proceeds from the issue of the short-term
having, a rating of ‘A-1+’. The rating reflects the
commercial paper to Abel Tasman Holdings Pty.
unconditional and irrevocable guarantee by the
Ltd. to purchase high-quality structured portfolios
parent, ACE Overseas Ltd., to the prompt and
of receivables from companies, governments, and
punctual payment of all notes issued by ACE
financial institutions in Australia and the region
Overseas Corp.
and/or appropriately rated financial securities. ABN
AMRO Asset Management (Australia) Ltd. is the ACE Overseas Corp. is a wholly owned subsidiary
program manager of Abel Tasman Holdings Pty. of ACE Overseas Ltd. and is incorporated in Dela-
Ltd. and is responsible for monitoring the origina- ware, U.S. for the sole purpose of issuing and selling
tion and the servicing of the receivables. debt securities as a nominee for ACE Overseas Ltd.
The proceeds of the commercial paper are loaned to
ACE Overseas Ltd. which, in turn, will invest in an
investor unit of the ACE Overseas Ltd. master trust.
ACE Overseas Ltd.
The master trust will in turn use the funds to invest
Rating in a number of subtrusts, each of which will be
US$1 billion Euro commercial paper program A-1+ restricted to holding debt obligations of a single
entity that is rated at least ‘AA-’ or ‘A-1+’. The
RATIONALE
timing and the amount of cash flow entitlement of
The rating on commercial paper issued by ACE each subtrust investment will exactly match the
Overseas Ltd. (AOL) reflects the credit quality of obligations of the master trust under the investor
Standard & Poor’s 120
 Structured Finance Australia & New Zealand ¨ April 1999

unit. On each maturity date of the notes issued by is sufficient available enhancement to support them.
ACE Overseas Corp., ACE Overseas Ltd. undertakes The required credit support will be adjusted based
to deposit funds with the issuing and paying agent on the receivable portfolio’s cumulative and current
equal to the face value of the maturing notes. loss performance, subject to both a minimum and
maximum level. As in other term note programs,
Standard & Poor’s reserves the right to review and
Asset Based Financing Trust reassess the adequacy of the available credit support.
Furthermore, any additional receivable purchases
Rating
must meet various prespecified program eligibility
A$683.2 million senior floating-rate class A notes
criteria, which include receivables type, tenor and
due December 2005 AA-
obligor diversity.
A$17.5 million subordinated floating-rate class B
notes due December 2008 BBB Standard & Poor’s expects the full payment of
interest and principal on the notes, before or on the
RATIONALE maturity date, will be in line with the terms and
The ratings on Asset Based Financing Trust (ABF conditions of the notes, and consistent with the
Trust) reflects: the credit quality of the underlying ‘AA-’ and ‘BBB’ ratings assigned to the class A and
receivables, which exhibited a low level of historical class B notes respectively. The ratings are con-
(seven years) losses; the diversified receivables pool strained by the rating of SGAL, based on the legal
by obligor, industry, geographic location, and assignment of collections only (that is, not financing
equipment type; the inclusion of a dynamic credit agreements), its indemnities for excess concentration
support and other performance requirements prior risks, its role as swap counterparty, servicer and
to future receivable purchases and note issuances; trustee, and its provision for trust expenses.
Societe Generale Australia Ltd.(SGAL) indemnities
for various trust expenses, obligor and vendor
concentration risks; credit analysis that assumes no Asset Collateralised Entity Ltd.
recovery benefits; the ability to apply principal Rating
collections to fund interest payments; and an interest A$1.5 billion series 2 commercial paper program A-1+
rate swap agreement with SGAL. US$1 billion series 2 Euro commercial paper
This is the first securitisation of equipment financing program A-1+
agreements originated by SGAL. The credit support
for the ‘AA-’ rated class A senior notes is 4.5% of RATIONALE
the total notes issued by ABF Trust. This credit The rating on the series 2 asset-backed commercial
support consists of a class B note subordination of paper issued by Asset Collateralised Entity Ltd.
2.5% and a cash reserve of 2.0%. (ACE) reflects the credit quality of underlying
ABF Trust was established in the Australian Capital securities that are rated at least ‘AA-’ and/or ‘A-1+’,
Territory as a bankruptcy-remote, special-purpose and the matching of obligations due from underly-
trust. A security trustee holds a first fixed-and- ing securities and those ultimately due to commer-
floating charge over the assets of ABF Trust for the cial paper holders through liquidity facilities and
benefit of its secured creditors, including risk management agreements with entities which
noteholders and the interest rate swap counterparty. have, or are supported by, an entity which has a
ABF Trust will issue the rated notes, and use the rating of ‘A-1+’.
proceeds to initially purchase collections from a ACE is a special-purpose entity incorporated in the
A$700.7 million pool of small- and medium-ticket Australian Capital Territory for the purpose of
equipment financing agreements. During the initial issuing discounted commercial paper. The proceeds
three years of the class B notes, ABF Trust is able to of the commercial paper are used by ACE to fund
apply all principal collection allocated to the the subscription in an investor unit in a master trust.
subordinated notes toward the purchase of new The master trust in turn invests in a unit in a series
receivables, provided there is sufficient enhancement of sub-trusts, each of which will invest the proceeds
to support the class A notes. in fixed- or floating-rate securities rated at least
Under the terms of the trust deed, ABF Trust may ‘AA-’ and/or ‘A-1+’. Commercial paper is issued
issue further notes (up to A$1 billion) to fund the under two programs, the domestic commercial paper
purchase of collections from additional financing program and the Euro commercial paper program.
agreements. These notes may be issued only if there The Euro commercial paper program is a multi-

Standard & Poor’s 121

 Structured Finance Australia & New Zealand ¨ April 1999

currency allowing for the issuance of any currency The ‘AAA’ rating of senior tranches also reflects the
subject to compliance with the relevant regulatory first loss protection provided by the subordinated
requirements. bonds, which represent over 4% for Fund I and 3%
for Fund II of the outstanding bonds on issue by the
funds.
Australian Barley Board Assets of the funds consist of a pool of residential
Rating property mortgages and other appropriately rated
A$400 million fully supported commercial investments. The credit quality of the mortgages is
paper notes A-1+ enhanced by primary mortgage insurance policies
from the Housing Loans Insurance Corp. and
RATIONALE MGICA Ltd. In addition to the 100% principal and
The rating on the fully supported commercial paper interest cover, the mortgage insurance policies also
(CP) notes issued by the Australian Barley Board provide at least 36 months cash flow cover for
reflects the credit and liquidity support provided by delinquencies.
the Commonwealth Bank of Australia (‘AA-/A-1+’)
and Rabo Australia Ltd. (‘AAA/A-1+’).
The Australian Barley Board is a statutory market- Australian Securitisation Corp. No. 1
ing authority constituted under Acts of Parliament Rating
in both South Australia and Victoria. The proceeds A$50 million promissory notes A-1+
from the issue of the CP notes are used by the Board
primarily to make payments to growers for the RATIONALE
season’s crops. Pursuant to the multi-option facility, The rating on the promissory notes issued by
the Commonwealth Bank of Australia (CBA) and Australian Securitisation Corp. No. 1 (ASC) reflects
Rabo Australia Ltd. (Rabo) severally make a the enhancement provided by the standby liquidity
commitment to provide guarantees for the CP issued support facility from Westdeutsche Landesbank
by the Board up to a face amount of A$400 million. Girozentrale; the 25% overcollateralisation of
The multi-option facility also provides that security mortgages, and the 100% primary mortgage
holders will, on maturity, be paid directly by the insurance cover.
CBA and Rabo rather than by the Board. This direct
ASC is a special-purpose entity incorporated in the
pay feature, as well as the guarantees, ensure that
Australian Capital Territory for the purpose of
investors’ exposure is limited to the CBA and Rabo.
issuing promissory notes. It is wholly owned by
RMB Australia Ltd. The proceeds of the notes
issued by ASC are used to fund a pool of fixed- and
Australian Mortgage Securities Ltd. floating-rate fully amortising residential mortgages
AMS—ARMS II Fund I and Fund II originated by First Australian Building Society. The
administration of the mortgages will continue to be
Rating
carried out by First Australian Building Society.
Fund I
A$112 million tranche 1 pass-through bonds AAA
A$32 million tranche 2 pass-through bonds AAA
A$6 million tranche 3 pass-through bonds AA- Banksia Series 1 Trust
Fund II Rating
A$485 million tranche 1 pass-through bonds AAA A$122.0 million residential mortgage-backed
A$15 million tranche 2 pass-through bonds AA- bonds AAA

RATIONALE RATIONALE
The ‘AAA’ rating on the senior tranche bonds and The rating on the Banksia Series 1 Trust’s bonds
the ‘AA-’ rating on the subordinated tranche bonds primarily reflects:
issued by Australian Mortgage Securities Ltd. ♦ The credit quality of the assets of the trust;
AMS—ARMS II Fund I and II reflect the credit ♦ The primary mortgage insurance provided by
quality of the assets of the funds, the enhancement Housing Loans Insurance Corp. (‘insurer finan-
provided by creditworthy third parties, and the cial strength rating) on each mortgage loan in the
maintenance of a minimum level of cash collateral. trust; and

Standard & Poor’s 122

 Structured Finance Australia & New Zealand ¨ April 1999

♦ The maintenance of a liquidity reserve equal to Security Assurance Inc., which supports both
1.25% of the outstanding principal balance of principal and interest payments on the bonds,
bonds to cover any short-term income shortfalls. providing a strong level of protection to bondholders.
The bonds are backed by fully amortising floating- BSF Bonds No. 1 Ltd. and BSF Bonds No. 2 Ltd. are
rate residential mortgage loans located throughout special-purpose entities incorporated to issue CPI
Australia. The interest rate charged on the mortgage indexed fixed principal repayment bonds. Each
loans is a discretionary rate, which is reset on a bond is a fully amortising, CPI indexed fixed
monthly basis. The interest rate applicable to the principal repayment security backed by rental
bonds will be floating-rate, based on a margin over payments from office buildings located in Brisbane.
the 30-day bank bill rate. Proceeds from the bond issue of BSF Bonds No. 1
Ltd. and BSF Bonds No. 2 Ltd. were on-lent to
Suncorp Insurance and Finance to finance existing
Brentwood (Australis) Ltd. properties known as Forestry House and Health
House, both located in Mary Street, Brisbane.
Rating
A$39.5 million zero coupon bonds AA
A$28.6 million scheduled indexed bonds AA
Burnie Hospital Ltd.
RATIONALE Rating
The rating on the scheduled indexed bonds issued by A$28.7 million tranche A CPI indexed annuity bonds AAA
Brentwood (Australis) Ltd. reflects State Bank of A$2.6 million tranche B CPI indexed annuity bonds AAA
South Australia’s (SBSA) obligations to cover any
shortfalls in rental income resulting from a default RATIONALE
under a lease between the major tenant and The ratings on the amortising CPI indexed annuity
Brentwood (Australis) Ltd. The rental income from bonds issued by Burnie Hospital Ltd. (BHL) is based
the major tenant is sufficient to fully support the on a financial guarantee provided by Financial
scheduled payments to the bondholders. The rating Security Assurance Inc. (FSA), which uncondition-
also reflects the obligation of SBSA under a put ally and irrevocably guarantees the principal and
option to purchase the Australis Centre for A$39.5 interest payments on the bonds. FSA has a claims-
million if the property is unable to realise sufficient paying ability rating of ‘AAA’.
funds to pay the bonds in full on the maturity date. BHL is a special-purpose entity incorporated in the
Brentwood (Australis) Ltd. is a special-purpose Australian Capital Territory for the primary purpose
entity incorporated for the purpose of raising debt of owning the North West Regional Hospital at
as an agent for a joint venture. The proceeds from Burnie, and for issuing bonds. The hospital has been
the sale of the bonds, together with an equity leased for a period of 15 years to the Tasmanian
investment by the joint venture participants, were government. The bonds are structured so as to allow
used to finance the purchase of the Australis Centre the bonds to be called should the hospital lease be
building located in Adelaide’s central business terminated; the call premium is based on a 4% real
district. yield repayment calculation. The lease will provide
the cash flow to service the quarterly in-arrears CPI
indexed coupon payments.
BSF Bonds No. 1 Ltd. and BSF Bonds
No. 2 Ltd.
Construction and Development Co. Ltd.
Rating
A$30 million CPI indexed fixed principal Rating
repayment bonds AAA A$166 million capital indexed bonds AAA
A$28 million CPI indexed fixed principal
RATIONALE
repayment bonds AAA
The rating on the bonds issued by Construction and
RATIONALE Development Co. Ltd. (CDC) reflects the credit
The ratings on the issue of CPI indexed annuity quality of the lessee, the Commonwealth of Australia
principal repayment bonds issued by BSF Bonds No. (Department of Social Security); the high level of
1 Ltd. and BSF Bonds No. 2 Ltd. reflect the uncon- security provided, and the deed of indemnity from
ditional and irrevocable guarantee of Financial the Commonwealth of Australia supporting the

Standard & Poor’s 123

 Structured Finance Australia & New Zealand ¨ April 1999

obligations of the lessor, Tuggeranong Office Park CASAL has been established to issue discounted CP
Pty. Ltd. (TOP), under the transaction. in the U.S. The proceeds of the CP issued by CASAL
CDC is a special-purpose entity incorporated to are lent to its parent company, CRS, to finance the
issue capital indexed bonds, the proceeds of which purchase of corporate and government receivables
were on-lent to TOP to finance the design and and appropriately rated financial securities from
construction of an office park at Tuggeranong in the Australia and other appropriately rated countries.
Australian Capital Territory. Construction of the
office complex was completed in October 1991 with
the lease to the Department of Social Security Corporate Australasian Securitisation
commencing in December 1991. The lease will Transactions Pty. Ltd.
provide the cash flow to service coupon payments
Rating
and to fund the repayment of the bonds at maturity.
A$1 billion asset-backed commercial paper
program A-1+

Corporate Asset Securitisation RATIONALE

Australia Ltd. Inc. The rating on the commercial paper program
Rating reflects:
US$1.5 billion commercial paper program A-1+ ♦ The credit support provided in respect of each
loan of commercial paper proceeds made by the
RATIONALE issuer to its parent company, Corporate Receiva-
The ‘A-1+’ rating assigned to the commercial paper bles Securitisation Ltd. (CRS);
notes (CP) issued by Corporate Asset Securitisation ♦ The existence of liquidity facility from appropri-
Australia Ltd., Inc. (CASAL) reflects: ately rated parties;
♦ The quality of the assets; ♦ Programwide credit support of 10% provided
♦ 10% programwide credit support provided by from appropriately rated parties; and
appropriately rated entities with the exception ♦ The strong legal structure of the transaction.
that for financial securities rated ‘AA-’ or higher, Corporate Australasian Securitisation Transactions
or ‘A-1+’, the 10% program credit support is not Ltd. (CAST) is a limited-purpose entity incorporated
required in respect of those securities subject to under the laws of the Australian Capital Territory
the tenor of CP being limited to a maximum of for the purpose of issuing discounted commercial
120 days or the number of financial assets being paper. The company is a wholly owned subsidiary of
limited to 10; and CRS, an existing special-purpose finance entity
♦ 100% liquidity support is provided by an ‘A-1+’ incorporated in New South Wales. CRS has another
financial institution who agrees to purchase all or existing subsidiary, Corporate Asset Securitisation
a portion of performing receivables if CASAL has Australia Ltd. (CASAL), which is incorporated in
insufficient funds to pay maturing CP. Currently Delaware, U.S. CASAL issues commercial paper in
this support is supplied by Citibank Ltd. and UBS the U.S. to finance Australian receivables via a loan
Australia Ltd. If Citibank Ltd. is rated less than to CRS.
‘A-1+’, additional liquidity support will be CAST is set up to mirror the CASAL structure and is
provided by appropriately rated entities. established for the purpose of issuing commercial
CASAL is a limited-purpose entity incorporated paper in Australia, the proceeds of which are lent to
under the laws of Delaware, U.S., and a wholly its parent company, CRS, will use the loan to
owned subsidiary of Corporate Receivables finance the purchase of Australian receivables. The
Securitisation Pty. Ltd (CRS), a special-purpose program consists of 100% liquidity support pro-
finance company incorporated in New South Wales vided from appropriately rated parties and a
in 1989. CRS has another subsidiary, Corporate programwide credit support of 10% provided from
Australasian Securitisation Transactions Pty. Ltd. appropriately rated parties. Citicorp Capital Mar-
(CAST), which was incorporated in New South kets Australia Ltd. is the operating agent and is
Wales in late 1997. The CP issued by CAST is rated responsible for monitoring the organisation and
‘A-1+’. servicing of receivables.

Standard & Poor’s 124

 Structured Finance Australia & New Zealand ¨ April 1999

owned subsidiary of GE Capital Australia Ltd.

Crusade CP No. 1 Pty. Ltd. (AAA/Stable/A-1+); the maintenance of a minimum
Rating level of cash collateral; interest risk management
A$500 million asset-backed commercial paper instruments provided by appropriately rated
program A-1 counterparties; and cross currency swaps with
Deutsche Bank AG, London Branch (‘AA+’) that
RATIONALE transform the Australian dollar cash flow streams on
The rating on Crusade CP No. 1 Pty. Ltd.’s the underlying assets into U.S. dollar cash flow
(Crusade) commercial paper program reflects: streams facilitating payment of principal and interest
♦ The credit quality of an unlimited number of under the notes.
underlying assets, which are rated at least ‘A-1’ The class B notes benefit from these features with
and/or ‘A’ and are dependent ratings to that of the exception of the subordination.
the commercial paper; The class A and class B notes are backed by fully
♦ The provision of liquidity facilities provided by at amortising floating-rate residential mortgage loans
least ‘A-1’ rated counterparties; located throughout Australia. Noteholders will
♦ The provision of hedge agreements provided by receive a quarterly distribution of principal and
at least an ‘A-1’ rated counterparty; interest. The interest rate applicable to the notes will
♦ The matching of asset or swap payment dates be a floating rate based on a margin over three
with commercial paper maturity dates; and month U.S. dollar LIBOR. The final maturity date of
♦ Limitation on commercial paper tenor to a the notes is June 10, 2029. Given the pass-through
maximum of 95 days. nature of the notes, however, the actual date on
which the principal amount of the notes will be fully
Crusade was incorporated in the Australian Capital
repaid will be determined by the actual prepayment
Territory as a bankruptcy-remote, special-purpose
rate experienced on the mortgage pool. As such, the
entity to issue commercial paper and use the proceeds
risk of mortgage prepayments is borne by
to purchase a trust note issued by a Crusade CP trust.
noteholders.
There are an unlimited number of Crusade CP trusts,
which will use the funds from the sale of their
respective trust notes to purchase structured receiva-
bles or asset-backed securities rated at least ‘A/A-1’.
Crusade Euro Trust No. 2 of 1998
A security trustee holds a first fixed and floating Rating
charge over Crusade’s assets for the benefit of its US$314 million class A mortgage-backed
secured creditors, including noteholders, hedge and pass-through notes AAA
liquidity bank providers. US$11 million class B mortgage-backed
pass-through notes AA-
Standard & Poor’s will review the terms of each asset
purchase before the transfer of each asset to a Crusade RATIONALE
trust. The rating on Crusade Euro Trust No. 2 of 1998’s
class A notes reflects: the credit quality of the assets;
the subordination of the class B notes to the class A
Crusade Euro Trust No. 1 of 1998 notes; primary mortgage insurance provided by
Rating insurance providers having an insurer financial
US$496 million class A mortgage-backed strength rating of ‘AA-’ or higher; the maintenance
pass-through notes AAA of a minimum level of cash collateral; interest rate
US$4.0 million class B mortgage-backed risk management instruments provided by appropri-
pass-through notes AA+ ately rated counterparties; and cross-currency swaps
with Deutsche Bank AG (DBAG), London Branch
RATIONALE (AA+/Watch Neg/A-1+) that transform the Austral-
The rating on Crusade Euro Trust No. 1 of 1998’s ian dollar cash flow streams on the underlying assets
class A notes reflects the credit quality of the assets; into U.S. dollar cash flow streams facilitating
the subordination of the class B notes to the class A payment of principal and interest under the notes.
notes; 100% primary mortgage insurance provided Deutsche Bank has agreed to post sufficient collat-
by Housing Loans Insurance Corp. Ltd. (HLIC Ltd.) eral to support the rating of the class A notes if its
on each mortgage loan. HLIC Ltd. is a wholly rating is downgraded.

Standard & Poor’s 125

 Structured Finance Australia & New Zealand ¨ April 1999

The class B notes benefit from these features with 1996-7, 1996-8, 1997-1, 1997-2, 1997-3, 1997-4,
the exception of the subordination. 1997-5, 1997-6, 1998-10, 1998-11, 1998-12 and
The class A and class B notes are backed by fully 1998-13 series class A bonds issued by the Diners
amortising fixed-rate and floating-rate residential Club Master Trust reflects the protection embodied
mortgage loans located throughout Australia. in the trust deed whereby a deterioration in the
Noteholders will receive a quarterly distribution of credit quality or payment behaviour of the portfolio
principal and interest. The interest rate applicable to triggers an early commencement of the amortisation
the notes will be a floating rate based on a margin period and early return of principal to bondholders.
over three-month U.S. dollar LIBOR. The final The rating also reflects the subordination of the
maturity date of the notes is Nov. 12, 2029. Given class B bonds (unrated), which insulates the holders
the pass-through nature of the notes, however, the of class A bonds against loss by absorbing credit
actual date on which the principal amount the notes losses and dilutions relating to the charge card
will be fully repaid will be determined by the actual receivables purchased by the trust.
prepayment rate experienced on the mortgage pool. The Diners Club Master Trust was established to
As such, the risk of mortgage prepayments is borne purchase, by equitable assignment, a portfolio of
by noteholders. charge card receivables originated or serviced by
Diners Club Australia. The structure of the transac-
tion incorporates a revolving period, during which
Crusade Trust No. 1 of 1997 the trustee purchases new receivables, and a nine-
month amortisation period, during which principal
Rating
is repaid to bondholders. The beneficial interest in
A$500 million mortgage-backed bonds AAA
the trust has been retained by Diners Club Australia.
RATIONALE
The rating on Crusade Trust No. 1 of 1997’s bond
issue reflects the credit quality of the assets, the Eden Park Trust #1
primary mortgage insurance provided by Housing Rating
Loans Insurance Corp. (HLIC) on each mortgage A$97 million class A1 senior floating-rate
loan, the maintenance of a minimum level of cash notes due Sept. 15, 2001 AAA
collateral, and the sound legal structure of the A$97 million class A2 senior floating-rate
transaction. HLIC’s obligations under the primary notes due Oct. 15, 2003 AAA
insurance policy are guaranteed by the Common- A$6 million class B subordinated floating-rate
wealth of Australia (local currency AAA/Stable/A-1+). notes due Oct. 15, 2003 A
Bondholders will receive a quarterly distribution of
RATIONALE
principal and interest. The interest rate applicable to
the bonds will be a floating rate based on a margin The credit support for the class A1 and class A2
over the 90 day bank bill swap rate. The final ‘AAA’ rated notes is 6.5% of the total rated notes
maturity date of the bonds is July 10, 2029. Given issued by Eden Park Trust #1 (Eden), consisting of
the pass-through nature of the bonds, however, the class B note subordination of 3%, and unrated seller
actual date on which the principal amount of the note subordination of 3.5%. Credit support for the
bonds will be fully repaid will be determined by the ‘A’ rated notes is 3.5%, consisting of the unrated
actual prepayment rate experienced on the mortgage seller note subordination. The credit support does
pool. As such, the risk of mortgage prepayments is not amortise over the life of the transaction.
borne by bondholders. The ratings also reflect:
♦ the credit quality of ORIX Australia Corp. Ltd.’s
(ORIX) commercial hire-purchase portfolio,
Diners Club Master Trust which has shown a very low level of historical
Rating losses;
A$290 million series A bonds AAA ♦ credit analysis based on zero benefit to recoveries;
A$44.5 million series B bonds Not rated ♦ the diversity of the underlying commercial hire-
purchase agreements by obligor, equipment type,
RATIONALE and industry; and
The rating assigned to the 1995-5, 1995-6, 1995-7, ♦ a fixed-to-floating rate interest rate swap from an
1996-1, 1996-2, 1996-3, 1996-4 1996-5, 1996-6, appropriately rated counterparty.

Standard & Poor’s 126

 Structured Finance Australia & New Zealand ¨ April 1999

The program has a revolving period during which Through a separate trust, the Home Purchase
new receivables can be purchased by Eden. The Assistance Fund, the government is legally obliged to
rating reflects the inclusion of trigger events and ensure sufficient funds are available to enable the
cash retention events during the substitution period FANMAC trustee to meet its obligations to bond-
and loss trigger protection that will force excess holders, and to purchase outstanding mortgages at
available income to be captured within the transac- bond maturity.
tion for the benefit of noteholders.

FATO Ltd.
Endeavour Mortgage Trust Funds Rating
Rating A$41 million fixed-rate bonds AAA
NZ$6.884 million mortgage trust certificates AA-
RATIONALE
RATIONALE The rating on the amortising bonds issued by FATO
The rating on the mortgage trust certificates issued Ltd. is based on a financial guarantee provided by
by Endeavour Mortgage Trust Funds reflects the Financial Security Assurance Inc. (FSA), which
credit quality of the residential and commercial unconditionally and irrevocably guarantees the
mortgages securing the mortgage trust certificates principal and interest payments on the bonds. FSA
(MTCs) and the enhancement provided by the has an insurer financial strength rating of ‘AAA’.
enhancement facility deed, whereby ANZ Banking FATO Ltd. is a special-purpose entity incorporated
Group (New Zealand) Ltd. (ANZ Bank), rated in the Australian Capital Territory to issue amortis-
‘AA-’, provides complete financial and management ing bonds. Proceeds from the issue of the amortising
support to the trustee. bonds were on-lent to Celestial Proprietary Ltd., a
MTCs are unit trust certificates issued by Endeavour special-purpose entity whose business activities are
Mortgage Trust Funds and represent an undivided limited to the ownership and operation of the
beneficial interest in a group of mortgages. Mort- building located at 89-95 Waymouth Street, Ad-
gage loans are originated by ANZ Bank and are elaide. Celestial Proprietary Ltd. is wholly owned by
fixed-rate, interest-only, and fixed-term. The Multiplex Constructions Pty. Ltd., the developer of
matching of investments with particular mortgages the property. The property is leased for an initial
is achieved through a number of group investment period of 10 years to the Commonwealth Govern-
funds (GIFs) constituted under the trust deed. The ment on behalf of the Australian Taxation Office.
various GIFs are defined by the maturity dates and
coupon rates of MTCs issued and are legally distinct
subfunds of the trust. Financial Assets Specialised Trust No. 1
Rating
A$100 million asset-backed commercial paper
FANMAC Premier Trusts program A-1
Rating
A$2.28 billion mortgage-backed bonds AAA RATIONALE
The rating on the discounted commercial paper (CP)
RATIONALE issued by Financial Assets Specialised Trust No. 1
The rating on the 13 series of bonds issued by the (FAST Trust No. 1) reflects the credit quality of the
FANMAC Premier Trusts (FANMAC Trusts) reflects assets, the overcollateralisation of the assets, the
the explicit support provided by the State Govern- credit facility equal to 10% of outstanding CP, and
ment of New South Wales. the liquidity facility covering 90% of the CP on
The FANMAC Trusts consist of pools of low-start issue provided by parties with a rating of at least
and affordable mortgage loans originated through a ‘A-1’ by Standard & Poor’s.
program sponsored and formally supported by the Perpetual Trustee Co. Ltd., as trustee for FAST Trust
State Government of New South Wales to raise No. 1, issues CP from time to time to purchase an
funds to lend to eligible low- and moderate-income equitable interest in consumer and proprietor loan
earners in New South Wales to buy a principal receivables from Harvey Norman Financial Services.
residence.

Standard & Poor’s 127

 Structured Finance Australia & New Zealand ¨ April 1999

The trustee is empowered to take action on the

receivables in its own name or obtain legal Ford Credit Receivables Trust 1998-1
ownership of the receivables. The Harvey Norman Rating
franchisees sell a broad range of household products A$58.841 million series 1998-1-A1 fixed rate
such as building supplies, electrical appliances, pass-through bonds due Oct. 10, 2004 AAA
computer goods, furniture and carpets. A$43.577 million series 1998-1-A2 fixed rate
pass-through bonds due Oct. 10, 2004 AAA
A$28.089 million series 1998-1-A3 fixed rate
Financial Assets Specialised Trust No. 2 pass-through bonds due Oct. 10, 2004 AAA
Rating RATIONALE
A$100 million commercial paper program A-1
The ratings on the A$130.5 million of class A bonds
RATIONALE issued by Ford Credit Receivables Trust 1998-1
(FCRT) reflect;
The rating on the discounted commercial paper (CP)
issued by Financial Assets Specialised Trust No. 2 ♦ the credit quality of the receivables which were
(FAST Trust No. 2) reflects the credit quality of the originated by Ford Credit Australia Ltd. and
assets of FAST Trust No. 2, the issuance restrictions other qualifying investments of FCRT;
in the documentation that result in overcollateral- ♦ any excess cash flow from the underlying receiva-
isation of at least 111%, the credit facility equal to bles is held within the transaction structure for
10% of outstanding CP provided by parties rated at the benefit of bondholders until it is distributed
least ‘A-1’ by Standard & Poor’s, and the liquidity by FCRT, quarterly in arrears, to the servicer and
facility covering 90% of outstanding CP provided beneficiary;
by parties with a rating of at least ‘A-1’ by Standard ♦ the hard credit support at closing in the form of
& Poor’s. A$19.5 million of subordinated, unrated series
The CP program has been structured to provide 1998-B bonds; and
funding for the small business loans offered by ♦ the sequential pay structure of the transaction
Highland Finance Pty. Ltd. Highland provides loans which ensures that the credit support does not
to small businesses throughout Australia to fund the amortise over the life of the transaction.
cost of insurance premiums. These loans are secured The program has a revolving period during which
by a mortgage over the borrowers’ right to receive a new receivables can be purchased by FCRT. Accord-
refund of the insurance premium in the event of ingly, amortisation events have been documented,
early cancellation of the policy. which if breached during the revolving period, will
commence the amortisation phase of the transaction.

Financial Assets Specialised Trust No. 3

Rating
Generic Loan Asset Securitisation
A$100 million commercial paper program A-1+ Structures Ltd.
Rating
RATIONALE
A$600 million note program A-1+
The rating on the discounted commercial paper (CP) A$185 million series 1 commercial paper A-1+
issued by Financial Assets Specialised Trust No. 3
(FAST Trust No. 3) reflects the credit quality of the RATIONALE
assets of FAST Trust No. 3; the issuance restrictions The rating on Generic Loan Asset Securitisation
in the documentation, which result in overcollateral- Structures Ltd. (GLASS) A$600 million note
isation of at least 111%; and the credit facility equal program primarily reflects:
to 10% of outstanding CP provided by parties rated ♦ The credit quality of the assets to be purchased
at least ‘A-1+’ by Standard & Poor’s. from time to time by GLASS as governed by the
The CP program, which purchases the credit card securities issuance facility agreement and the
receivables of Harris Scarfe, a midsize Australian security trust deed;
retailer, is backed by a liquidity facility covering ♦ The liquidity support that may be required in
90% of outstanding CP provided by parties with a respect of specific assets and may be provided in
rating of at least ‘A-1+’ by Standard & Poor’s. The a variety of ways; and
CP facility is designed so that all outstanding CP
will be rolled over or retired every month. Standard & Poor’s 128
 Structured Finance Australia & New Zealand ¨ April 1999

♦ The conditions precedent to issuing commercial

paper in the transaction documents. Home Owner Mortgage Enhanced
The proceeds of each series of the notes will be used Securities Ltd.—MTN Program
to purchase a series of assets. The assets purchased
Rating
with each series of notes will be held in a separate A$303.8 million floating-rate medium-term notes AA
series of a special-purpose entity. GLASS will grant a
first ranking charge over the assets of series one, RATIONALE
unless the official name is Series 1 to the security The ‘AA’ rating on the A$303.8 million medium-
trustee for the benefit of secured creditors, including term notes (MTN) issued by Home Owner Mort-
noteholders and swap counterparties. The charge, gage Enhanced Securities Ltd. (HOMES) under its
with respect to each series, will be granted to a A$1 billion residential mortgage-backed medium-
separate security trustee, applicable to the assets term note program reflects the credit quality of the
purchased. underlying assets and the liquidity facility which
covers any timing mismatches between the underly-
ing assets and the rated debt obligations. The rating
Home Owner Mortgage Enhanced also reflects the credit quality of the derivative
Securities Ltd. counterparty for any relevant risk management
agreement entered into by HOMES for that series,
Rating
and the sound legal structure of the transaction.
A$1 billion mortgage-backed commercial paper A-1+
The proceeds of each series of MTNs are used by
RATIONALE HOMES to fund subscription in an investor unit in
The ‘A-1+’ rating on the residential mortgage- the corresponding HOMES Series MTN Master
backed commercial paper issued by Home Owner Trust. The HOMES Series MTN Master Trust in
Mortgage Enhanced Securities Ltd. (HOMES) turn invests in a unit in one or more series MTN
reflects the credit quality of underlying securities subtrusts, each of which will invest the proceeds in
rated at least ‘AA-’ and/or ‘A-1+’. The ‘A-1+’ rating floating-rate residential mortgage-backed securities
also reflects the matching of obligations due from rated at least ‘AA-’. To cover any mismatch that may
underlying securities and those ultimately due to occur between obligations due from underlying
commercial paper holders via liquidity facilities and securities and obligations ultimately due to MTN
risk management agreements with entities which holders, each subtrust will, where appropriate, enter
have, or are supported by an entity which has, a into liquidity facilities and risk management agree-
rating of ‘A-1+’. ments (interest rate agreements, guaranteed invest-
ment contracts, and other approved derivative
The proceeds of the commercial paper are used by
instruments) with entities having, or supported by
HOMES to fund the subscription in an investor unit
an entity having, a rating of at least ‘AA-/A-1+’.
in the HOMES Series 1 Master Trust. The HOMES
Series 1 Master Trust in turn invests in a unit in one
or more Series 1 subtrusts, each of which will invest
the proceeds in fixed- or floating-rate residential Initial Corporate Obligation Notes Pty.
mortgage-backed securities rated at least ‘AA-’ and/ Ltd.
or ‘A-1+’. To cover any mismatch that may occur
Rating
between obligations due from underlying securities A$400 million commercial paper program A-1+
and obligations ultimately due to commercial paper
holders, each subtrust will, where appropriate, enter RATIONALE
into liquidity facilities and risk management agree- The rating on Initial Corporate Obligation Notes
ments (interest rate agreements, guaranteed invest- Pty. Ltd.’s (ICON) commercial paper (CP) program
ment contracts and other approved derivative reflects:
instruments) with entities having, or supported by
♦ The quality of the underlying asset, which is rated
an entity having, a rating of ‘A-1+’. In respect of
‘AAA’;
each purchase of securities, Standard & Poor’s
♦ The quality of the liquidity provider in respect of
reviews the terms of the securities, liquidity facility
the liquidity facility provided to ICON, to
and any risk management agreement prior to the
support the timely redemption of CP; and
purchase of the security by a subtrust.

Standard & Poor’s 129

 Structured Finance Australia & New Zealand ¨ April 1999

♦ The matching of the tenor of CP to the coupon

period of the underlying assets. Interstar Securities MBS Program
ICON is a special-purpose entity incorporated in the Rating
Australian Capital Territory to issue discounted CP. A$334 million senior certificates AAA
The company is owned by a discretionary trust. The A$55 million subordinated certificates AA-
proceeds of the CP are used by ICON to fund the
purchase of the series A1 notes issued by Initial RATIONALE
Corporate Obligation Notes Trust. A liquidity The ratings on the certificates issued by Interstar
facility equal to the face value of outstanding CP is Securities MBS Program (Interstar) reflect the credit
provided to ICON by Citibank N.A. to support the quality of the residential mortgage assets, the
timely redemption of CP. To mitigate any mismatch enhancement provided by 100% pool mortgage
between payment obligations due from the underly- insurance endorsed with cash flow cover, the
ing asset and those due to CP holders, ICON will protection provided by internal liquidity reserves,
issue CP with tenor that matches the coupon period and, in certain pools, a level of subordination.
of the underlying asset. Interstar mortgage-backed, pass-through certificates
are issued under a mortgage-backed securities
program created and managed by Interstar Securities
Initial Corporate Obligation Notes Trust Pty. Ltd. The certificates are issued by Perpetual
Trustees Victoria Ltd., as custodian for the program,
Rating
A$310.5 million series A1 notes AAA and represent a beneficial interest in a pool of
A$200.0 million series A2 notes AAA mortgages and other authorised investments. Under
A$40.0 million series B1 notes Not rated the program, certificates will be issued from time to
A$35.5 million series B2 notes Not rated time, with each series representing a separate pool.
Certificate holders will have recourse only to the
RATIONALE assets of a particular pool and not to the assets of
The rating on the series A notes issued by Initial other pools created under the program.
Corporate Obligation Notes Trust (ICON Trust
reflects the:
♦ Credit quality of the underlying corporate loans; Interstar RD25 Master Trust
♦ Subordination of the series B notes to the series A Rating
notes equal to 12.88% of the initial principal A$720 million class A senior mortgage-backed
balance of notes issued by the trust; pass-through certificates AAA
♦ A$20 million liquidity facility provided by A$80 million class B subordinated mortgage-
Citibank N.A. to cover any short-term income backed pass-through certificates AA-
shortfalls;
RATIONALE
♦ Currency swap provided by Citibank N.A. to
The ratings on certificates issued by Interstar RD25
cover any currency exchange risks;
Master Trust (RD25) reflect the credit quality of the
♦ Basis swap provided by Citibank N.A. to cover
assets of RD25; 100% primary mortgage insurance
any interest rate risks;
on all mortgages endorsed with 12 months timely
♦ Guaranteed investment contract provided by
payment cover for the class A certificates; the
Citibank N.A. to cover any reinvestment risks;
subordination of the class B certificates; the
and
manager’s obligation to set the interest rate on the
♦ Sound legal structure of the transaction. mortgage loans at a level that will enable the trustee
ICON Trust is a special-purpose entity established to meet the expenses of RD25 as they fall due; the
under a trust deed to purchase a pool of corporate ability of the trustee to use principal to meet short
loans originated by the local branch of Citibank term liquidity shortfalls; and the subordination of
N.A. Purchase of the loans is funded by the issue of manager’s fees.
rated senior notes and unrated subordinated notes.

Standard & Poor’s 130

 Structured Finance Australia & New Zealand ¨ April 1999

RD25 is a bankruptcy-remote and legally distinct

trust entered into by Perpetual Trustees Victoria Ltd. JEMstone Fund
in its capacity as trustee of the RD25 Master Trust. Rating
The trust issues floating-rate, pass-though certifi- Residential and commercial mortgage-backed
cates and uses the proceeds to purchase mortgage securities
loans over residential property and additional A$130.0 million tranche 1 bonds AAA
authorised investments that meet specific rating A$14.1 million tranche 2 bonds AA
criteria. RD25 has been structured to allow multi- A$11.9 million tranche 3 bonds BBB
issues of certificates. Certificates issued by the trust A$13.0 million tranche 4 bonds Not rated
will be secured by a pro rata interest in a sole pool
of assets designated as Interstar RD25 Master Trust RATIONALE
assets. Each issue will be governed by the informa- The investment grade ratings on the tranche 1,
tion memorandum. No issue of class A2, A3, or B tranche 2 and tranche 3 bonds of this multitranche
certificates will occur after July 2, 1999. issue reflect the JEMstone Fund’s ability to pay
interest to bondholders in full on each interest
payment date and to repay principal in full no later
Jem Bonds Ltd. than the final rated maturity date according to the
Rating terms of the transaction documents.
A$150 million bonds AAA This assessment is based on: the quality of the assets
and portfolio diversification; adequate levels of
RATIONALE subordination to support the ratings assigned to
The rating on the bonds issued by Jem Bonds Ltd. tranches 1, 2, and 3; primary mortgage insurance
reflects the obligations of Barclays Australia Ltd., policies from insurers with insurer financial strength
Bank of Western Australia, and the Western Aus- ratings of ‘AA-’ or higher on a portion of the loans
tralia State Supply Commission as the obligors secured by residential properties (loans carrying
responsible primarily for the coupon payments due primary mortgage insurance comprise 39% of the
on the bonds, as well as the structural enhancement aggregate asset pool); the transaction’s structure
provided by Financial Security Assurance Inc. (notably, the sequential payment allocation between
(insurer financial strength rated ‘AAA’). tranches); liquidity support provided by the subordi-
Jem Bonds Ltd. is a special-purpose entity incorpo- nate bond classes and the internal liquidity reserve
rated in the Australian Capital Territory to issue funded from bond proceeds and invested in liquid
bonds as trustee of the Jem WA Vehicle Fleet Bonds authorised investments; and adequate hedging and
Trust. The proceeds from the issue will be on-lent to management of fixed-to-floating interest rate and
Westfleet Pty. Ltd. under a loan facility. Westfleet basis risk.
will use the loan proceeds, along with other funds, The bonds are backed by a pool of 710 performing
to finance the purchase of the Western Australian residential and commercial mortgage loans with an
government’s motor vehicle fleet. Once purchased, aggregate loan balance of A$133 million and an
the fleet will be leased by Westfleet to both Barclays average loan balance of only A$187,774. Only ten
Australia Ltd. and the Bank of Western Australia loans had original loan balances exceeding A$1
Ltd. There will be separate leases between each of million. Since the loan balances are so small, and the
these parties and Westfleet. Barclays and the Bank of total number of assets in the underlying pool is so
Western Australia will then sublease their portion of large, an actuarial approach has been taken in rating
the fleet to the Western Australia State Supply this transaction. Standard & Poor’s calls the process
Commission, which is a body corporate established of analysing an issue based on its assessment of the
under the State Supply Commission Act. Obligations credit quality of the mortgage pool, without ad-
of the supply commission are obligations of the dressing each loan on a property-specific basis, the
State of Western Australia (local currency “actuarial” rating approach. The structure of these
AAA/Stable/A-1+). securities resembles that of rated residential pass-
through securities. Repayment of the securities relies
on the cash flow generated by the mortgage pool.

Standard & Poor’s 131

 Structured Finance Australia & New Zealand ¨ April 1999

Western Australia via a support agreement from the

JEM Warehouse Bonds Pty. Ltd. State Housing Commission of Western Australia
Rating (Homeswest) as agent of the crown.
A$58.34 million fixed-rate indexed annuity bonds A- Securities issued by KBL fund a program sponsored
by Homeswest to provide home ownership for low-
RATIONALE to-moderate income earners. The risk to bondhold-
The rating on the bonds issued by JEM Warehouse ers is against the mortgages funded by the scheme
Bonds Pty. Ltd. reflects the ability of the issuer to and ultimately against the support agreement from
pay to bondholders scheduled principal and interest Homeswest. Through the support agreement with
payments on each quarterly note payment date. the State government, Homeswest provides funds in
Bondholders will receive the face value of the bonds the event of cash shortfall to a support trust, which,
and any accrued interest in the event that the in turn, has undertaken to provide funds to KBL to
underlying properties currently being built are not enable it to service its commitments to bondholders
completed. in a timely manner.
Key strengths include:
♦ The provision of a letter of credit, provided by
ABN AMRO Australia Ltd. (AA/Stable/A-1+), to Longreach CP Ltd.
support interest and principal payments to Rating
bondholders during the construction of the A$600 million series 1 commercial paper A-1+
properties;
♦ The simple nature of the underlying asset type. RATIONALE
The assets are large warehouse distribution The rating on series 1 commercial paper issued by
centres with basic construction requirements; Longreach CP Ltd. (LCP) reflects the financial
♦ The credit quality of the single tenant, Coles guarantees provided by MBIA Insurance Corp.
Myer Ltd. (A/Stable/A-1), to support its obliga- (MBIA) in favour of Longreach Prime Projects Pty.
tions under the agreement for leases and operat- Ltd., guaranteeing principal and interest payments
ing leases post construction; from the Loy Yang B loan, and payments from the
♦ The obligation of Honeywell Ltd. (guaranteed by swap.
Honeywell Holdings Pty. Ltd., A/Negative/—) to It also reflects the credit quality of:
provide various maintenance, repairs and ♦ the liquidity provider, to support the timely
financial obligations on behalf of the lessor post redemption of commercial paper notes;
construction; ♦ the swap counterparty, to match the payment
♦ The obligation of insurance providers rated at obligations due from the underlying assets and
least ‘A’ to insure against inherent defects, public those due to noteholders;
and product liability, and industrial special risks. ♦ the advances provider, to cover the potential
♦ The transaction documents, which isolate delay between payment dates of the LYB loan,
insolvency risks of the nonrated transaction and the MBIA guarantee claim; and
parties from JEM (the issuer) and Icebrook (the ♦ the tax indemnity provider, to cover withholding
lessor under the operating lease). taxes that may be imposed on fees paid to MBIA.
LCP is a special-purpose entity incorporated in the
Australian Capital Territory to issue discounted
Keystart Bonds Ltd. commercial paper. Commercial paper will be issued
Rating in series that are segregated, and may be differently
A$1 billion medium term note program AAA rated. LCP has used the proceeds of series 1 com-
A$728 million 2M Keystart bonds AAA mercial paper to fund a loan to a subsidiary com-
A$750 million commercial paper A-1+ pany, which has, in turn, used the proceeds to
finance a portion of a fully drawn project finance
RATIONALE loan provided to LoyVic Pty. Ltd. in respect of the
The ratings on the securities issued by the special- acquisition of the Loy Yang B power station, in
purpose entity Keystart Bonds Ltd. (KBL) reflect the south-eastern Victoria.
support provided by the State government of

Standard & Poor’s 132

 Structured Finance Australia & New Zealand ¨ April 1999

coupon to investors in full on the coupon

MBS New Zealand No. 1. Ltd. distribution dates on a timely basis, and repay
Rating principal to investors no later than the final maturity
NZ$138.75 million senior mortgage-backed date, in line with the terms of the transaction
pass-through securities AAA documents.
NZ$11.25 million subordinated mortgage-backed The ratings on the tranche 1 and tranche 2 senior
pass-through securities AA- bonds reflect: credit quality of the assets of the
issuer; primary mortgage insurance on each mort-
RATIONALE gage loan in the portfolio, including 12 months
The rating on the senior bonds is based on the credit principal and interest timely payment cover; subor-
quality of the underlying assets; primary mortgage dination of tranche 3 bonds to tranche 1 and 2
insurance on each mortgage loan, including 12 bonds equal to 7.5% of the aggregate principal
months timely payment cover; credit enhancement in balance of bonds issued by the issuer at closing;
the form of 7.5% subordinated bonds; a liquidity liquidity reserve equal to a minimum 0.5% of the
reserve equal to 0.25% of the original aggregate aggregate principal balance of bonds issued at
principal balance of the bonds; hedging agreements closing; interest rate risk management agreements
provided by appropriately rated counterparties; and with appropriately rated counterparties; and the
the strength of the transaction structure. The rating sound legal structure of the transaction.
on the subordinated bonds benefits from the same The tranche 3 subordinated bonds benefit from the
features with the exception of the subordination. above features, with the exception of the subordina-
MBS New Zealand No. 1. Ltd. is a special-purpose tion.
entity incorporated in New Zealand. The proceeds The bonds are backed by fully amortising, residen-
of the bond issuance will be used to purchase fully tial mortgage loans originated by Sovereign Home
amortising residential mortgage loans originated Mortgages Ltd. The final maturity date of the bonds
throughout New Zealand by Sovereign Home is Oct. 15, 2031. Interest rates charged on the
Mortgage Ltd. mortgage loans consist of discretionary variable
The principal of the bonds will be redeemed in a rates with the ability to fix for a set period of time,
sequential structure; any prepayments or scheduled on a fully hedged basis. The issuer has the discretion
amortisations can be use to fund redraw or head- to adjust the interest rate on the underlying mort-
room advances to existing mortgagors or purchase gages to meet the interest payments due to the
additional mortgages for the first 24 months of the bondholders and expenses of the issuer.
transaction. Between the end of the substitution Tranche 1 bondholders will receive a semiannual,
period and November 2000, all principal payments fixed-rate coupon until the option date, Sept. 15,
will be paid into the principal reserve. After Novem- 2001, and a quarterly floating-rate coupon thereaf-
ber 2000, all principal held in the reserve and ter. The tranche 2 and 3 bondholders will receive a
subsequent repayments will be passed through to the quarterly floating-rate coupon. The floating interest
bondholders in a sequential order—tranche 1, rate applicable to each tranche is based on the three-
tranche 2, and tranche 3 bonds. month bank bill bid rate (BBBR), plus a margin. The
issuer has the ability to use principal payments on
the underlying assets to fund redraw or headroom
MBS New Zealand No. 2 Ltd. advances to the existing mortgagors. The issuer also
Rating may purchase additional mortgages during the
NZ$75.00 million tranche 1 mortgage-backed substitution period, which is the first 24 months of
pass-through securities AAA the transaction. Between the end of the substitution
NZ$63.75 million tranche 2 mortgage-backed period and September 2001, all principal payments
pass-through securities AAA will be paid into the principal reserve. After Septem-
NZ$11.25 million tranche 3 mortgage-backed ber 2001, all principal held in the reserve, or
pass-through securities AA- subsequent repayments, will be passed through to
the bondholders, according to the priority of
RATIONALE payments. Given the pass-through nature of the
The ratings on MBS New Zealand No. 2 Ltd.’s (the bonds, the actual date on which each class of bonds
issuer) residential, mortgage-backed, pass-through
securities reflect the ability of the issuer to pay the

Standard & Poor’s 133

 Structured Finance Australia & New Zealand ¨ April 1999

will be fully repaid will be determined by the actual

prepayment rate experience on the mortgage pool. MI Trust
As such, risks associated with mortgage Rating
prepayments are borne by the bondholders. A$340.9 million mortgage-backed pass-through
securities AA/AA-

Medical Mortgages Ltd. RATIONALE

Rating The ‘AA’ rating of the class ‘A-1’ and class ‘A-2’
NZ$100 million residential mortgage-backed senior bonds reflects the credit quality of the trust’s
commercial paper program A-1+ assets, mortgage insurance on all mortgages from
insurers rated ‘AA-’ or higher, and interest rate risk
RATIONALE management instruments provided by appropriately
The rating on the commercial paper (CP) program rated counterparties. The rating also reflects the
issued by Medical Mortgages Ltd. reflects the: terms of the trust’s payment to the residuary
♦ Credit quality of the assets held by Medical beneficiary, which is payable only to the extent that
Mortgages; there is excess income available after paying both
senior and subordinated classes’ coupon obligations
♦ Primary mortgage insurance on each mortgage
and other fees and expenses of the trust. A liquidity
loan;
facility is provided by a financial institution rated at
♦ Subordinated loan from Medical Securities Ltd.
least ‘A-1+’ and the subordination of the class B
equal to 5% of the total eligible receivables;
bonds, whose principal balance is equal to 0.8% of
♦ Liquidity facility equal to 100% of the outstand-
the aggregate principal balance of bonds issued
ing CP; and supports the class A bonds. The class B bonds
♦ Sound legal structure of the transaction. benefit from these features with the exception of the
Medical Mortgage is a special-purpose entity subordination.
incorporated in New Zealand to issue CP to fund a The assets of the trust consist primarily of fully
portfolio of residential mortgage loans originated in amortising, variable-rate, bank-originated mortgage
the name of Medical Mortgages, by Medical loans. A basis swap has been entered into to fully
Securities Ltd., a wholly owned subsidiary of hedge any mismatch between the interest basis on
Medical Assurance Society Ltd. group. the mortgages and the bonds.
The CP is backed by fully amortising, residential Bond holders benefit from a floating charge over the
mortgages. Interest rates charged on the mortgage assets of the fund which may, under certain events of
loans consist of discretionary variable and fixed default, be crystallised to a fixed charge over the
rates. Medical Mortgages has the discretion to fund’s assets. This charge also benefits the interest
adjust the interest rate on the underlying mortgages risk manager and liquidity facility provider.
to meet the redemption of the CP and expenses of
the special-purpose entity.
Liquidity facilities at least equal to the face value of Mortgage Corp. of New Zealand No. 2
outstanding CP are provided to Medical Mortgages
by financial institutions rated at least ‘A-1+’. These
Ltd.
facilities support the timely redemption of CP in Rating
circumstances other than where a default on the NZ$70 million bonds AA-
underlying residential mortgage has occurred. Where
RATIONALE
Medical Mortgages buys or originates a mortgage
that pays a fixed rate of interest, an interest rate The rating on the bonds issued by Mortgage Corp.
swap agreement with entities rated at least ‘A-1+’ of New Zealand No. 2 Ltd. (MCNZ No. 2) reflects
will be entered into. the credit quality of the underlying defeasance
investments, which are unconditional obligations of
ANZ Investment Bank is the program’s arranger and
Westpac Banking Corp. (rated ‘AA-/A-1+’) and of
lead manager.
the cash flows arising under the interest rate swap
agreement with ANZ Banking Group (New Zea-
land) Ltd. (rated ‘AA-/A-1+’) and Banque Indosuez
whose obligations are guaranteed by Banque

Standard & Poor’s 134

 Structured Finance Australia & New Zealand ¨ April 1999

Nationale de Paris (rated ‘A+/A-1’). The floating- contracts and 20% for leasing contracts, the 100%
rate and zero coupon deposits issued by Westpac liquidity support provided by counterparties rated at
Banking Corp. are an amount sufficient to service least ‘A-1+’ by Standard & Poor’s, and the foreign-
the existing interest rate swap agreements under exchange and interest rate hedging agreements in
which MCNZ No. 2 pays floating rate and receives place.
fixed rate. This facilitates the payment of scheduled MTF Securities is a special-purpose entity incorpo-
coupon, and repayment of principal, under the rated under the New Zealand Companies Act 1993.
remaining fixed-rate bonds in a full and timely The assets purchased by MTF Securities Ltd.
manner. Separate deposits have been made to meet comprise loans made by Motor Trade Finances Ltd.
possible enforcement expenses and contingency to its motor vehicle members, which then finance on
claims. a back-to-back basis hire-purchase, chattel mort-
gage, and lease contracts written by those dealers
with customers. It also includes hire-purchase and
Mount Gambier Hospital Ltd. chattel mortgage contracts purchased outright by
Rating Motor Trade from the New Zealand Automobile
A$24.7 million CPI bonds AA Association. The program was arranged and is
managed by Credit Lyonnais Australia Ltd.
RATIONALE
The rating on the CPI bonds issued by Mount
Gambier Hospital Ltd. (MGHL) primarily reflects Mustang No. 1 Trust
the obligations of the South Australian Health Rating
Commission (SAHC) and the Mount Gambier and A$1 billion asset-backed commercial paper
Districts Health Services Inc. (MGDHS) under the program A-1+
transaction documents, which are guaranteed by the
Treasurer of South Australia. The Government of RATIONALE
South Australia is rated ‘AA’ with a stable rating The rating on Mustang No. 1 Trust’s (Mustang)
outlook. commercial paper (CP) program reflects the:
MGHL is a special-purpose entity incorporated in ♦ Credit quality of the underlying assets, which are
the Australian Capital Territory to issue CPI bonds. rated ‘AAA’ or have a rating that enables the CP
The proceeds of the issue are to be used to fund the to have a rating of ‘A-1+’;
construction of a new acute treatment hospital in ♦ Provision of liquidity facilities by appropriately
Mount Gambier, South Australia. MGHL has rated counterparties;
entered into an operating sublease with MGDHS to ♦ Provision of hedge agreements by appropriately
use the premises to operate a public hospital for a rated counterparties;
period of 25 years. A completion guarantee has been
♦ Matching of asset or hedge payment dates with
provided by SAHC, which guarantees the successful
CP maturity dates; and
and timely completion of the hospital mitigating any
♦ Limitations on CP tenor to a maximum of 95
construction risk. The rentals payable under the
days and the number of assets that can be
lease will be sufficient to pay interest and principal
purchased by Mustang to 10.
due on the bonds.
Each asset purchased by Mustang will be a depend-
ent rating to the Mustang CP, and should one asset
MTF Securities Ltd. be downgraded, the CP will be downgraded unless
the adversely affected asset is sold or refinanced with
Rating no adverse impact on the rating of the program.
US$500 million asset-backed Euro commercial
Standard & Poor’s will review the terms of each
paper A-1+
asset before its purchase by Mustang.
RATIONALE
The rating on the securities issued by MTF Securities
Ltd. reflects the credit quality of the assets, the credit
support initially set at 11% for hire-purchase

Standard & Poor’s 135

 Structured Finance Australia & New Zealand ¨ April 1999

the interest rate risk. Bondholders will receive a

National Mutual Home Loans quarterly distribution of principal and interest. The
Securitisation Funds No. 1 and No. 2 interest rate applicable to the bonds will be a
floating rate based on a margin over the 90-day
Rating bank bill swap rate.
A$220 million mortgage-backed bonds AAA

RATIONALE
NSW (Jersey) Ltd.
The ‘AAA’ rating on the bonds issued by National
Mutual Home Loans Securitisation Funds No. 1 and Ratings
No. 2 reflects the credit quality of the underlying A$63.1 million zero coupon interest bonds AAA
assets, the primary mortgage insurance provided by A$129.5 million zero coupon principal bonds AAA
Housing Loans Insurance Corp. on each mortgage RATIONALE
loan, the maintenance of a minimum level of cash
The ratings on the zero coupon bonds issued by
collateral, and the sound legal structure of the
NSW (Jersey) Ltd. (NSWJ) reflect the guarantee
transactions.
provided by the State government of New South
The bonds are backed by fully amortising floating- Wales on the underlying assets.
rate residential mortgage loans located throughout
NSWJ is a sole purpose, limited-liability entity
Australia. The interest rate charged on the mortgage
incorporated in Jersey, Channel Islands, for the
loans is a discretionary variable rate, which is reset
purpose of issuing the zero coupon interest bonds
on a quarterly basis, with an option to fix. Any
and zero coupon principal bonds. The proceeds of
switch to a fixed rate is at the trust manager’s
the bonds were used to purchase A$129.5 million of
discretion and subject to an acceptable swap
6.5% guaranteed exchangeable bonds due May 1,
agreement to mitigate the interest rate risk. Interest
2006, issued by the New South Wales Treasury
will be paid to bondholders quarterly in arrears,
Corp. and guaranteed by the State Government of
together with principal collected on the mortgages
NSW, which is rated ‘AAA/A-1+’.
during the preceding quarter.

National Mutual Home Loans New Zealand Receivables Corp. Ltd.

Securitisation Fund No. 3 Rating
NZ$250 million commercial paper facility A-1+
Rating
A$110 million mortgage-backed bonds AAA RATIONALE
RATIONALE The rating on the secured commercial paper issued
by New Zealand Receivables Corp. Ltd. (NZRC)
The rating on the bonds issued by National Mutual
reflects the credit quality and liquidity of the
Home Securitisation Fund No. 3 reflects:
receivables, the level of loss reserves established on
♦ The credit quality of the assets;
the individual pools of receivables, the external
♦ The primary mortgage insurance provided on credit and liquidity support provided by appropri-
each mortgage loan by either Housing Loans ately rated entities, and the structure of the program.
Insurance Corp. (HLIC) or Housing Loans
NZRC is a special-purpose entity incorporated in
Insurance Corp. Ltd. (HLIC Ltd.);
New Zealand for the purpose of issuing discounted
♦ The maintenance of a minimum level of cash
commercial paper. The proceeds are on-lent to
collateral; and
wholly owned subsidiaries to purchase short-term
♦ The sound legal structure of the transaction. trade receivables from selected creditworthy New
The bonds are backed by fully amortising floating- Zealand companies. Funds to redeem NZRC’s
rate residential mortgage loans located throughout commercial paper are generated by the collection of
Australia. The interest rate charged on the mortgage the receivables and augmented by the liquidity
loans is a discretionary variable rate, with an option available to NZRC under a standby bill facility
to fix at the program manager’s discretion and equal to 100% of commercial paper issued. The
subject to an acceptable swap agreement to mitigate program is managed by Credit Lyonnais Australia
Ltd.

Standard & Poor’s 136

 Structured Finance Australia & New Zealand ¨ April 1999

Australian Industry Development Corporation

Orion Funding Pty. Ltd. (AIDC) (rated ‘AAA’) and a letter of credit agree-
Rating ment with highly rated banks. There also are
A$500 million commercial paper program A-2 structural protections that result in an early redemp-
tion of the bonds using bank and AIDC funds
RATIONALE before the termination or expiration of their
The rating on commercial paper issued by Orion facilities, and a quarterly valuation mechanism that
Funding Pty. Ltd. (Orion) reflects the credit quality determines whether the level of support provided by
of third party credit providers is enough to cover
♦ The underlying assets, which are rated at least redemption of the bonds. The bonds are part of a
‘BBB’ and/or ‘A-2’; funding package for the John Fairfax Holdings Ltd.
printing facility in Chullora, New South Wales.
♦ The liquidity providers, which are rated at least
‘A-2’, to support the timely redemption of
commercial paper notes; and
♦ The derivative counterparty, which is rated at
PAV Hospital Funding Ltd.
least ‘A-2’, to match payment obligations due Rating
from the underlying assets and those due to A$14 million medium-term notes AAA
noteholders.
RATIONALE
Orion is a special-purpose entity incorporated in the
The ‘AAA’ rating assigned to the notes issued by
Australian Capital Territory for the purpose of
PAV Hospital Funding Ltd. (PAV Funding) is based
issuing discounted commercial paper. It is owned by
on the financial guarantee provided by MBIA
a charitable trust. The program was arranged by
Insurance Corp. (MBIA) in favour of the
ANZ Investment Bank.
noteholders guaranteeing the payment of scheduled
amounts of principal and interest on the notes.
MBIA has an insurer financial strength rating of
Pacific Retail Securities Ltd. ‘AAA’.
Rating PAV Funding is a special-purpose entity incorpo-
NZ$250 million commercial paper program A-1+
rated in the Australian Capital Territory. It is owned
RATIONALE by an independently established charitable trust.
PAV Funding has issued A$14 million medium-term
The rating on the Pacific Retail Securities Ltd.’s
notes in a restructure of the A$88.7 million MBIA
(Pacific) NZ$250 million commercial paper program
Series 1 medium-term notes issued by Prime Asset
reflects the strength of the transaction structure, the
Vehicle (No. 2) Ltd.
credit quality of the underlying assets, the credit
reserves, and the standby liquidity facilities from
counterparties rated ‘A-1+’ by Standard & Poor’s.
Port Augusta Hospital Ltd.
Pacific is a special-purpose entity incorporated in
New Zealand. The proceeds of the commercial paper Rating
issuance will be used to purchase hire-purchase A$21 million CPI bonds AA
contract receivables originated by the Pacific Retail RATIONALE
Group Ltd. group of companies, the largest retailer of
The rating on the bonds issued by Port Augusta
home appliances and consumer electronics in New
Hospital Ltd. (PAHL) primarily reflects the obliga-
Zealand. The group consists of Noel Leeming, Bond
tions of Barclays Bank PLC and the Port Augusta
& Bond Ltd., and the Computer Store.
Hospital and Regional Health Service Inc. (PARHS)
under the transaction documents. Barclays is
providing a completion guarantee to cover the
Paper Bond Ltd. construction risk, and the obligations of PARHS, as
Rating the hospital lessee, are guaranteed by the treasurer
A$105.8 million class A CPI indexed bonds AAA of South Australia. The government of South
Australia is rated ‘AA’ with a stable rating outlook.
RATIONALE
PAHL is a special-purpose entity incorporated in the
The rating of the bonds issued by Paper Bond Ltd.
Australian Capital Territory to issue the CPI bonds.
reflects the credit support for the bonds provided by
Standard & Poor’s 137
 Structured Finance Australia & New Zealand ¨ April 1999

The proceeds of the issue will be deposited into

bank accounts held with Barclays Bank PLC, Prime Asset Vehicle Ltd.
Australian Branch, and will be used to fund the Rating
construction of a new hospital located in Port US$1 billion series 2 commercial paper program A-1+
Augusta, South Australia. Additional capital for the A$500 million series 4 commercial paper program A-1+
construction of the hospital will be contributed by
the equity holders in PAHL. The hospital is con- RATIONALE
structed on the existing public hospital site, to be The ratings on each series of commercial paper (CP)
leased by PAHL from the South Australian Health issued by Prime Asset Vehicle Ltd. (PAV) reflects the
Commission for a period of 50 years. credit quality of the assets owned by the special-
purpose subsidiaries, the terms upon which lines of
credit are made available to PAV to support the
POLAR Finance Ltd. timely redemption of notes, and the rating of the
Rating institutions that provide the lines of credit.
A$1 billion series one asset-backed commercial The series 2 lines of credit are available except where
paper A-1+ a default on the assets occurs or where the local
currency rating of the Commonwealth government
RATIONALE falls below investment grade. The availability of the
The rating of the series one commercial paper to be series 4 lines of credit depends on either the govern-
issued by POLAR Finance Ltd. reflects: ment of New South Wales (McKell tranche) or
♦ The credit quality of the underlying financial Commonwealth government (Wollongong and
securities, which are rated ‘A-1+’ or ‘AA-’ or Hurstville tranche) maintaining investment grade
higher by Standard & Poor’s, or assessed by ratings.
Standard & Poor’s to be of a ‘AA-’ or higher PAV is a special-purpose entity incorporated in the
credit quality. Australian Capital Territory to issue various series of
♦ The tenor of the commercial paper, which is discounted CP notes to acquire a secured interest in
limited to a maximum of 120 days. assets of high credit quality. The proceeds of the
♦ The tenor of commercial paper matching the issue of notes are used to make secured loans to a
coupon payment date and maturity date of the number of special-purpose entities which have
underlying assets. Where these tenors are not purchased various financial assets. Each series of
matched, derivative contracts will be entered into notes issued by PAV is secured by specific assets.
with parties rated at least ‘A-1+’ to match the There is no cross-collateralisation of assets between
timing of the obligations due from the underlying different series of notes.
assets with those obligations due to noteholders.
♦ The liquidity facility provided by UBS Australia
Ltd., to support the timely redemption of Prime Asset Vehicle No. 2 Ltd.
commercial paper notes. Rating
♦ The issuer is appropriately set up to issue multi- A$88.7 million MBIA series 1 medium-term notes AAA
ple series of securities, where each series is US$500 million BHP series commercial paper A-1
secured by a fixed charge over a separate portfo- A$150 million MBIA (Loy Yang B) series
lio of related assets and a separate swap agree- commercial paper A-1+
ment for the related cash flows. Only series one
noteholders have recourse against series one RATIONALE
assets. The ratings of each series are independent. The rating on the MBIA series 1 medium-term notes
POLAR Finance Ltd. is a special-purpose entity issued by Prime Asset Vehicle No. 2 Ltd. (PAV2)
incorporated in the Australian Capital Territory. It is reflects the financial guarantee provided by MBIA
ultimately owned by a fixed trust. POLAR Finance Insurance Corp. (MBIA) in favour of the note-
Ltd. has been set up to enable multiple issues of holders guaranteeing the payment of scheduled
securities that are segregated from all other series. amounts of principal and interest on the notes.
Different series may carry different ratings from MBIA has an insurer financial strength rating of
Standard & Poor’s, or be unrated, but each new ‘AAA’.
series will be reviewed by Standard & Poor’s to The proceeds of the notes were used by PAV2 to
ensure that the ratings on outstanding series are not refinance a loan provided by a syndicate of banks to
detrimentally affected by the new series.
Standard & Poor’s 138
 Structured Finance Australia & New Zealand ¨ April 1999

Ramsay Hospital Holdings (Queensland) Pty. Ltd.

and Ramsay Hospital Holdings Pty. Ltd. for the Prime Investment Entity Ltd.
purchase of Greenslopes Private Hospital in Bris- Rating
bane, and Hollywood Private Hospital in Perth, A$500 million commercial paper program A-1+
respectively.
The rating on the BHP series commercial paper (CP) RATIONALE
notes reflects the credit quality of: The rating on the commercial paper (CP) issued by
♦ The underlying assets; Prime Investment Entity Ltd. (PIE) reflects the credit
♦ The liquidity provider with respect to the liquid- quality of underlying securities which are rated at
ity facility provided to PAV2 to support the least ‘AA-’ and/or ‘A-1+’, and the matching of
timely redemption of CP notes; and obligations due from underlying securities and those
ultimately due to CP holders through a liquidity
♦ The derivative counterparty with respect to the
facility and interest rate swap agreements with
derivative contract entered into by PAV2, to
entities having, or guaranteed by entities having, a
match the payment obligations due from the
rating of ‘A-1+’.
underlying assets and those due to noteholders.
PIE is a special-purpose entity incorporated in the
Proceeds from the initial tranche of CP were used to
Australian Capital Territory for the purpose of
purchase US$100 million May 2002 floating-rate
issuing discounted CP. Ownership of PIE is vested in
notes issued by BHP Finance Ltd. The payment
a discretionary trust, of which Permanent Trustee
obligations of BHP Finance Ltd. under those notes
Company Ltd. is the trustee. The proceeds of the CP
are guaranteed by The Broken Hill Pty. Co. Ltd.
issue are used to purchase fixed-or floating-rate
The rating on the MBIA (Loy Yang B) series CP
securities rated at least ‘AA-’ and/or ‘A-1+’.
notes reflects the financial guarantees provided by
MBIA in favour of PAV2 guaranteeing the principal
and interest payment from the Loy Yang B loans and
the payments from the swap. It also reflects the
Progress 1997-1 Trust
credit quality of the liquidity provider to support the Rating
timely redemption of CP notes, the swap counter- A$485 million mortgage-backed class A notes AAA
party to match the payment obligations due from A$15 million mortgage-backed class B notes AA-
the underlying assets and those due to noteholders;
RATIONALE
and the advances provider to cover the potential
delay between the Loy Yang B loan payment date The ‘AAA’ rating on the class A notes issued by the
and the MBIA guarantee payment date. Progress 1997-1 Trust reflects the credit quality of
the underlying assets and 100% primary mortgage
CP notes will be issued by PAV2 under either its U.S.
insurance on all mortgage loans from insurers with a
debt instrument program or its domestic debt
financial insurer strength rating of ‘AA-’ or better.
instrument program. The proceeds of the notes will
The ‘AAA’ rating also reflects the subordinated class
be used to finance A$150 million of the interest-only
B notes equal to 3% of all notes issued, a liquidity
term facility in respect of the acquisition of the Loy
facility provided by a suitably rated counterparty
Yang B Power Station.
equal to 3.5% of the initial note balance, and
PAV2 is a special-purpose entity incorporated in the interest risk management instruments, including
Australian Capital Territory for the purpose of interest rate swaps, and a guaranteed investment
issuing medium-term notes and CP notes under the contract, provided by appropriately rated
A$3 billion euro program (which incorporates a counterparties. The class B notes benefit from these
US$1.5 billion U.S. program) and an unlimited features with the exception of the subordination.
domestic program. PAV2 is owned by an independ-
Class A1 noteholders benefit from a put option
ently established charitable trust. Notes will be
provided by Westpac Banking Corp. that may be
issued in series that are segregated, and may be
exercised by the trustee or trust manager on behalf
differently rated.
of class A1 noteholders if the trustee does not
exercise its class A1 call option. A further put option
has been provided by AMP Society and may be
exercised on the class A1 put date if Westpac
Banking Corp. does not meet its obligations under
its put option.

Standard & Poor’s 139

 Structured Finance Australia & New Zealand ¨ April 1999

Ltd. (PFL) reflect the credit quality of the underlying

Property Income Investment Trust Australian mortgage-backed debt securities payable
in Australian dollars (A$), which are rated ‘AAA’
Rating
and ‘AA-’ by Standard & Poor’s; and cross currency
A$200 million floating-rate medium term notes AA
swaps with appropriately rated counterparties that
RATIONALE transform the A$ cash flow streams on the underly-
ing assets into US$ cash flow streams, facilitating
The rating on the tranches 4, 6, 7, 9, 10 and 11
payment of principal and interest under each
medium-term notes issued under the A$200 million
respective series of Euronotes.
medium-term note program established for the
Property Income Investment Trust (PII) by Mac- Ordinarily, the rating of the Euronotes will be
quarie Bank (refer to page 114 for a complete list of constrained by the ‘AA’ foreign currency rating of
notes) reflects: the Commonwealth of Australia. The risks of
♦ a conservative debt-to-gross assets value ratio of currency convertibility and transferability, however,
approximately 26.3%; are being assumed by the counterparties under the
respective cross-currency swap agreements facilitat-
♦ the credit quality of the major tenants of nine
ing ratings on the class A US$ Euronotes of ‘AAA’.
properties;
♦ the long-term nature of the majority of leases; Notes are issued in series that are segregated from
other series, and are not rating dependent across
♦ the net debt service coverage ratio greater than
series. The proceeds of each series from the issue of
4.83 times;
notes are used to acquire specific assets. The
♦ the interest rate swaps entered into by PII with
transaction documents provide that with respect to
creditworthy counterparties to partially mitigate
each series, the recourse of each party is limited to
the interest rate exposure of PII; and
the charged underlying assets of that specific series.
♦ a cash reserve in excess of A$7 million, which is The parties cannot seek to recover any shortfall by
available to meet projected future nonrecurring applying for the winding-up of PFL, or by bringing
maintenance expenses and other nonscheduled any other legal proceedings against PFL or any of its
expenses and security over all of the assets of PII; other assets. PFL’s legal counsel has provided the
and opinion that the limited recourse provisions in the
♦ registered first mortgages in favour of the security transaction documents are enforceable against all
trustee over the properties owned by PII. parties to the transaction documents.

PUMA Finance Ltd. PUMA Masterfund P-5

Rating Rating
US$105 mil. series E-1(1a) class A1 senior A$1,231 million senior mortgage-backed
LIBOR + 0.08% pass-through notes AAA pass-through bonds AAA
US$560 mil. series E-1(1a) class A2 senior A$69 million subordinated mortgage-backed
LIBOR + 0.13% pass-through notes AAA pass-through bonds AA-
US$35 mil. series E-1(1b) class B subordinated
LIBOR+ 0.27% pass-through notes AA- RATIONALE
US$180 mil. series E-2(1a) class A1 senior The rating on PUMA Masterfund P-5’s senior bonds
LIBOR + 0.13% pass-through notes AAA primarily reflects:
US$666 mil. series E-2(1a) class A2 senior ♦ The credit quality of the assets of the fund;
LIBOR + 0.19% pass-through notes AAA
♦ 100% primary mortgage insurance on all
US$54 mil. series E-2(1b) class B subordinated
mortgages endorsed with timely payment cover
LIBOR+ 0.375% pass-through notes AA-
from insurers rated ‘AA-’ or higher by Standard
US$120 mil. series E-2(2a) class A1 senior
& Poor’s;
LIBOR + 0.10% pass-through notes AAA
♦ The subordination of the subordinated tranches,
US$330 mil. series E-2(2a) class A2 senior
whose principal balance is equal to 5.3% of the
LIBOR + 0.14% pass-through notes AAA
aggregate principal balance of series A and B
RATIONALE bonds issued;
The ratings assigned to the U.S. dollar (US$) ♦ Interest risk management instruments provided
floating-rate Euronotes issued by PUMA Finance by appropriately rated counterparties; and

Standard & Poor’s 140

 Structured Finance Australia & New Zealand ¨ April 1999

♦ The terms of the fund manager’s fee, which is

payable only to the extent that there is excess PUMA Masterfund E-1
income available after paying both senior and Rating
subordinated tranches’ coupon obligations and A$866.23 million senior mortgage-backed
other fees and expenses of the fund. pass-through certificates AAA
The subordinated bonds benefit from all of the A$45.59 million subordinated mortgage-backed
above features, with the exception of the pass-through certificates AA-
subordination.
RATIONALE
The ‘AAA’ rating on the senior certificates reflects:
PUMA Masterfund P-6 ♦ The credit quality of the assets of PUMA
Masterfund E-1;
Rating
A$948 million senior mortgage-backed ♦ The credit enhancement in the form of the
pass-through bonds AAA subordinated certificate to the senior certificate;
A$52 million subordinated mortgage-backed ♦ 100% primary mortgage insurance on all
pass-through bonds AA- mortgages endorsed with a minimum 24 months
timely payment cover from insurers with insurer
RATIONALE financial strength ratings of ‘AA-’ or higher;
The ‘AAA’ rating of the senior bonds reflects: ♦ Interest risk management instruments provided
♦ The credit quality of the assets of PUMA by appropriately rated counterparties;
Masterfund P-6; ♦ The terms of the manager’s fee, such that the fee
♦ The subordination of the subordinated bonds to is payable only if excess income is available after
the senior bonds; paying fees, expenses, both senior and subordi-
♦ 100% primary mortgage insurance on all nated masterfund certificate coupon obligations,
mortgages endorsed with a minimum 24 months and the reinstating of the principal cash balance if
timely payment cover from insurers with insurer used in previous periods to support coupon
financial strength ratings of ‘AA-’ or higher; payments; and
♦ Interest risk management instruments provided ♦ The manager’s undertaking to ensure that the
by appropriately rated counterparties; masterfund will be able to meet its fees and
♦ The terms of the manager’s fee such that it is expenses as they fall due. Primarily, the manager
payable only to the extent that there is excess ensures that this is possible by setting the interest
income available after paying fees, expenses, both rate on the mortgage loans (where it has the
senior and subordinated coupon obligations, and discretion to do so).
the reinstating of the principal cash balance if The subordinated certificate benefits from these
used in previous periods to support coupon features with the exception of the subordination.
payments; and The masterfund has been structured to allow multi-
♦ The manager’s undertaking to ensure the fund issues of certificates. Any series of certificates issued
will be able to meet its fees and expenses as they by the masterfund will be secured by the pool of
fall due. Primarily, the manager ensures this is assets designated as Masterfund E-1 assets. Each
possible by setting the interest rate on the series of certificates issued by the masterfund will be
mortgage loans (where it has the discretion to do governed by the master information memorandum
so). and a series supplement peculiar to each series.
The subordinated bonds benefit from these features,
with the exception of the subordination.
The fund has been structured to allow multi-issues
of bonds. Any series of bonds issued by the fund
will be secured by the one pool of assets designated
as Masterfund P-6 assets.

Standard & Poor’s 141

 Structured Finance Australia & New Zealand ¨ April 1999

The aggregate level of subordination within PUMA

PUMA Masterfund E-2 Masterfund E-2 may change with each new issue,
Rating reflecting the quality of the assets, the insurer
A$1.2 billion series 1 senior mortgage-backed financial strength ratings of the primary mortgage
pass-through certificates AAA insurers, and the amount of subordination required,
A$79.3 million series 1 subordinated to enable Standard & Poor’s to assign ratings to the
mortgage-backed pass-through certificates AA- new certificates and to affirm the ratings on all
A$725.8 million series 2 senior mortgage-backed outstanding certificates.
pass-through certificates AAA

RATIONALE PUMA Sub-Fund No. 2

The ‘AAA’ rating of the senior certificates reflects; Rating
♦ The credit quality of the assets of PUMA A$34 million class A registered stock AAA
Masterfund E-2; A$8 million class B registered stock AA-
♦ 100% primary mortgage insurance on all
mortgages endorsed with a minimum 24 months RATIONALE
timely payment cover from insurers with insurer The rating on the class A stock issued by Sub-Fund
financial strength ratings of ‘AA-’ or higher; No. 2 reflects the quality of the mortgage loans, the
♦ The series 1 subordinated certificates, which are primary mortgage insurance, the hedging of interest
subordinated to both series 1 and series 2 senior rate risk by Prudential Global Funding Inc. (rated
certificates; ‘A+/Stable/A-1’), and the subordination of the class
♦ interest risk management instruments provided B stock. The rating of the class A stock issued by
by appropriately rated counterparties; PUMA Sub-Fund No. 2 also reflects the joint
support of Macquarie Bank Ltd. as standby interest
♦ The terms of the manager’s fee ensure that this fee
risk manager and the adoption of Standard & Poor’s
is payable only if excess income is available after
criteria for jointly supported obligations in struc-
the payment of fees, expenses, and senior and
tured finance ratings.
subordinated masterfund certificate coupon
obligations, and after the reinstating of the The rating assigned to the class B stock is based on
principal cash balance if used in previous periods the enhancement provided by the mortgage insurers
to support coupon payments; and and the level of hedging of interest rate risk by
♦ The manager’s undertaking to ensure that the Prudential. PUMA Sub-Fund No. 2 is established
masterfund will be able to meet its fees and pursuant to a trust deed between the trustee and the
expenses as they fall due. Primarily, the manager manager. The assets of the sub-fund consist of
ensures that the masterfund fees and expenses can legally distinct pools of mortgage loans acquired
be met by setting the interest rate on the mort- from various mortgage originators approved by the
gage loans (where it has the discretion to do so). manager and mortgage insurers, and other rated
investments.
The subordinated certificate benefits from these
features, with the exception of the subordination.
PUMA Masterfund E-2 has been structured to allow
PUMA Sub-Funds P-1 and P-2
multi-issues of certificates. Any series of certificates
issued by the masterfund will be secured by a sole Rating
pool of assets designated as PUMA Masterfund E-2 A$466 million senior bonds AAA
assets. Each series may consist of any combination A$34 million subordinated bonds AA-
of senior, fast prepayment, and/or subordinated
RATIONALE
certificates. The subordinated certificates of any
series are subordinated to all series’ senior certifi- The ratings on the bonds issued by Sub-Fund P-1 &
cates and fast prepayment certificates. Before issuing Sub-Fund P-2 reflect the credit quality of the
a series of certificates, the manager must ensure that underlying assets, the enhancement provided by
the ratings on any outstanding certificates are not creditworthy third parties, and the maintenance of a
adversely affected by the new issue. minimum level of cash collateral. The ‘AAA’ rating of
the senior bonds also reflects the first loss protection

Standard & Poor’s 142

 Structured Finance Australia & New Zealand ¨ April 1999

provided by subordination, which represents 7% and 2, 3 and 4 reflects the credit quality of the underly-
6.7% respectively of the outstanding bonds issued by ing assets, and 100% primary mortgage insurance
Sub-Fund P-1 and Sub-Fund P-2. on all mortgages endorsed with 12 months timely
The bonds are floating-rate mortgage-backed payment cover from insurers with claims-paying
securities issued by Perpetual Trustees Australia Ltd. ability ratings of ‘AA-’ or higher. The ‘AAA’ rating
in its capacity as trustee of the funds. Mortgage also reflects the subordinated class B bonds, and the
principal repayments and prepayments are passed threshold rate, whereby the manager is bound to set
through to bondholders on a quarterly basis after the interest rate on the mortgage loans at a level that
the end of the substitution period or earlier if enables RMC to meet its obligations as they fall due.
suitable authorised mortgages or investments are not The class B bonds benefit from these features with
available for substitution. Before the securities the exception of the subordination.
become pass-through in nature, principal collections The bonds are backed by floating-rate, amortising
will be reinvested in mortgages and other authorised loans secured by first registered mortgages over
investments. property located throughout Australia. The loans all
have been originated by RAMS Home Loans Pty.
Ltd. The interest rate applicable to the securities will
PUMA Sub-Funds P-3 and P-4 be a floating rate, based on a margin over the 30-
day bank bill swap rate. Bondholders are protected
Rating
by a fixed and floating equitable charge over certain
A$1.463 billion senior bonds AAA
assets of RMC in favour of the security trustee. In
A$86.8 million subordinated bonds AA-
the event of a default under a specific series, the
RATIONALE security trustee will take possession of certain assets
of the issuer relating to that series to protect the
The ratings on the bonds issued by Sub-Funds P-3
interests of the bondholders and other secured
and P-4 reflect the credit quality of the underlying
creditors of that series.
assets, the enhancements provided by creditworthy
third parties, and the maintenance of a minimum
level of cash collateral. The ‘AAA’ rating of the
senior bonds also reflects the first loss protection RAMS Mortgage Corp. Ltd.—Euro
provided by subordination, which represents 5.7% Issue
and 5.5% of the outstanding bonds issued by Sub-
Rating
Fund P-3 and Sub-Fund P-4 respectively.
US$100 million series 5E class A1 notes 90 day
The bonds are mortgage-backed securities issued by LIBOR + 0.14% AAA
Perpetual Trustees Australia Ltd. in its capacity as US$284 million series 5E class A2 notes 90 day
trustee of the funds. All tranches receive floating- LIBOR + 0.18% AAA
rate interest payments except tranche 1F of each US$16 million series 5E class B notes 90 day
sub-fund, which receive fixed-rate interest rate LIBOR + 0.43% AA-
payments until June 1, 1998 and July 1, 1999
respectively, thereafter reverting to floating-rate RATIONALE
interest securities. The bonds are pass-through The rating on class A notes issued by RAMS
securities, although principal repayments to the Mortgage Corp. Ltd. (RMC) reflects:
holders of tranche 1F bonds will be deferred until ♦ The credit quality of the mortgage assets, and
June 1, 1998 and July 1, 1999 respectively. other approved investments (RMC);
♦ 100% primary mortgage insurance on all
mortgages endorsed with a minimum of 12
RAMS Mortgage Corp. Ltd. month timely payment cover from insurers with
Series 1, 2, 3 and 4 insurer financial strength ratings of ‘AA-’ or
higher;
Rating
A$2,078 million mortgage-backed class A bonds AAA ♦ The threshold rate, whereby the manager is
A$122 million mortgage-backed class B bonds AA- bound to set the interest rate on the mortgage
loans at a level that enables RMC to meet its
RATIONALE obligations as they fall due;
The ‘AAA’ rating on the class A bonds issued by ♦ The subordination of the class B notes; and
RAMS Mortgage Corp. Ltd. (RMC) under Series 1,
Standard & Poor’s 143
 Structured Finance Australia & New Zealand ¨ April 1999

♦ The terms of the originator’s fees, which are and external enhancements provided by creditwor-
payable only to the extent that there is excess thy counterparties. Series A bonds also benefit from
income available after paying both senior and the subordination of series B bonds.
subordinated tranches, coupon obligations, and Mortgages are introduced by approved originators
other fees and expenses. and their credit quality is enhanced by mortgage
The ‘AA-’ rating on the class B notes reflects these insurance. The mortgages of Trust No. 4 are
features with the exception of the subordination. residential, 20-year, floating rate and fully amortis-
The ratings on the U.S. dollar bonds would ordinar- ing and located throughout Australia. The mort-
ily be constrained by the ‘AA’ foreign currency gages of Trust No. 4 must mature at least one month
rating on the Commonwealth of Australia. However, before the final redemption date of the bonds.
the risks of currency convertibility and transferabil-
ity are being assumed under the cross currency swap
by the swap providers. This allows a rating of ‘AAA’ Resimac Series 1998-1 Fund
to be assigned to the U.S. dollar class A1 and class Rating
A2 bonds. A$193.2 million class A senior bonds 3 month
BBSW + 0.29% AAA
A$8.8 million class B subordinated bonds
RAMS Net Interest Margin Ltd. 3 month BBSW + 0.53% AA-
Rating
RATIONALE
A$18.4 million net interest margin floating-rate
pass-through bonds A- The ratings assigned to the residential mortgage-
backed pass-through bonds reflect:
RATIONALE ♦ The credit quality of the fund’s assets, including
The rating on the bonds issued by RAMS Net 100% primary mortgage insurance (PMI) on all
Interest Margin Ltd. reflects the ability of the issuer housing loans from insurers with insurer financial
to meet all its obligations, including timely payment strength ratings of ‘AA-’ or higher. All PMI
of interest and principal no later than the final policies are endorsed with 12 months timely
maturity date, using the origination fee purchased payment cover;
from RAMS Home Loans Pty. Ltd. earned from ♦ For class A bonds, the subordination of the class
originating mortgages on behalf of RAMS Mortgage B bonds equal to 4.35% of all bonds issued; and
Corp. and the cash reserve. ♦ A liquidity facility initially equal to 1.75% of all
The cash reserve, initially set at A$400,000, is bonds issued to supplement the liquidity support
subject to a floor of three months interest due under provided by the timely payment cover under the
the bond to ensure timely payment of interest to PMI policies.
bondholders. An interest rate swap has been entered The bonds are backed by a pool of 1,542 fully
into with Bankers Trust Australia Ltd. A/Watch Pos/ amortising loans secured by first-registered mort-
A-1 to mitigate interest rate risk. A high degree of gages over 1,641 residential properties located
legal certainty exists that the seller will continue to throughout Australia. FANMAC Ltd. guarantees
be entitled to the origination fee for the term and certain obligations of Fiduciary Services Ltd. and the
that the sale of the rights to receive future origina- manager under the transaction documents.
tion fees will survive an insolvency of the seller. FANMAC Ltd. is not rated by Standard & Poor’s.
FANMAC’s obligations under its guarantee are
supported by a A$500,000 deposit lodged with the
Registered Australian Mortgage Secu- security trustee.
rities Trust No. 4
Rating
A$18 million series A senior bonds AAA
Retail Financial Services Ltd.
A$2 million series B subordinated bonds AA- Rating
NZ$600 million asset-backed program A-1+
RATIONALE
RATIONALE
The ratings on the bonds issued by Registered
Australian Mortgage Securities (RAMS) Trust No. 4 The rating on the securities issued by Retail Financial
reflect the credit quality of the assets of each trust Services Ltd. (RFSL) primarily reflects the credit
Standard & Poor’s 144
 Structured Finance Australia & New Zealand ¨ April 1999

quality of the underlying credit card and hire-

purchase receivables originated through the Farmers RMT Securitisation Trust No. 3
Trading Co. Ltd. and other approved merchants. Rating
Credit support is provided by way of dynamic A$27 million class A1 floating-rate pass-through
overcollateralisation subject to a minimum level of notes AAA
7.45%. The transaction incorporates portfolio A$39 million class A2 floating-rate pass-through
triggers, which, if breached, will see an early amorti- notes AAA
sation of the debt securities. One of these triggers is A$125 million class A3 floating-rate pass-through
the maintenance of an 8% gross interest rate spread. notes AAA
RFSL has the ability to protect itself from a deteriora- A$3 million class B floating-rate pass-through
tion in the spread by entering into interest rate caps. notes AA-
As RFSL is the credit provider and counterparty
selling goods to customers, adequate product RATIONALE
liability insurance by suitably rated counterparties is The ratings on the class A1, A2 and A3 notes issued
required to achieve ratings on the securities. Also, by the RMT Securitisation Trust No. 3 reflect:
letters of credit are provided by eligible lenders or ♦ The credit quality of the trust’s assets;
supported by eligible lenders to cover potential ♦ Primary mortgage insurance on each mortgage
goods and services tax liabilities. RFSL can cease the loan in the trust;
provision of credit services in certain circumstances, ♦ Subordination of class B notes to class A notes,
including where it is unable to issue notes or make equal to 1.5% of the aggregate principal balance
drawings under the standby facility. of notes issued by the trust at closing;
♦ Liquidity facility equal to 2.5% of the aggregate
principal balance of notes issued by the trust at
RMT Securitisation Trusts No. 1 and closing; and
No. 2 ♦ The sound legal structure of the transaction.
Rating The trust’s class B notes benefit from the above
A$415 million mortgage-backed class A bonds AAA features, with the exception of the subordination.
A$25 million mortgage-backed class B bonds AA- The notes are backed by fully amortising, residential
mortgage loans originated by FAI First Mortgage
RATIONALE
Pty. Ltd. Interest rates charged on the mortgage
The ‘AAA’ rating on the class A bonds issued by loans consist of discretionary variable rates, with the
RMT Securitisation Trusts No. 1 and No. 2 reflects ability to fix for up to five years on a fully hedged
the credit quality of the underlying assets, the basis. The trustee has the discretion to adjust the
primary mortgage insurance on each mortgage loan, interest rate on the underlying mortgages, to meet
the subordination of the class B bonds, the liquidity interest payments due to the noteholders, and trust
facilities from appropriately rated counterparties expenses. Class A1 noteholders will receive a
and the sound legal structure of the transactions. quarterly distribution of principal and interest, in
The class B bonds benefit from these features with accordance with the priority of payments set out in
the exception of the subordination. the series supplement. Classes A2, A3 and B note-
The bonds are backed by fully amortising, residen- holders will receive a monthly distribution of
tial mortgage loans originated by FAI First Mortgage principal and interest, in accordance with the
Pty. Ltd. Interest rates charged on the mortgage priority of payments set out in the series supple-
loans consist of discretionary variable rates, with the ment. Interest rates applicable to the notes will be a
ability to fix for up to five years on a fully hedged floating rate, based on a margin over the 90- or 30-
basis. The trust has the discretion to adjust the day bank bill swap rate.The final maturity date of
interest rate on the underlying mortgages to meet the the notes is December 2024.
interest payments due to the bondholders and The class A1 and A2 notes are subject to a planned
expenses of the trust. Bondholders will receive a amortisation for the first 12 and 36 months respec-
monthly distribution of principal and interest. tively. They are then subject to put and call options,
or revert to pass-through notes. The planned
amortisation however, is subject to the availability of

Standard & Poor’s 145

 Structured Finance Australia & New Zealand ¨ April 1999

collections to pay principal, and therefore, while The noteholders in this transaction are protected
prioritised in the repayment of principal, the from these risks by the seller depositing at closing,
repayment of principal is not guaranteed. Given the an amount sufficient to cover the anticipated title
pass-through nature of all the notes, the actual date perfection costs, with a suitably rated institution.
on which all classes of notes will be fully repaid will
be determined by the actual prepayment rate on the
mortgage pool. As such, risks associated with SABRE New Zealand Ltd.
mortgage prepayments are borne by the noteholders.
Rating
NZ$500 million asset-backed commercial paper
program A-1
Rock Trust
Rating RATIONALE
A$88.04 million class A senior residential The rating reflects the strength of the transaction
mortgage-backed pass-through floating rate notes AAA structure, the credit quality of the underlying assets,
A$1.96 million class B subordinated residential the standby liquidity facilities from counterparties
mortgage-backed pass-through floating rate notes AA- rated at least ‘A-1’, the matching of the obligations
due from underlying assets with those ultimately due
RATIONALE to holders of SABRE’s commercial paper via
The ratings on the notes issued by Rock Trust liquidity facilities, and interest rate swap agreements
reflect: with financial institutions having a rating of ‘A-1’ or
♦ The credit quality of the mortgage assets and better.
other authorised investments of the trust; SABRE New Zealand Ltd. (SABRE) is a special-
♦ Mortgage insurance policies provided by purpose entity incorporated in New Zealand for the
counterparties whose insurer financial strength purpose of issuing discounted commercial paper to
ratings are at least ‘AA-’; fund intercompany loans to subsidiaries purchasing
♦ Interest risk management instruments provided qualifying assets. These assets may be either fixed or
by appropriately rated counterparties; and floating investments rated at least ‘A-1’.
♦ A liquidity facility equal to 3.65% of the aggre-
gate invested amount of all notes, provided or
guaranteed by an appropriately rated SABRE Securitisation Ltd.
counterparty. Rating
The class A notes also benefit from subordination of A$700 million asset-backed commercial paper A-1
the class B notes equal to 2% of the invested
amount of all notes. RATIONALE
The mortgage pool has significant geographic The rating on SABRE Securitisation Ltd.’s commer-
concentration risk as the majority of the loans are cial paper reflects the credit quality of the underlying
secured by mortgages over properties located assets held by SABRE. It reflects the matching of the
throughout Queensland. Also, the risks associated obligations due from the underlying assets, with
with equitable assignment in this transaction are those ultimately due to the holders of SABRE’s
greater than in some other rated transactions commercial paper through liquidity facilities and
because The Rock Building Society Ltd., the seller, is interest rate swaps with creditworthy counterparties.
an unrated entity. SABRE is a special-purpose entity incorporated in
The primary risk is that if a title perfection event the Australian Capital Territory for the purpose of
occurs, stamp duty and registration costs are issuing discounted commercial paper to fund
associated with the transfer of legal title from the financial assets authorised in the security trust deed.
seller to Rock Trust. In many mortgage-backed These assets may be either fixed- or floating-rate
equitable assignment transactions, the seller of the investments rated at least ‘A’ and/or ‘A-1’ by
assets is highly rated and certain rating triggers are Standard & Poor’s. The financial assets will be held
incorporated to reduce risks associated with an directly by SABRE rather than in subsidiaries or
equitable assignment of the mortgages to the issuer. subtrusts.

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 Structured Finance Australia & New Zealand ¨ April 1999

cial paper in a number of receivables trusts, which,

SBC Warburg Australia Securities in turn, will acquire trade or other receivables from
Trust No. 1 one or more companies within a group as sellers to
the program.
Rating
A$500 million CPI indexed notes, CPI indexed A separate receivables trust will be formed to
annuity notes, Guarantee on-death notes AA+ purchase the receivables of each seller or group of
sellers. State Street Capital Corp. is the program
RATIONALE administrator of Schooner and each of the receivable
The rating on the notes issued by SBC Warburg trusts and is responsible for monitoring the origina-
Australia Securities Trust No. 1 primarily reflects the tion and servicing of the receivables under the
sound legal structure of the transaction and the transaction documents. The security trustee holds a
rating of Warburg Dillon Read Australia Ltd. registered first-ranking fixed and floating charge
(AA+/Stable/A-1+) as the swap provider. granted in respect of the assets of Schooner, includ-
ing the investor unit in each receivables trust. The
The issuer is a special-purpose trust established
charge is held on trust for the benefit of noteholders,
under the SBC Warburg Australia Securities Trust
liquidity, and credit providers.
deed. Upon the issue of the notes, the proceeds are
invested in assets that provide a cash flow stream
sufficient to meet the issuer’s obligations under the
interest rate swap. Under the swap agreement, the SECURE Australia Ltd.
issuer will receive sufficient cash flow to service Rating
coupons due on the notes, as well as meet all fees A$1 billion note program AAA
and expenses payable. The receipt of these funds by
the issuer does not rely on the fulfilment of its
RATIONALE
obligations under the swap. The rating on the notes issued by SECURE Australia
Ltd. under its A$1 billion program reflects the credit
quality of various assets to be purchased or origi-
Schooner Capital Pty. Ltd. nated by SECURE as governed by the terms and
conditions of receivables acquisition agreements
Rating
with individual sellers, or origination agreements;
A$1 billion asset-backed commercial paper A-1
and the credit enhancement that may be required in
RATIONALE respect of specific assets and which may be provided
in a variety of ways (for example, overcollateral-
The rating on the commercial paper notes issued by
isation, cash collateral, or third party support),
Schooner Capital Pty. Ltd. reflects:
depending on the nature of the receivables.
♦ The quality of the receivables and debt securities;
SECURE’s fleet lease series is backed by state
♦ The ongoing portfolio monitoring process;
government motor vehicle lease receivables.
♦ The liquidity support in which financial institu-
tions rated at least ‘A-1’ (initially, State Street
Bank & Trust Co.) agree to provide funds for the
company to meet its obligations by paying
Secured Asset Funding Entity No. 1 Ltd.
amounts due to commercial paper holders, Rating
funding Schooner’s investments in investor units A$1 billion asset-backed commercial paper
and making other payments under the transaction program A-1
documents; and
♦ The 10% programwide credit enhancement
RATIONALE
provided by State Street Bank & Trust Co. under The rating on Secured Asset Funding Entity (SAFE)
the credit enhancement facility agreement, which No. 1 Ltd.’s commercial paper (CP) program reflects:
forms a second level of loss support for the ♦ The credit quality of an unlimited number of
purchased receivables and for pools of debt underlying assets, which are rated at least ‘A-1’
securities. and/or ‘A’ and are dependent ratings to that of
Schooner is a special-purpose entity incorporated in the CP;
New South Wales, Australia. The shares in Schooner ♦ The provision of liquidity facilities provided by at
are held by a charitable trust. Schooner will invest least ‘A-1’ rated counterparties;
the proceeds from the issue of short-term commer-
Standard & Poor’s 147
 Structured Finance Australia & New Zealand ¨ April 1999

♦ The provision of hedge agreements provided by securities are backed by floating-rate residential
at least an ‘A-1’ rated counterparty; mortgage loans originated by Citibank Ltd. which
♦ The matching of asset or swap payment dates has been retained as the servicer of the mortgage
with CP maturity dates; and loan portfolio. Security holders receive a monthly
♦ Limitation on CP tenor to a maximum of 95 distribution of principal and interest, according to
days. the priority of payments set out in the trust deed.
SAFE No. 1 Ltd. has been incorporated in the
Australian Capital Territory as a bankruptcy-remote
special-purpose entity. The entity’s function is to Securitised Australian Mortgage Trust
issue CP and use proceeds in payment of notes 1997-1, 1997-2, and 1998-1
issued by an unlimited number of trusts, which, in Rating
turn, will purchase at least ‘A/A-1’ rated asset- A$602.9 million class A mortgage-backed
backed securities. pass-through securities AAA
A security trustee holds a first fixed and floating A$14.6 million class B mortgage-backed
charge over SAFE’s assets for the benefit of its pass-through units AA-
secured creditors, including noteholders and hedge
and liquidity bank providers. RATIONALE
Each asset purchased by a SAFE trust will be a The ratings on the pass-through securities issued by
dependent rating to the SAFE CP, and should one Securitised Australian Mortgage Trust (SAM Trust)
asset be downgraded, the CP will be downgraded 1997-1, 1997-2, and 1998-1 reflect the credit
unless sold or refinanced with no adverse impact on quality of the assets of SAM Trust 1997-1, 1997-2,
the rating of the program. and 1998-1, a pool mortgage insurance policy that
will cover losses on loans with loan-to-value ratios
Standard & Poor’s will review the terms of each
of 80% or less, 100% primary mortgage insurance
asset purchase before the transfer of each asset to a
policies on all loans with loan-to-value ratios greater
SAFE trust.
than 80%, and the availability of a liquidity facility
from Citibank Ltd. to cover any short-term income
shortfalls.
Securitised Australian Mortgage Trust
Class A notes also benefit from the subordination of
1995-1 and 1996-1 class B units regarding principal and interest losses
Rating suffered on the underlying mortgages. Class B units
A$616.6 million class A notes AAA receive the benefit of excess servicing, which is
A$9.5 million class B units AA available to absorb any credit losses. The class A and
A$10.0 million class B notes AA- B securities are backed by floating-rate residential
mortgage loans originated by Citibank Ltd. which has
RATIONALE been retained as the servicer of the mortgage loan
The ratings on the pass-through securities issued by portfolio. Security holders receive a monthly distribu-
Securitised Australian Mortgage Trust 1995-1 and tion of principal and interest, according to the
1996-1 reflect the credit quality of the underlying priority of payments set out in the trust deed.
assets; the mortgage insurance; an A$19 million
pool policy for the 1995-1 trust and an A$18
million pool policy for loans with loan-to-value Series 1996-1 Torrens Trust
ratios of 80% or less and 100% primary mortgage
Rating
insurance on all loans with loan-to-value ratios
A$182.2 million class A residential mortgage-
greater than 80% for the 1996-1 trust; and the
backed securities AAA
availability of liquidity facilities initially equal to
A$13.2 million class B residential mortgage-
A$6 million and A$10 million for the 1995-1 and
backed securities AA-
1996-1 trusts, respectively, from Citibank Ltd.
Class A notes also benefit from the subordination of RATIONALE
class B units regarding principal and interest losses The rating on class A notes issued by Series 1996-1
suffered on the underlying mortgages. Class B units Torrens Trust reflects the credit quality of the assets
receive the benefit of excess servicing that is avail- of the trust, the primary mortgage insurance on each
able to absorb any credit losses. The class A and B mortgage loan in the trust, the subordination of

Standard & Poor’s 148

 Structured Finance Australia & New Zealand ¨ April 1999

class B notes to class A notes equal to 6.76% of the of discretionary variable rate, concessional introduc-
original aggregate note balance, and a liquidity tory one-year fixed rate, fixed rate for up to five
facility equal to 2.1% of the original aggregate note years, and the ability to convert from variable to
balance. fixed rate (and vice versa). The trust hedges any
The rating also reflects the availability of the basis- mismatches between interest receipts due from the
and fixed-rate swaps, the set-off cash collateral, the mortgage loans and interest payments due to the
cash collateralisation of the obligations of Adelaide noteholders.
Bank as liquidity provider and interest rate swap
provider, and the standby guarantee provided by
UBS Australia Ltd. equal to A$40 million to support Series 1998-2 Torrens Trust
the role performed by Adelaide Bank as depository Rating
for the series trust account. The class B notes benefit A$197.00 million class A notes AAA
from the above features with the exception of the A$3.35 million class B notes AA-
subordination.
The notes are backed by fully amortising, residential RATIONALE
mortgage loans originated by Adelaide Bank. The rating on class A notes issued by Series 1998-2
Interest rates charged on the mortgage loans consist Torrens Trust reflects the credit quality of the assets
of discretionary variable rate, concessional introduc- of the trust, the primary mortgage insurance on each
tory one-year fixed rate, fixed rate for up to five mortgage loan in the trust, the subordination of
years, and the ability to convert from variable to class B notes to class A notes equal to 1.67% of the
fixed rate (and vice versa). The trust hedges any original aggregate note balance, and a liquidity
mismatches between interest receipts due from the facility equal to 1.6% of the original aggregate note
mortgage loans and interest payments due to the balance.
noteholders. The rating also reflects the availability of the basis-
and fixed-rate swaps, the set-off cash collateral, the
cash collateralisation of the obligations of Adelaide
Series 1998-1 Torrens Trust Bank as liquidity provider and interest rate swap
Rating provider, and the standby guarantee provided by
A$243.0 million class A notes AAA UBS Australia Ltd. equal to A$20 million to support
A$3.7 million class B notes AA- the role performed by Adelaide Bank as depository
for the series trust account. The class B notes benefit
RATIONALE from the above features with the exception of the
The rating on class A notes issued by Series 1998-1 subordination.
Torrens Trust reflects the credit quality of the assets The notes are backed by fully amortising, residential
of the trust, the primary mortgage insurance on each mortgage loans originated by Adelaide Bank.
mortgage loan in the trust, the subordination of Interest rates charged on the mortgage loans consist
class B notes to class A notes equal to 1.5% of the of discretionary variable rate, concessional introduc-
original aggregate note balance, and a liquidity tory one-year fixed rate, fixed rate for up to five
facility equal to 1.6% of the original aggregate note years, and the ability to convert from variable to
balance. fixed rate (and vice versa). The trust hedges any
The rating also reflects the availability of the basis- mismatches between interest receipts due from the
and fixed-rate swaps, the set-off cash collateral, the mortgage loans and interest payments due to the
cash collateralisation of the obligations of Adelaide noteholders.
Bank as liquidity provider and interest rate swap
provider, and the standby guarantee provided by
UBS Australia Ltd. equal to A$20 million to support Series 1997-1 CATS Trust
the role performed by Adelaide Bank as depository Rating
for the series trust account. The class B notes benefit A$202 million mortgage-backed bonds AAA
from the above features with the exception of the
subordination. RATIONALE
The notes are backed by fully amortising, residential The rating on Series 1997-1 CATS Trust’s bond issue
mortgage loans originated by Adelaide Bank. reflects the credit quality of the assets, the lender’s
Interest rates charged on the mortgage loans consist mortgage insurance pool policy provided by

Standard & Poor’s 149

 Structured Finance Australia & New Zealand ¨ April 1999

Housing Loans Insurance Corp. (HLIC) on each The notes are backed by fully amortising, residential
mortgage loan, the provision of a liquidity facility, mortgage loans originated by Colonial State Bank.
and the sound legal structure of the transaction. Interest rates charged on the mortgage loans consist
HLIC’s obligations under the lender’s mortgage of discretionary variable rate, and fixed rate for up
insurance pool policy are guaranteed by the Com- to five years, and the ability to convert from variable
monwealth of Australia (local currency to fixed rate (and vice versa). The trust will enter
AAA/Stable/A-1+). into appropriate interest rate swaps to hedge any
Bondholders will receive a monthly distribution of mismatch between interest receipts due from the
principal and interest. The interest rate applicable to mortgage loans and interest payments due to the
the bonds will be a floating rate based on a margin noteholders.
over the 30-day bank bill swap rate. The final
maturity date of the bonds is Dec. 15, 2028. Given
the pass-through nature of the bonds, however, the Series 1997-1 Medallion Trust
actual date on which the principal amount of the Rating
bonds will be fully repaid will be determined by the A$277.2 million mortgage-backed bonds AAA
actual prepayment rate experienced on the mortgage
pool. As such, the risk of mortgage prepayments is RATIONALE
borne by bondholders. The rating on the bonds issued by the Series 1997-1
Medallion Trust reflects the credit quality of the
underlying assets; the threshold rate mechanism,
Series 1998-1 CATS Trust whereby the manager is bound to set the interest
Rating rate on the mortgage loans at a level that enables the
A$248 million class A-1 residential mortgage- trust to meet its obligations as they fall due; a
backed notes AAA liquidity facility initially equal to 3.61% of all bonds
A$245 million class A-2 residential mortgage- issued provided by an appropriately rated counter-
backed notes AAA party; the mortgage insurance pool policy and
individual high-lend mortgage insurance policies
RATIONALE provided by Housing Loans Insurance Corp.; and an
The ‘AAA’ ratings on the class A-1 and class A-2 interest risk management instrument provided by an
notes issued by the Series 1998-1 CATS Trust reflect: appropriately rated counterparty.
♦ The credit quality of the assets of the trust; The bonds are backed by fully amortising, residen-
♦ The 100% primary mortgage insurance and a tial mortgage loans located throughout Australia.
pool mortgage insurance policy provided by The loans have been originated by the Common-
Housing Loans Insurance Corp. Ltd. on each wealth Bank of Australia. The bonds are pass-
mortgage loan; through in nature, and principal will be repaid to
♦ The availability of basis- and fixed-rate swaps to
bondholders monthly.
cover any interest rate risk;
♦ The availability of a clean legal opinion from
issuer’s legal counsel, concluding that set-off does Series 1998-1 Medallion Trust
not apply; Rating
♦ The cash collateralisation of the obligations of A$300 million class A residential mortgage-
State Bank of New South Wales Ltd. (trading as backed pass-through notes AAA
Colonial State Bank) as liquidity facility equal to A$3 million class B residential mortgage-
A$13.85 million, or 2.70% of the principal backed pass-through notes AA+
outstanding plus accrued interest, at closing;
RATIONALE
♦ The standby guarantee provided by UBS Aus-
tralia Ltd. equal to A$40 million to support the The ratings on the notes issued by the Series 1998-1
role performed by Colonial State Bank as Medallion Trust reflect:
depository for the series trust account, into which ♦ The credit quality of the mortgage assets and
the mortgage loan collections, cash collateral other authorised investments of the trust;
required under the liquidity facility, and prepay- ♦ A liquidity facility initially equal to A$12 million
ments under the basis swap are deposited; and or 3.96% of all notes issued, provided by an
♦ The sound legal structure of the transaction. appropriately rated counterparty;

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 Structured Finance Australia & New Zealand ¨ April 1999

♦ Interest risk management instruments provided

by appropriately rated counterparties; Series 1997-2 and Series 1997-3 WST
♦ The mortgage insurance pool policy and indi- Trusts
vidual high-lend mortgage insurance policies
Rating
provided by counterparties, whose insurer
A$1.27 billion mortgage-backed class A notes AAA
financial strength ratings are ‘AAA’; and
A$27.2 million mortgage-backed class B notes AA-
♦ The threshold rate mechanism whereby the
manager is bound to set the interest rate on the RATIONALE
mortgage loans at a level that enables the trust to The ‘AAA’ rating assigned to the class A notes issued
meet its obligations as they fall due. by the Series 1997-2 and Series 1997-3 WST Trusts
The class A notes also benefit from the subordina- reflects the credit quality of the underlying assets;
tion of the class B notes. the subordination of the class B notes; 100%
The notes are backed by fully amortising residential primary mortgage insurance or a pool mortgage
mortgage loans located throughout Australia. The insurance policy; and interest risk management
loans have been originated by the Commonwealth instruments provided by appropriately rated
Bank of Australia. The notes are pass-through in counterparties. Additionally, the payment to the
nature, and principal will be repaid to noteholders residuary beneficiary of the trust is payable only to
monthly. the extent that there is excess income available after
paying fees, expenses, senior and subordinated
classes’ coupon obligations, and the reinstating of any
Series 1998-1 Medallion Trust liquidity draws used in previous periods to support
coupon payments. The class B notes benefit from
Rating these features with the exception of the subordination.
A$300 million class A residential mortgage-
backed pass-through notes AAA The class A and class B notes are backed primarily
A$3 million class B residential mortgage- by fully amortising floating-rate, residential mort-
backed pass-through notes AA+ gage loans originated by Westpac Banking Corp.
and are located throughout Australia. The floating
RATIONALE interest rates charged on the mortgage loans in the
The ratings on the notes issued by the Series 1998-1 portfolio are discretionary variable rates that may be
Medallion Trust reflect: reset on a monthly basis. Borrowers with a floating-
rate loan have the option to fix the rate on their
♦ The credit quality of the mortgage assets and
loan for a period up to 10 years. Interest will be
other authorised investments of the trust;
paid to noteholders monthly in arrears, together
♦ A liquidity facility initially equal to A$12 million
with principal collected on the mortgages during the
or 3.96% of all notes issued, provided by an
preceding month. Any mismatch between interest
appropriately rated counterparty;
payable on the mortgages and interest payable on
♦ Interest risk management instruments provided the notes is fully hedged.
by appropriately rated counterparties;
♦ The mortgage insurance pool policy and indi-
vidual high-lend mortgage insurance policies
Series 1997-4E WST Trust
provided by counterparties, whose insurer
financial strength ratings are ‘AAA’; and Rating
US$499.0 million class A Euro notes AAA
♦ The threshold rate mechanism whereby the
US$17.6 million class B Euro notes AA-
manager is bound to set the interest rate on the
mortgage loans at a level that enables the trust to RATIONALE
meet its obligations as they fall due.
The ‘AAA’ rating on the class A floating-rate, pass-
The class A notes also benefit from the subordina- through Euro notes issued by the Series 1997-4E
tion of the class B notes. WST Trust reflects:
The notes are backed by fully amortising residential ♦ The credit quality of the underlying mortgage
mortgage loans located throughout Australia. The assets and other authorised investments;
loans have been originated by the Commonwealth ♦ The 100% primary mortgage insurance or a
Bank of Australia. The notes are pass-through in mortgage pool policy that will cover all mort-
nature, and principal will be repaid to noteholders gages;
monthly.
Standard & Poor’s 151
 Structured Finance Australia & New Zealand ¨ April 1999

♦ Interest risk management instruments provided ♦ A liquidity facility equal to 3.5% of all notes
by appropriately rated counterparties; issued, provided by an appropriately rated entity;
♦ The terms of the residuary beneficiary’s payment, ♦ The interest rate swap agreements entered into
which is payable only if excess income is available with an appropriately rated entity, to mitigate
after paying both senior and subordinated classes’ Australian dollar interest rate risk; and
coupon obligations and other fees and expenses ♦ The prepayable Australian dollar to U.S. dollar
of the trust; cross-currency swaps entered into with appropri-
♦ A liquidity facility equal to 3.5% of the initial ately rated entities to mitigate the currency risk
receivables balance provided by an appropriately between the Australian dollar assets and the U.S.
rated counterparty; dollar notes, and Australian dollar convertibility
♦ The subordinated class B Euro notes equal to and transfer risks.
3.4% of all Euro notes issued; and Westpac Banking Corp. the seller, is Australia’s
♦ The cross-currency swaps that transform the third-largest bank and second-largest home loan
Australian dollar cash flow streams on the provider. This transaction marks the sixth issue by
underlying assets into U.S. dollar cash flow Westpac using its WST trust structure. The first
streams facilitating payment of principal and transaction was a private Australian dollar domestic
interest under the Euro notes. deal. This was followed by two, Australian dollar,
The class B Euro notes benefit from these features domestic public issues; a U.S. dollar cross-border
with the exception of the subordination. Euro issue; and a New Zealand assets, Australian
dollar debt issue. This transaction brings the total of
Ordinarily, the ratings on the U.S. dollar Euro notes
Australian housing loan assets securitised by
would be constrained by the ‘AA’ foreign currency
Westpac to date to A$5,241.3 million (US$3,202.4
rating on the Commonwealth of Australia. The risks
million).
of currency convertibility and transferability are
being assumed under the cross currency swap by the
swap provider, facilitating a rating of ‘AAA’ on the
U.S. dollar senior Euro notes. Series 1998-1 REDS Trust
Rating
A$189.4 million class A mortgage-backed notes AAA
Series 1998-1G WST Trust A$10.6 million subordinated class B
mortgage-backed notes AA-
Rating
US$1,372.7 billion class A senior notes AAA RATIONALE
US$32.3 million class B subordinated
The ratings on the notes issued by Series 1998-1
floating-rate notes AA-
REDS Trust primarily reflect:
RATIONALE ♦ The credit quality of the mortgage assets and

The ratings on Series 1998-1G WST Trust reflect the other authorised investments of REDS;
trustee’s ability to pay interest to noteholders in full ♦ Primary mortgage insurance on each mortgage
on each quarterly coupon payment date and the from MGICA Ltd. (insurer financial strength
trustee’s ability to repay principal in full no later rated ‘AA-’);
than the final maturity date. This transaction marks ♦ A liquidity facility equal to A$7.26 million, or
the largest issue by an Australian securitiser and the 3.63% of the initial note principal balance; and
first issue of Australian residential mortgage-backed ♦ A standby guarantee provided by SBC Warburg
securities into the U.S. market. The notes are being Dillon Read Australia Ltd. to support certain
offered in both the U.S. and the Euro markets. facilities provided by Bank of Queensland Ltd.
Standard & Poor’s assessment is based on: The class A notes also benefit from the subordina-
♦ The prime credit quality of the trust’s assets; tion of the class B notes equal to 5.3% of the initial
♦ The mortgage insurance provided by, or guaran- note principal balance.
teed by, entities with insurer financial strength The notes are backed by fully amortising, floating-
ratings of ‘AA-’ or higher; rate residential mortgage loans originated by Bank
♦ For the class A notes, the subordination of the of Queensland Ltd. and located primarily in Queens-
class B notes, equal to 2.3% of all notes issued; land. The interest rate applicable to the notes will be
a discretionary floating rate, based on a margin over

Standard & Poor’s 152

 Structured Finance Australia & New Zealand ¨ April 1999

the 30-day bank bill rate. The final maturity date of

the bonds is March 28, 2024. Given the pass- Structured Prime Asset Receivables
through nature of the notes, the actual date on No. 2 Ltd.
which the principal amount of the notes will be fully
Rating
repaid will be determined by the actual prepayment
A$236 million commercial paper A-1
rate experienced on the mortgage pool.
RATIONALE
The rating on Structured Prime Asset Receivables
Speirs Securities Ltd. No. 2 Ltd.’s (SPARs) Australian commercial paper
Rating program reflects a foreign-exchange swap contract
NZ$250 million asset-backed commercial paper with an appropriately rated counterparty; the credit
program A-1+ quality of the qualifying assets of SPARs; the
liquidity facility covering 100% of outstanding
RATIONALE commercial paper provided by parties with a rating
The rating on Speirs Securities Ltd.’s commercial of at least ‘A-1’; and the sound legal structure of the
paper program reflects: transaction.
♦ The credit quality of the underlying receivables
SPARs is a special-purpose company incorporated in
and other authorised investments;
the Cayman Islands and is owned by an independent
♦ The liquidity and credit support provided by charitable trust. The business of SPARs is restricted
appropriately rated counterparties for 100% of to issuing short-term commercial paper notes to
the face value of any commercial paper issued; acquire the qualifying asset and enter into foreign-
♦ Swap agreements entered into with appropriately exchange swap contracts. The commercial paper
rated counterparties to hedge the fixed rate notes will be secured by the qualifying assets, the
received on the receivables and the floating rate swap contract, and the liquidity facility.
payable on the commercial paper;
♦ The provision of credit support by way of
overcollateralisation equal to 8% of the face Superannuation Members’ Home
value of the commercial paper issued, and a cash
reserve equal to 2%;
Loans Securitisation Funds No. 1, 2, 3,
♦ The residual value guarantee and guaranteed 4, 5, 6 and 7
buyback contract provided by an appropriately Rating
rated counterparty, which covers 100% of any A$1100 million mortgage-backed bonds AAA
residual funding risk on the receivables; and
♦ The portfolio triggers contained in the documen-
RATIONALE
tation: bad debts equal or exceed 2.5% on any The ‘AAA’ rating on the bonds issued by Superan-
two consecutive funding dates and the arrears nuation Members’ Home Loans Securitisation Funds
percentage equals or exceeds 5%. No. 1, 2, 3, 4, 5, 6 and 7 reflects the credit quality
of the underlying assets; the primary mortgage
The commercial paper is backed by fixed-rate
insurance provided by Housing Loans Insurance
automobile receivables originated by Speirs Group
Corp. on each mortgage loan; the maintenance of a
Ltd. and which meet documented eligibility criteria.
minimum level of cash collateral; and the sound
The receivables consist of hire purchase contracts,
legal structure of the transaction.
secured advances, finance leases, and operating
leases. All the receivables are located in New The bonds are backed by fully amortising, floating-
Zealand. rate residential mortgage loans located throughout
Australia. The interest rate charged on the mortgage
loans is a discretionary variable rate, which is reset
on a quarterly basis, with an option to fix. Any
switch to a fixed rate is at the trust manager’s
discretion and subject to an acceptable swap
agreement to mitigate the interest rate risk. Interest
will be paid to bondholders quarterly in arrears,
together with principal collected on the mortgages
during the preceding quarter.

Standard & Poor’s 153

 Structured Finance Australia & New Zealand ¨ April 1999

♦ Diversity of asset pool by obligor, equipment

SWORD Securitisation Ltd. type, and industry;
Rating ♦ Expected minimum 2% net excess spread
A$1 billion commercial paper program. A-1+ generated per year; and
♦ Loss trigger protection that will force the remain-
RATIONALE ing spread to be captured within the transaction
The ‘A-1+’ rating on the program reflects: structure.
♦ The credit quality of the assets to be held by
SWORD (minimum rating of ‘AA-’ or ‘A-1+’). At
present, it is envisaged that the program will Sydney Capital Corp. Inc.
purchase only one asset unless other program
Rating
enhancements are implemented; US$1.6 billion commercial paper program A-1+
♦ The liquidity support available for the redemp-
tion of notes through the commitment of the RATIONALE
liquidity provider (rated ‘A-1+’) of a facility equal The rating on the commercial paper (CP) issued by
to the aggregate face value of all notes issued by Sydney Capital Corp. Inc. reflects the credit quality
SWORD at the asset level; and of the receivables purchased by Waratah Receivables
♦ The matching of obligations due from the Corp. Pty. Ltd., the terms and conditions of the
underlying asset and those due to the commercial receivables purchase agreement under which the
paper holders. If the physical match funding is receivables have been acquired, a liquidity facility to
not achieved or continued, the hedging of any cover the equivalent of the face value of CP issued
interest rate and/or currency risks through by Sydney Capital, and external programwide credit
derivative contracts must be entered into with support equal to 15% of the CP issued by Sydney
counterparties rated ‘A-1+’. Capital. The liquidity facility and programwide
credit support are provided by Westpac Banking
Corp.
Symphony Trust No. 1 Sydney Capital is a special-purpose entity incorpo-
Rating rated under the laws of Delaware, U.S. The proceeds
A$144 million class A senior floating-rate notes of the issuance of CP to U.S. investors will be lent to
due July 15, 2003 AAA Sydney Capital’s parent company, Waratah, an
A$6 million class B subordinated floating-rate incorporated company in the Australian Capital
notes due July 15, 2003 BBB Territory. Waratah will swap the U.S. dollar funds
that were borrowed from Sydney Capital for
RATIONALE Australian dollars to purchase interests in legally
Credit and liquidity support for the ‘AAA’ notes is distinct pools of Australian loan receivables.
6.5% of total notes issued by Symphony Trust No.
1, consisting of class B note subordination, 1.0%
cash, 0.8% overcollateralisation, and 0.7% in Tasman Funding Inc.
retained excess spread. Credit and liquidity support
Rating
for the ‘BBB’ notes is 2.5%, consisting of 1.0% in US$1 billion commercial paper notes A-1+
cash, 0.8% overcollateralisation, and 0.7% in
retained excess spread. The credit and liquidity RATIONALE
support does not amortise over the life of the The ‘A-1+’ rating on the commercial paper notes
transaction. issued by Tasman Funding Inc. (Tasman Funding)
The ratings reflect: reflects:
♦ The credit quality of Sanwa Australia Finance ♦ The quality of the receivables and debt securities
Ltd.’s commercial hire-purchase portfolio which (the assets);
has exhibited a very low level of historical losses; ♦ The ongoing portfolio monitoring process;
♦ Credit analysis that assumes zero benefit to ♦ The liquidity support provided to the program by
recoveries; an asset purchase agreement, under which ABN
♦ A seasoned pool of assets; AMRO Australia Ltd. agrees to purchase all or a
♦ A closed end pool with no substitution of portion of nondefaulted assets if the issuer has
receivables; insufficient funds to pay maturing notes;
Standard & Poor’s 154
 Structured Finance Australia & New Zealand ¨ April 1999

♦ The liquidity support provided to the program by ♦ The provision of hedge agreements provided by
the time zone agreement with ABN-AMRO Bank at least ‘A-1+’ rated counterparties in respect of
N.V., which protects U.S. investors against CP issuance and at least ‘AA-’ in respect of MTN
repayment delays as a result of time differences issuance;
between New York and Sydney, Australia; ♦ The matching of asset or swap payment dates
♦ The 10% programwide credit enhancement with CP maturity dates; and
provided by ABN AMRO Australia Ltd. under an ♦ Limitation on CP tenor to a maximum of 125
irrevocable letter of credit, forming a second level days.
of loss support for purchased receivables and for Titan was incorporated in the Australian Capital
pools of debt securities exceeding 10 in number. Territory as a bankruptcy-remote special-purpose
No further commercial paper may be issued entity whose function is to issue CP and/or MTNs,
unless the minimum programwide credit support and use proceeds in payment of notes issued by an
is in place; and unlimited number of trusts. In turn, those trusts will
♦ The legal structure of Tasman Funding as a purchase at least ‘A-1+’ and/or ‘AA-’ rated or credit-
bankruptcy-remote entity. assessed single or pools of asset-backed securities.
Tasman Funding is a limited-purpose company The lowest asset rating dependency in the program
incorporated in Delaware, U.S. and is a wholly will dictate the highest achievable MTN rating for
owned subsidiary of Abel Tasman Holdings Pty. Ltd. all MTNs to be issued under the program.
(Abel Tasman). Abel Tasman is a limited-purpose A security trustee holds a first fixed and floating
company incorporated in the Australian Capital charge over Titan’s assets for the benefit of its
Territory. Tasman Funding was specifically incorpo- secured creditors including noteholders and hedge
rated to issue commercial paper notes in the U.S., providers.
and to lend proceeds from the issuance to Abel
The rating of the Titan CP/MTN will be rating
Tasman in Australia. Abel Tasman uses these
dependent on the rating or credit assessment of each
proceeds to fund the purchase of high-quality
asset purchased. Should one asset be downgraded,
structured portfolios of receivables and/or appropri-
the CP/MTN will be downgraded unless sold with
ately rated financial securities from companies,
no adverse impact on the rating of the program.
governments, and financial institutions generally
located in, but not limited to, Australia and the Standard & Poor’s will review the terms of each
Asia-Pacific region. asset purchase prior to the transfer of each asset to a
Titan trust.

Titan Securitisation Ltd.

Transferable Investment Certificates
Rating
A$1 billion asset-backed combined CP Rating
and medium-term note program A-1+/at least AA- A$ category one TICs AA/A-1+
A$ category two TICs Not rated
RATIONALE A$ category three TICs AA-/A-1+
The rating on Titan Securitisation Ltd.’s (Titan) A$1 A$ coupon TICs AA/A-1+
billion asset-backed combined commercial paper
(CP) and medium-term note (MTN) program RATIONALE
reflects: The ratings on the three categories of Transferable
♦ A requirement of underlying trusts to purchase Investment Certificates (TICs) and the coupon TICs
assets rated or credit-assessed to at least ‘A-1+’ in reflect the credit quality of the underlying securities.
respect of CP issuance and at least ‘AA-’ in TICs and coupon TICs are issued by Australian TIC
respect of MTN issuance. The number of MTN Management Pty. Ltd. (ATM), a special-purpose
issues is restricted to a maximum of 10 and the company wholly owned by Commonwealth Bank of
ratings of the assets are dependent on that of the Australia.
CP and MTNs; TICs and coupon TICs (certificates) are bearer
♦ The provision of liquidity facilities provided by at certificates evidencing the holders’ beneficial
least ‘A-1+’ rated counterparties in respect of CP ownership of the securities underlying the certifi-
issuance; cates. Under the term and conditions of certificates,
ATM is appointed as agent of each certificate holder

Standard & Poor’s 155

 Structured Finance Australia & New Zealand ¨ April 1999

and has the discretion to acquire and trade the

underlying securities, provided that the face value of Waratah Securities Australia Ltd.
the underlying securities is equal to the face value of
Rating
the certificates. Certificates are issued at a discount
A$2 billion Australian commercial paper program A-1+
to face value, or on an interest-bearing basis. On
NZ$500 million New Zealand commercial paper
maturity, ATM is required to sell the underlying
program A-1+
securities in order to repay certificates to the
certificate holders. RATIONALE
Waratah Securities Australia Ltd. (Waratah Securi-
ties), an existing Australian commercial paper (CP)
Universal Mirror Trust issuer sponsored by Westpac Banking Corp.
Rating (Westpac), has been restructured into a segregated
Index replication notes AA+r issuer with the intention and capability to issue
limited recourse Australian dollar CP secured by
RATIONALE Australian assets and limited recourse New Zealand
The rating on the notes issued by Universal Mirror dollar CP separately secured by New Zealand assets.
Trust reflects the rating of the underlying assets; the Should the New Zealand CP issued to support the
rating of Warburg Dillon Reed. (AA+/Stable/A-1) as purchase of New Zealand assets be downgraded or
swap counterparty; and the obligation of SBC under in default, there will be no impact on the rating of
the put options to purchase the underlying assets at the Australian CP issued and visa-versa.
par to ensure the noteholders receive adequate funds As part of the restructuring, Waratah Receivables
on maturity. Corp. N.Z. Ltd. (Waratah NZ) has been established
The proceeds generated from the issue of each series as a New Zealand purchaser of portfolios of
of notes will be used to purchase securities rated at receivables located in New Zealand. Waratah N.Z.
least ‘AA+/A-1+’. The coupon payments from the will grant a first ranking charge over its assets to the
underlying securities are made on a periodic basis, N.Z. Security Agent for the benefit of its creditors,
depending on the assets purchased, to SBC under the including Waratah Securities. Waratah N.Z. is a
swap agreement. Any principal received by the wholly owned subsidiary of the Waratah Receivables
trustee will be reinvested in further securities rated Corp. Pty. Ltd. (Waratah Receivables). Westpac
at least ‘AA+/A-1+’. The trustee will pay to SBC the provides credit and liquidity enhancements to
coupon payments from the assets as and when they Waratah N.Z. The proceeds from New Zealand CP
are received from the trustee. In return, SBC, as will be used by Waratah Securities to make a loan to
swap counterparty, will make periodic payments to Waratah N.Z. for the purpose of acquiring portfo-
the trustee, which equal the payments due on the lios of New Zealand receivables.
notes plus all fees and expenses due. The Australian company structure remains un-
SBC has granted the trustee put options over the changed with the proceeds from Waratah Securities
underlying assets of the trust. Before maturity of the Australian CP being used to make a loan to its
notes, the trustee has the option the sell the remain- parent company, Waratah Receivables, which
ing assets of the trust to SBC at their par value. This purchases various portfolios of receivables located in
will ensure that the noteholders will be repaid the Australia. Waratah Receivables also owns a special-
face value of their initial investment on the maturity purpose entity incorporated in the state of Delaware
date of the series notes (provided the relevant index in the U.S., Sydney Capital Corp. Inc. (Sydney
has not made a negative return during the term and Capital). Sydney Capital will issue CP denominated
none of the assets have defaulted). in U.S. dollar and will loan the proceeds to Waratah
Receivables, also for the purchase of Australian
receivables. Westpac continues to provide credit and
liquidity enhancements to Waratah Receivables.

Standard & Poor’s 156

 Structured Finance Australia & New Zealand ¨ April 1999

the WB Trust - 1998, and the reinstating of any

WB Trust principal charge-offs;
Rating ♦ Interest risk management instruments provided
A$50 million mortgage-backed class A notes AA by appropriately rated counterparties; and
♦ A liquidity facility equal to 5% of the initial class
RATIONALE A note balance, provided by, or guaranteed by, an
The ‘AA’ rating on the class A notes issued by the appropriately rated counterparty.
WB Trust reflects the credit quality of the underlying The rating also reflects the subordinated class B
assets, 100% primary mortgage insurance on all unrated notes equal to 5.5% of the class A note
loans from Housing Loans Insurance Corp., interest balance.
risk management instruments and a liquidity facility
The notes are mortgage-backed, and as all of the
equal to 5% of the initial senior note balance. The
loans are secured by mortgages over properties
‘AA’ rating also reflects the subordinated class B
located throughout Queensland there is significant
unrated notes equal to 5% of the initial class A note
geographic concentration risk. Also, some of the
balance, and the terms of the residuary beneficiary’s
risks associated with equitable assignment are
payment, only payable if excess income is available
greater in this transaction than other equitable
after paying both senior and subordinated classes’
assignment mortgage-backed programs because the
coupon obligations, other fees and expenses of the
seller is an unrated entity. The primary risk is that if
trust and the reinstating of any principal charge-offs.
a title perfection event occurs, there are stamp duty
The notes are mortgage-backed, and as all the loans and registration costs associated with the transfer of
are secured by mortgages over properties located legal title from the seller to the WB Trust - 1998.
throughout Queensland, there is significant geo- The class A noteholders are protected from these
graphic concentration risk. Also, some of the risks risks by the unrated subordinated class B notes.
associated with equitable assignment are greater in
this transaction than other equitable assignment
mortgage-backed programs because the seller is an
WISDOM Prime Asset Trust No. 1
unrated entity. The primary risk is that if a title
perfection event occurs, there are stamp duty and Rating
registration costs associated with the transfer of A$500 million CP program A-1+
legal title from the seller to the WB Trust. The class
A noteholders are protected from these risks by the RATIONALE
unrated subordinated class B notes. The rating on the commercial paper issued by
WISDOM Prime Asset Trust No. 1 reflects the
nature of the repackaging program, in which the
WB Trust - 1998 trust is limited to purchasing a maximum of 10
assets whose ratings are dependent on the rating of
Rating
the commercial paper; the ‘AA-/A-1+’ credit quality
A$141.3 million class A senior mortgage-backed
of the underlying assets, the ‘A-1+’ rated liquidity
pass-through notes AA
and support facility provider, and the matching of
RATIONALE asset coupon with commercial paper maturity.

The rating on the notes reflects: WISDOM Prime Asset Trust No. 1 is the first trust
♦ The credit quality of the assets of the trust,
to be set up under Westpac’s WISDOM Master Trust
including 100% primary mortgage insurance on structure whereby the form of documentation
all loans from an insurer with an insurer financial enables separate trusts to be set up under umbrella
strength rating of ‘AA-‘ or higher; documentation. Each trust’s activities are limited to
the special purpose defined in the documentation.
♦ The terms of the residuary beneficiary’s payment,
only payable if excess income is available after
paying both senior and subordinated classes’
coupon obligations, other fees and expenses of

Standard & Poor’s 157

 Structured Finance Australia & New Zealand ¨ April 1999

than the final rated maturity date according to the

WST Funding Trust New Zealand terms of the transaction documents. Using assump-
Sub-Series 1 tions consistent with the rating level of the notes,
Standard & Poor’s analysis indicates that the trust
Rating
will be in a position to pay interest and repay
A$243.69 million class A floating-rate senior
principal on the notes in full, and on a timely basis.
notes sub-series 1 due 2024 AAA
A$16.95 million class B floating-rate subordinated Key credit strengths are the credit quality of the
notes sub-series 1 due 2024 AA trust’s assets; mortgage insurance; for class A notes,
the subordination of the class B notes equal to 6.5%
RATIONALE of all notes issued; a liquidity facility initially equal
The ratings on the notes reflect the issuer’s ability to to 3.52% of all notes issued provided by appropri-
pay interest to noteholders in full on each interest ately rated counterparties; and interest risk manage-
payment date and to repay principal in full no later ment instruments provided by appropriately rated
than the final rated maturity date according to the counterparties.
terms of the transaction documents. Using assump-
tions consistent with the rating level of the notes,
Standard & Poor’s analysis indicates that the trust Zenith Funding Pty. Ltd.
will be in a position to pay interest and repay Rating
principal on the notes in full, and on a timely basis. A$200 million commercial paper program A-3
The key credit strengths are the credit quality of the
trust’s assets and currency risk management instru- RATIONALE
ments provided by appropriately rated counter- The rating on commercial paper issued by Zenith
parties. Funding Pty. Ltd. (Zenith) reflects the credit quality
of the underlying assets, which are rated at least
‘BBB-’ and/or ‘A-3’; the liquidity facility providers,
WST-NZ Series 1998-1 Trust rated at least ‘A-3’ to support the timely redemption
of commercial paper; and the derivative counter-
Rating
NZ$278.82 million class A senior three-month party, which is rated at least ‘A-3’, to match pay-
NZ$ bank rate + 0.39% mortgage-backed ment obligations due from the underlying assets and
pass-through floating-rate notes due 2024 AAA those due to noteholders.
NZ$19.393 million class B subordinated three- Zenith is a special-purpose entity incorporated in
month NZ$ bank rate + 0.62% mortgage-backed the State of Victoria for the purpose of issuing
pass-through floating-rate notes due 2024 AA discounted commercial paper. It is owned by a
charitable trust. The program was arranged by ANZ
RATIONALE Investment Bank.
The ratings on the notes reflect the issuer’s ability to
pay interest to noteholders in full on each interest
payment date and to repay principal in full no later

Standard & Poor’s 158

 Structured Finance Australia & New Zealand ¨ April 1999

Rating Definitions
LONG-TERM RATINGS of adverse business, financial or economic condi-
AAA An obligation/obligor rated ‘AAA’ has the tions, the obligor is not likely to have the capacity to
highest rating assigned by Standard & Poor’s. The meet its financial commitment on the obligation.
obligor’s capacity to meet its financial commitment CC An obligation/obligor rated ‘CC’ is CUR-
on the obligation is EXTREMELY STRONG. RENTLY HIGHLY VULNERABLE to nonpayment.
AA An obligation/obligor rated ‘AA’ differs from C The ‘C’ rating may be used to cover a situation
the highest rated obligations only in small degree. where a bankruptcy petition has been filed or similar
The obligor’s capacity to meet its financial commit- action has been taken, but payments on this obliga-
ment on the obligations is VERY STRONG. tion are being continued.
A An obligation/obligor rated ‘A’ is somewhat more SD A SD (selective default) rating will be assigned
susceptible to the adverse effects of changes in to an obligor which has failed to pay one or more of
circumstances and economic conditions than its financial obligations, rated or unrated, when it
obligations/obligor in higher rated categories. came due. An SD rating is assigned when Standard
However, the obligor’s capacity to meet its financial & Poor’s believes that the obligor has selectively
commitment on the obligation is still STRONG. defaulted on a specific issue or class of obligations
BBB An obligation/obligor rated ‘BBB’ exhibits but will continue to make timely payments on its
ADEQUATE protection parameters. However, other obligations. Such circumstances increasingly
adverse economic conditions or changing circum- characterize defaults of sovereign governments and
stances are more likely to lead to a weakened other obligors in emerging markets. Ratings assigned
capacity to the obligor to meet its financial commit- to specific issues will illuminate their individual
ment on the obligation. payment prospects.
An obligation/obligor rated ‘BB’, ‘B’, ‘CCC’, D A ‘D’ rating will be assigned when Standard &
‘CC’ and ‘C’ are regarded as having significant Poor’s believes that an obligor will generally default
speculative characteristics. ‘BB’ indicates the least on its obligations, failing to pay all of them as they
degree of speculation and ‘C’ the highest. While come due. This will typically occur if the obligor has
such obligations will likely have some quality and filed for bankruptcy protection.
protective characteristics, these may be outweighed R An ‘R’ rating is assigned to a financial institution
by large uncertainties or major exposures to adverse to signify that it is under regulatory supervision
conditions. owing to its financial condition. Regulators may
BB An obligation/obligor rated ‘BB’ is LESS have the power to pay some obligations and not
VULNERABLE to nonpayment than other specula- others. Application of the ‘R ’ symbol has been
tive issues. However, it faces major ongoing uncer- broadened to a wide range of financial institutions;
tainties or exposure to adverse business, financial, or previously, it was applicable only to insurance
economic conditions which could lead to the companies.
obligor’s inadequate capacity to meet its financial Entities rated in the ‘BBB’ category or above are
commitment on the obligation. classified as investment grade. Entities rated ‘BB’,
B An obligation/obligor rated ‘B’ is MORE ‘B’, ‘CCC’, ‘CC’, and ‘C’ are regarded as having
VULNERABLE to nonpayment than obligations predominantly speculative characteristics in their
rated ‘BB’, but the obligor currently has the capacity capacity to pay interest and repay principal. A ‘BB’
to meet its financial commitment on the obligation. rating indicates the least degree of speculation and
Adverse business, financial, or economic conditions ‘C’ the highest. While such entities likely will have
will likely impair the obligor’s capacity or willing- some quality and protective characteristics, these are
ness to meet its financial commitment on the outweighed by large uncertainties or major expo-
obligation. sures to adverse conditions.
CCC An obligation/obligor rated ‘CCC’ is CUR- Plus (+) or Minus (-): The ratings from ‘AA’ to
RENTLY VULNERABLE to nonpayment and is ‘CCC’ may be modified by the addition of a plus or
dependent upon favourable business, financial, and minus sign to show relative standing within the
economic conditions for the obligor to meet its major rating categories.
financial commitment on the obligation. In the event
Standard & Poor’s 159
 Structured Finance Australia & New Zealand ¨ April 1999

r This symbol is attached to the ratings of instru- characterize defaults of sovereign governments and
ments with significant noncredit risks. It highlights other obligors in emerging markets. Ratings assigned
risks to principal or volatility of expected returns to specific issues will illuminate their individual
which are not addressed in the credit rating. payment prospects.
Examples include: Obligations linked or indexed to D A ‘D’ rating will be assigned when Standard &
equities, currencies, or commodities; obligations Poor’s believes that an obligor will generally default
exposed to severe prepayment risk—such as on its obligations, failing to pay all of them as they
interest-only or principal-only mortgage securities; come due. This will typically occur if the obligor has
and obligations with unusually risky interest terms, filed for bankruptcy protection.
such as inverse floaters.
R An ‘R’ rating is assigned to a financial institution
SHORT-TERM RATINGS to signify that it is under regulatory supervision
owing to its financial condition. Regulators may
A-1 A short-term obligation/obligor rated ‘A-1’ is
have the power to pay some obligations and not
rated in the highest category by Standard & Poor’s.
others. Application of the ‘R’ symbol has been
The obligor’s capacity to meet its financial
broadened to a wide range of financial institutions;
commitment on the obligation is strong. Within this
previously, it was applicable only to insurance
category, certain obligations are designated with a
companies.
plus sign ‘+’. This indicates that the obligor’s
capacity to meet its financial commitment on these GENERAL DEFINITIONS
obligations is extremely strong.
CreditWatch highlights an emerging situation
A-2 A short-term obligation/obligor rated ‘A-2’ is which may materially affect the profile of a rated
somewhat more susceptible to the adverse effects of corporation and can be designated as positive,
changes in circumstances and economic conditions developing or negative. Following a full review the
than obligations in higher rating categories. How- rating may either be affirmed or changed in the
ever, the obligor’s capacity to meet its financial direction indicated.
commitment on the obligation is satisfactory.
A Rating Outlook assesses the potential direction
A-3 A short-term obligation/obligor rated ‘A-3’ of an issuer’s long-term debt rating over the interme-
exhibits adequate protection parameters. However, diate- to long-term. In determining a Rating
adverse economic conditions or changing Outlook, consideration is given to possible
circumstances are more likely to lead to a weakened changes in the economic and/or fundamental
capacity of the obligor to meet its financial business conditions. An Outlook is not necessarily a
commitment on the obligation. precursor of a rating change or future Credit-
B A short-term obligation/obligor rated ‘B’ is Watch action. A ‘Rating Outlook - Positive’
regarded as having significant speculative character- indicates that a rating may be raised; ‘Negative’
istics. The obligor currently has the capacity to meet means a rating may be lowered; ‘Stable’ indicates
its financial commitment on the obligation, however, that ratings are not likely to change; and ‘Develop-
it faces major ongoing uncertainties which could ing’ means ratings may be raised or lowered. N.M.
lead to the obligor’s inadequate capacity to meet its means not meaningful, e.g. for structured or
financial commitment on the obligation. managed fund ratings.
C A short-term obligation/obligor rated ‘C’ is
currently vulnerable to nonpayment and is depen-
dent upon favourable business, financial, and
economic conditions for the obligor to meet its
financial commitment on the obligation.
SD A ‘SD’ (selective default) rating will be assigned
to an obligor which has failed to pay one or more of
its financial obligations, rated or unrated, when it
came due. An ‘SD’ rating is assigned when Standard
& Poor’s believes that the obligor has selectively
defaulted on a specific issue or class of obligations
but will continue to make timely payments on its
other obligations. Such circumstances increasingly

Standard & Poor’s 160

 Structured Finance Australia & New Zealand ¨ April 1999

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