Asset Backed Commercial Paper Criteria Report

7/23/2019 Asset Backed Commercial Paper Criteria Report

1/33

November 2013

Methodology

Asset-Backed Commercial PaperCriteria Report: U.S. & European ABCPConduits - Request for Comment


2/33

contact information

Matthew La Capra, CPASenior Vice President - Head of U.S. & European ABCP+1 212 806 [email protected]

Jerry van KoolbergenManaging Director - Structured Credit+1 212 806 3260

[email protected]

DBRS is a full-service credit rating agencyestablished in 1976. Privately owned and operatedwithout af liation to any nancial institution,DBRS is respected for its independent, third-partyevaluations of corporate and government issues,spanning North America, Europe and Asia.DBRSs extensive coverage of securitizationsand structured nance transactions solidi es ourstanding as a leading provider of comprehensive,in-depth credit analysis.

All DBRS ratings and research are available inhard-copy format and electronically on Bloombergand at DBRS.com, our lead delivery tool fororganized, Web-based, up-to-the-minute infor -mation. We remain committed to continuouslyre ning our expertise in the analysis of creditquality and are dedicated to maintainingobjective and credible opinions within the global

nancial marketplace.

This methodology replaces and supersedes allrelated prior methodologies. This methodologymay be replaced or amended from time to timeand, therefore, DBRS recommends that readersconsult www.dbrs.com for the latest version of itsmethodologies.


3/33

Asset-Backed Commercial Paper Criteria Report: U.S. & European ABCP Conduits Credit and LiquidityNovember 2013

Introduction 6The DBRS Asset-Backed Commercial Paper Conduit Rating 6

Primary Risks of ABCP 6DBRS Short-Term Rating 6

General 6More Gradations 6

Commercial Paper Fundamentals 7Basic Mechanics of ABCP Structures 7

ABCP Conduit Revolving Phase 7ABCP Conduit Wind-Down Phase 7

Key Conduit Types 8Multi-Seller Conduit 8Single-Seller Conduit 9Collateralized Commercial Paper (CCP) Program 9

Conduit Liabilities 10Commercial Paper 10Callable / Puttable Feature 10

Conduit Credit Variations 10Credit Risk 11

Transaction-Speci c Credit Enhancement 11Types of Analysis at the Transaction Level 11Transaction Characteristics 11Transaction-Level Credit Enhancement 12Revolving Transactions Sizing Transaction-Level Credit Enhancement 12

Amortizing Transactions Sizing Transaction-Level Credit Enhancement 13Revolving and Amortizing Transactions 13Public Explicitly Rated Transactions 13Transaction-Level Triggers 14

Program-Wide Credit Enhancement 14PWCE Rationale 15Risk Factors 15Risk-Mitigating Factors 15Net Effects 15Sizing PWCE 16Excess PWCE 16

Program-Level Structural Features 16Key CP Cease Issuance/Asset Purchase Tests 16Program Waterfall 16Minimum PWCE Test 16Other General Program-Level Structural Features 17

Other Risks 17Interest Rate Risk 17

Interest Rate Mitigant Transaction-Level 17Additional Interest Rate Mitigant Transaction-Level 17


4/33

Asset-Backed Commercial Paper Criteria Report: U.S. & European ABCP ConduitsNovember 2013

4

Interest Rate Mitigants Program-Level 18Foreign Exchange Risk 18

Foreign Exchange Mitigants Transaction-Level 18Foreign Exchange Mitigant Program-Level 19

Commingling Risk 19Commingling Mitigant Transaction-Level 19Additional Commingling Mitigant Transaction-Level 19Commingling Mitigant Program-Level 20

Dilution Risk 20Dilution Mitigant Transaction-Level 20Additional Dilution Mitigant Transaction-Level 20Dilution Risk Mitigant Program-Level 20

Liquidity Risk 21General 21

Forms of Liquidity Agreements 21Same-Day Funding 21Liquidity Funding Formula 22Rating Thresholds for Liquidity Support 22Liquidity Covering Other Risks 22Liquidity Covering Credit Risks 22Exceptions to Liquidity Funding 22

Legal Risk 24Bankruptcy Risk 24Conduit-Level Risk 24

Conduit Level Structural Mitigants: 24Review of Organizational Documents 26Conduit & Transaction Level Risk 26

Preference Risk 26Mitigants to Preference Risk 26

Stay Risk 26Mitigants to Stay Risk: 27

Review of Excess Funds, Limited Recourse, Non-Petition and Rating Agency Condition 27Excess Funds / Limitation on Payments 27Limited Recourse 27No Proceeding / Non Petition 27Rating Agency Noti cation (RAN) 27

Legal Opinions 27Conduit Level 27Transactional Level 27Necessary Legal Opinions 27

Operational Risk 28Review of the Administrator/Sponsor 28Review of the Program Documents 28

Origination & Execution Advisory Services 28


5/33

Asset-Backed Commercial Paper Criteria Report: U.S. & European ABCP Conduits Credit and LiquidityNovember 2013

Issuing & Paying Advisory Services 29Day to Day Operational Services 29

Operational Risk Mitigants 29Surveillance 29

Monthly Review 29Ongoing Periodic Reviews 30

Rating Process and Documentation Review 30Rating Process Initiation 30Conduit Rating Program Analysis 30Conduit Con rmation Transaction Analysis 30

Asset Transfer Agreement / Receivable Purchase Agreement 31Liquidity Agreement 31


6/33


6

Introduction

This publication outlines the updated proposed DBRS methodology for rating Asset-Backed CommercialPaper (ABCP) in the United States and Europe. DBRS requests comments be received on or beforeDecember 30, 2013. Please submit comments to [email protected] publishes on its website all comments received from a comment period, except in cases where con -

dentiality is requested by the respondent. Following the review and evaluation of all submissions, DBRSwill publish a nal version of this methodology.

The criteria in this publication should not be seen as static. DBRS continually reviews market develop -ments on an on-going basis to ensure that its policies and criteria remain relevant. In addition, DBRSanalysis and processes may deviate from this methodology if the circumstances applicable to a particu-lar Commercial Paper (CP) Program so require. DBRS may publish updates to this criteria, as well asaddenda to address country-speci c issues. Updates will be publicly available on www.dbrs.com.

The rating process outlined herein represents an update to the Asset-Backed Commercial PaperCriteria Report: U.S. & European ABCP Conduits methodology published in August 2009.

This framework is applied in conjunction with a number of other DBRS publications, including: Legal Criteria for European Structured Finance Transactions ; and Legal Criteria for U.S. Structured Finance Transactions .

The DBRS Asset-Backed Commercial Paper Conduit Rating

PRIMARY RISKS OF ABCP

ABCP is a short-term debt instrument issued by a conduit and backed by a variety of individual asset-backed transactions. In order to issue a short-term rating on CP issued by an ABCP conduit, DBRSanalyzes the comprehensive risk pro le of the conduit, focusing on the four primary risk areas. They areas follows:

Credit Risk. Liquidity Risk. Legal Risk. Operational Risk.

DBRS SHORT-TERM RATING

General Regardless of the debt instrument the conduit issues, DBRS rates to the CP investor being paid in wholeand on time. Payments that are not timely or complete constitute a default.

More GradationsWith more short-term rating gradations than other rating scales, DBRS offers CP investors more infor -mation and transparency. DBRSs ratings of R-1 (high), R-1 (middle) and R-1 (low) on an ABCP conduitrange from a AAA to an A (low) risk pro le. DBRS believes that investors can better understand risksinherent in ABCP portfolios through more granular short-term ratings.


7/33


Commercial Paper Fundamentals

An ABCP conduit is a special-purpose vehicle that is structured to be bankruptcy remote and legallyseparate from its sponsor. The conduit acquires assets via an asset purchase or a secured lending trans-action. Some common assets or asset interests that ABCP conduits nance are trade receivables, autoand equipment loans and leases, credit-card receivables, mortgages and collateralized debt obligations(CDOs). ABCP tenors are generally limited to 365 days, but can be as long as 397. Both are issued oneither a discount or interest bearing basis.

BASIC MECHANICS OF ABCP STRUCTURES

ABCP Conduit Revolving PhaseAn ABCP conduit is a vehicle that is usually intended to last until a program wind-down occurs. CP isissued against transactions that have been accumulated over time. During the revolving phase, an ABCPconduit typically acquires and retires transactions at the same time as it issues and retires CP.

Payment of Interest on Commercial Paper and Conduit Fees : Although interest is typically covered onthe transaction level by the liquidity facilities, the conduits sponsor and/or administrator designs theprogram to cover interest and CP conduit fees in one of two ways:

Interest-Bearing Assets : For transactions that have underlying interest-bearing assets, typicallyinterest collected on the assets pays the interest on the CP and the conduit fees.

Non-Interest-Bearing Assets : For transactions that have non-interest-bearing assets, typicallyadditional reserves in the form of overcollateralization are established to cover interest andconduit fees.

Payment of Principal on Commercial Paper : During the revolving phase, the conduit will issue new

CP and generally use the proceeds thereof to pay maturing CP in a process called rolling the CP.CP can generally be rolled against performing transactions. The ABCP program contains limits (seeProgram-Level Structural Features on page 16) on the amount of CP that can be issued at any timebased on a variety of factors, including the amount of performing assets in the conduit. Rolling theCP typically repays 100% of the principal component of maturing CP.

ABCP Conduit Wind-Down PhaseVoluntary Wind-Down : For various reasons, program sponsors may choose to wind down a CP conduit.In this case, the portfolio of transactions may naturally amortize. During the natural amortization of thetransactions within the conduits portfolio, maturing CP is typically paid by both collections from theassets and from issuing new CP. This will recur until the conduits transactions are completely amortized.Alternatively, banks may choose to fund some or all of the transactions with a liquidity facility, thereby

immediately removing any or all of the investor exposure to such transactions. Involuntary Wind-Down :An involuntary conduit wind-down may occur if the conduit breaches speci c program triggers that areset out at the conduits inception. The section entitled Program-Level Structural Features on page 16outlines some of the material triggers that would invoke an involuntary conduit wind-down.


8/33


8

KEY CONDUIT TYPES

Multi-Seller Conduit

General : A multi-seller conduit is a limited-purpose, bankruptcy-remote vehicle that provides fundingto a multitude of unaf liated originators/sellers in exchange for asset interests. 1 Individual sellersassets are acquired transaction by transaction, typically accumulating into a diversi ed portfolioacross asset types and industries to support the CP issued by the program.

Credit : Each transaction that is added to the conduits portfolio must be structured and/or creditenhanced so that the resulting risk pro le of the CP conduit is commensurate with its CP rating.

Program-wide credit enhancement (PWCE) is available as a fungible layer of credit enhancementacross all transactions. (Please see Program-Wide Credit Enhancement on page 14 for more details.)An integral part of assessing the CP risk pro le of a conduit is the size of its PWCE relative to the sizeand composition of its portfolio of transactions.

Liquidity : A liquidity bank, typically the conduits bank sponsor, provides a liquidity facility for eachtransaction to address timing mismatches between the payment streams of the assets and the CPmaturity dates or to repay CP investors in the event that CP cannot be rolled, namely a market disrup -

1. The conduits portfolio consists of transactions collateralized by underlying assets. Such underlying assets are referred toherein as underlying assets, assets or collateral. The conduits interest in these transactions is referred to hereinas asset interests.


9/33


tion. Liquidity facilities generally will support a transaction in one of three ways; 1) They may coverthe vast preponderance of risks except for defaulted assets, they may cover a portion of the credit riskby short tailing a transaction, (see page 23), or 3) they may fully wrap a transaction by coveringall credit risks. Sponsor banks providing liquidity, in the form of a liquidity funding agreement, mayuse the facility to transfer the transaction out of the conduit for any reason.

Single-Seller Conduit

General : A single-seller conduit is a limited-purpose, bankruptcy-remote vehicle that provides fundingto a single seller in exchange for interests in its pool of receivables. Single-seller programs are popularamong large credit-card issuers, major auto manufacturers and mortgage originators.

Credit : As is the case for multi-seller conduits, single-seller conduits acquire transactions that arestructured and/or credit enhanced so that the resulting risk pro le of the CP conduit is commensuratewith its CP rating. Credit enhancement addresses historical and projected asset deterioration at aparticular rating level commensurate with the risk to the CP investors.

Liquidity : As in the case of multi-sellers, the liquidity provider(s) address timing mismatches betweenthe payment streams of the assets and the CP maturity dates or issues that arise when CP cannot berolled, including a market disruption. If the sellers short-term rating is high enough, it may serve asthe liquidity provider. If not, one bank or a syndicate of liquidity banks may serve as the liquidityprovider(s). If a syndicate of over 10 liquidity banks is utilized, DBRS will assess the overall risk ofthe portfolio of liquidity banks as compared to ratings sought. In this case, there will likely be anexpectation of additional liquidity coverage.

Collateralized Commercial Paper (CCP) Program

General : A Collateralized Commercial Paper program is similar to the repo-backed ABCP conduits

that have been around since the 90s. While ABCP conduits in general are backed by 100% liquid -ity usually provided by the sponsor bank, conduits that use repurchase agreements as their sourceof liquidity use those repurchase agreements to match fund asset and liability cash ows. Some dif -ferences are that CCP notes are typically direct unconditional obligations of the parent (or jointobligation with an LLC set up by the parent) rather than of a legally separate SPV, like a conduit.The other notable difference is the ultimate borrowers of ABCP conduits are often anonymous to theinvestors. For CCP programs the obligation of the parent is known. Thus, CCP is functionally similarto unsecured corporate CP as it relies on the parent to fund. The added bene t to investors though isthat if the parent (and their related SPV, if applicable) fails to meet their obligation, investors can takepossession of the collateral under the repo.

Credit : Relies primarily on the unconditional obligation of the issuer/parent to pay the CCP on a

timely basis. An additional feature is that investors have access to repo collateral.

Liquidity : Legally, there is no formal traditional liquidity facility like an ABCP conduit. Instead thereliance is on the parent to honor their obligation to pay the CCP notes. However, like Repo-BackedABCP conduits the repurchase agreements may be match funded with the notes issued.


10/33


10

CONDUIT LIABILITIES

Commercial Paper ABCP is generally limited to maximum maturities of 365 but can be as long as 397 days.

CP can be issued on a discount or interest-bearing basis.

Discounted CP : The investor purchases discounted CP for a price that is less than the face amountdue at maturity. The interest is imputed from the difference between the purchase price and the facevalue. This is the most common form of issuance.

Interest-Bearing CP : Interest-bearing CP accrues interest on the amount of the investors purchaseprice paid for the CP. The investor will collect all interest and principal at the maturity of the CP.

Callable / Puttable FeatureFollowing recent developments on the regulatory front, speci cally in response to the impending LiquidityCoverage Requirements, many CP conduits have amended their programs to include puttable/callable CP.These features respectively provide the investor the ability to put the CP note back to the Issuer at parand the Issuer the ability to redeem the note prior to its stated maturity.

Callable CP is typically structured such that 1) The CP tenor is longer than 30 days and 2) it can beredeemed or called by the issuer any time before 30 days of the legal maturity date. It is generallypresumed the issuer will invoke this call. The typical notice given to the investor is 1 day.

Puttable CP provides the investor the exibility to sell or put the CP note back to the Issuer. Thetypical notice that the Investor must provide the issuer to put is at least 30 days.

CONDUIT CREDIT VARIATIONS

Fully Supported : Fully supported ABCP conduits are distinguished from partially supported programsbecause they are 100% credit enhanced by an appropriately rated entity, often the sponsor but some -times a third party nancial guarantor. For these conduits, the analysis is not focused on the underlyingcollateral, but rather on the party providing the credit enhancement. The risk to the CP investor isthat the credit enhancer itself becomes insolvent. The documents must dictate that the enhancer willirrevocably and unconditionally pay the liabilities in full and on time. The rating of the provider ofthe credit enhancement typically determines the maximum rating that can be assigned to the ABCP.

Partially Supported : Partially supported programs are characterized by having less than 100% creditenhancement. The analysis for partially supported conduits focuses on the transactions within theconduit and on the PWCE available.

Transaction-Level : The transaction analysis focuses on the credit quality of the underlying col-lateral, the liquidity-funding formula, the transaction-level credit enhancement and the structuraland legal protections. Credit enhancement at the transaction level represents the rst-loss protec -tion to the CP investors. 2

Program-Level : The program-level analysis focuses on the size of the PWCE relative to the overallcomposition of the conduits portfolio of transactions as well as program structural and legalfeatures. PWCE is generally regarded as second-loss protection to the CP investors.

2. For the sake of simplicity, this criteria ignores any rst-loss equity tranches.


11/33


Credit Risk

In order to protect the CP investor, conduit sponsors typically structure their vehicles to employ credit

enhancement on two levels: the transaction-speci c level and the program-wide level. Thus, for the CPinvestor to actually take a loss, the asset deterioration must be greater than the credit enhancementprovided on the transaction level and it must deplete the entire program-wide credit enhancement that isavailable across all transactions.

TRANSACTION-SPECIFIC CREDIT ENHANCEMENT

Transaction-speci c credit enhancement is rst-loss protection used to absorb any deterioration of thecollateral on speci c transactions within the conduits portfolio. DBRS checks whether each transactionadded to the underlying pool has been structured and/or credit enhanced such that the resulting riskpro le of the CP conduit is commensurate with its CP rating. Common forms of transaction-speci ccredit enhancement are overcollateralization, subordination, excess spread, seller recourse, cash reserves,

third-party guarantees, structured liquidity and total return swaps. Transaction-level credit enhancementis speci c to each transaction and cannot be applied to other conduit transactions.

Types of Analysis at the Transaction Level In order to rate ABCP, DBRS formulates a credit opinion on each underlying transaction. At the transac -tion level, DBRSs analysis can take the form of an internal assessment or a public explicit rating.

Internal Assessment : Many transactions acquired by a conduit do not carry public explicit ratings.For these transactions, DBRS performs a credit evaluation that is called an internal assessment. Theseassessments are used by DBRS as part of the analysis of the CP. An internal assessment is similarto the analysis of explicitly rated transactions, with some exceptions. For internally assessed trans -actions, DBRS relies on the conduits administrator to perform an in-depth review of the sellersoperations. Further, an internal assessment relies on many protections offered by the liquidity facility.For example, dilution and commingling risks are often covered by the liquidity facilities. DBRS,therefore, relies on the rating of the liquidity provider for many risks in internally assessed transac -tions. Detailed explanations of what the liquidity facility typically covers with respect to the aboverisks, as well as other risks, can be found in the Other Risks section beginning on page 17.

Public Explicit Ratings : Explicitly rated transactions are analyzed on a stand-alone, or term,basis. 3 However, the payments from the explicitly rated transaction to the conduit often do not matchthe payments from the conduit on the CP. Thus, there is a need for traditional liquidity support tomitigate cash ow timing mismatches, as well as any market disruption risk.

Transaction Characteristics

Revolving Transactions : A revolving transaction continually nances its receivables through theconduit until the date at which it terminates. New collateral enters the transaction and pays down onan ongoing basis. Transactions of this nature can theoretically nance their receivables inde nitely. Theassets in revolving transactions typically must conform to eligibility criteria that are reviewed by DBRS.

Generally, revolving transactions are characterized by having amortization triggers that are typi -cally checked monthly. These triggers are generally in place to ensure that the transaction has the

3. Stand alone, or term, transactions are rated such that the internal cash ows must be adequate to pay periodicinterest and ultimate payment of principal at the legal nal date.


12/33


12

proper credit enhancement on an ongoing monthly (reporting period 4) basis. If breached and leftuncured, an amortization of the transaction will occur. (Please see Revolving Transactions SizingTransaction-Speci c Credit Enhancement on page 11 for more details on the credit aspects of revolv -ing transactions.) Many public explicitly rated transactions initially revolve and subsequently, at apredetermined date, amortize.

Amortizing Transactions : An amortizing transaction is characterized by assets that typically amortizefrom the transactions inception until the assets completely wind down. Amortizing transactionsoften have a static asset pool. That is, the asset pool composition is set from inception. (Pleasesee Amortizing Transactions Sizing Transaction-Level Credit Enhancement on page 13 for moredetails on the credit aspects of amortizing transactions.)

Transaction-Level Credit Enhancement DBRS analyses both the credit enhancement for a transaction (using rating methodologies relevant to theparticular asset class) as well as the risks covered by the liquidity. The major factors that are consideredinclude, but are not limited to, the following:

Eligibility criteria or static pool characteristics. The history of delinquencies. The historical payment characteristics (e.g., seasonality). The historical timing of losses on vintage pools. Seller concentrations. The originators risk pro le. The quality of the servicer. Underwriting procedures and policies and recent changes therein. The quality of the data. Idiosyncratic factors speci c to the particular asset type. Industry/asset-type comparisons.

The type of analysis of underlying transactions will vary based on the asset sector (e.g., mortgages versusauto loans versus trade receivables). The type of analysis will also vary depending on whether the transac -tion is a revolving transaction or an amortizing transaction.

Revolving Transactions Sizing Transaction-Level Credit Enhancement

Topping up the Reserve in Revolving Transactions : Generally, for revolving transactions, the propercredit enhancement must be in place and fully intact at the start of each reporting period. This is oftenaccomplished via monthly (reporting period) credit triggers tied to a CP issuance test.

Generally, the most prevalent monthly credit trigger in a revolving transaction is known as the bor -rowing base test. This test ensures that the assets and the necessary credit enhancement are fully

intact on a go-forward basis. Any depletion of the credit enhancement resulting from asset deteriora -tion is typically cured by the seller in the form of contributing more receivables to the transaction.This ensures that after each monthly (reporting period) report, the transactions credit enhancementis fully intact. This procedure of restoring the necessary credit enhancement each month (reportingperiod) is called topping up the reserve. If the reserve is not topped up, the transaction will winddown and amortization begins.

Ascertaining the Exposure Horizon in Revolving Transactions : The key to accurately sizing thetransaction-level credit enhancement requirement focuses on the exposure horizon, which is the time

4. The reporting period is usually conducted on a monthly basis but may be shorter. It represents the frequency of reportson which key asset performance tests often rely.


13/33


during which the transactions collateral can experience losses.

For revolving transactions, as noted above, the credit enhancement is typically topped up on a monthlybasis. Therefore, revolving pools in effect have a fresh start each month (reporting period) becausethe credit enhancement is restored to its requisite level. If the credit enhancement is not topped up,the conduit is precluded from issuing CP supported by that transaction. Therefore, the transactioncannot purchase additional assets, thus causing the transaction to amortize.

The maximum time during which the collateral can experience losses, the exposure horizon, is typi -cally calculated by adding the time it takes for the assets to naturally amortize to the length of thereporting period.

Amortizing Transactions Sizing Transaction-Level Credit Enhancement

Ascertaining the Exposure Horizon in Amortizing Transactions : As is the case for revolving transac-tions, the key to accurately sizing the transaction-level credit enhancement requirement for amortizingtransactions is the exposure horizon, which is the time during which the transactions underlyingassets can experience losses. Calculating the exposure horizon for amortizing transactions is simplerthan for revolving transactions. Generally, the exposure horizon is the time it takes for the assets toamortize. Hence, the sizing of credit enhancement is based on the amortization period.

Revolving and Amortizing Transactions

Shortening the Exposure Horizon Via Structural Features : Most revolving or amortizing, non-explicitlyrated transactions that are in a conduits portfolio are sized as per their exposure horizon. However,there are structural features that may shorten the exposure horizon. For example, an appropriatelyrated takeout provider may promise to purchase a transaction at a particular time or a transactionmay be short-tailed as detailed in the Short-Tail Exposure summary on page 23. The sale shortensthe exposure horizon for that transaction.

Public Explicitly Rated TransactionsExplicitly rated transactions can be characterized as either revolving or amortizing.

Explicitly rated revolving transactions typically have a set revolving period followed by an amortizationperiod, the end of which is the legal nal date. During the revolving stage, these transactions typicallyhave amortization triggers that ensure that the transaction has the proper credit enhancement on a go-forward basis. These various triggers can be checked daily, weekly or monthly, depending on the type oftrigger. If breached and left uncured, an early amortization of the transaction will occur. This occurrence,along with greater-than-anticipated asset deterioration, could lead to the downgrade of the explicitlyrated transaction.

Similarly, for explicitly rated amortizing transactions, among other factors, poor asset performancebeyond the expected defaults could lead to a downgrade of the explicitly rated transaction. In both cases,the focus for ABCP is the downgrade itself.

If the explicitly rated transaction deteriorates more than anticipated and a ratings downgrade occurs, aconduits program and/or transaction documents will set forth a course of action. Areas addressed by thedocuments may include, but are not limited to, the following:

The actions that the rating downgrade will compel the conduits administrator to perform (e.g., sellthe asset, fund the asset with liquidity).


14/33


14

The timing by which the liquidity facility must fund upon certain events (e.g., a downgrade to a par -ticular level).

The additional credit enhancement that may be provided upon a downgrade.

In any event, DBRS must be con dent that the documents detail the conduits course of action and thataction suf ciently mitigates the risk to the CP investor of a downgrade of the transactions rating to arating level lower than that of the rating of the CP issued by the conduit.

Transaction-Level TriggersDBRS typically relies on structural triggers for many transactions. These triggers often necessitate remediesthat ensure that the transaction has the proper credit enhancement on a go-forward basis or, if not, causean amortization of that transaction. However, while certain triggers are integral to many transactions,such as the borrowing base test for revolving transactions, they are not necessarily required. For example,the sponsor bank may elect to 100% credit enhance or wrap a particular transaction with a liquidityfacility (liquidity will fund for the principal and interest on the CP). In this case, DBRS will rely on theliquidity banks rating. The Liquidity Covering Credit Risks section on page 22 addresses the possiblevarying magnitudes of credit coverage by liquidity facilities.

Because some triggers are more vital than others, the remedies for the breach of structural triggers varyaccording to their importance. Some triggers may not result in a particular transaction winding down butrather may invoke another action. For example, a credit deterioration trigger may invoke the trapping ofexcess spread from the assets to bolster the transactions credit enhancement. Some common triggers areexplained below.

Borrowing Base Test : The borrowing base test (Please see Revolving Transactions SizingTransaction- Speci c Credit Enhancement on page 11 for details) ensures that the transaction hasthe requisite credit enhancement each time the test is calculated. The frequency of its calculation canbe monthly, twice a month, weekly or daily.

Performance Triggers : Additionally, many transactions contain performance triggers that addressunderperforming collateral. Varying asset types command different quantitative triggers. Commonperformance tests include excess spread, delinquency and dilution triggers.

Seller Triggers : Qualitative seller triggers on the transaction level include, but are not limited to, thefollowing:

A seller/servicer insolvency. A seller/servicer downgrade. A material decline in the servicers ability to perform its duties. A breach of material representations and warranties.

The cross-default of the seller with respect to other debt obligations.

Conditions Precedent to Issuing CP : The conditions by which CP can be issued are an important partof revolving transactions. The breach of these conditions will preclude the conduit from issuing CPuntil cured. Thus, they ensure that some key elements on which the transactions rating was basedare fully intact each time the conduit issues CP. For example, the borrowing base test is a key condi -tion precedent to issuing CP as it ensures that upon each CP issuance, the proper credit reserves arein place.

Transaction Wind-Down : Uncured breaches of transaction-speci c triggers may invoke certainremedies, including a cease issuance of CP and/or no new purchases of assets. If such a breach is left


15/33


uncured, remedies such as this will effectively amortize the transaction.

PROGRAM-WIDE CREDIT ENHANCEMENT

Program-wide credit enhancement (PWCE) is a fungible layer of protection generally available to alltransactions within a conduits portfolio. PWCE is typically drawn after a transactions liquidity facilitieshave funded for the good (i.e. non-defaulted) assets. If, after the liquidity facility funds, a particular trans -actions credit enhancement is insuf cient to cover the deterioration of such a transaction, PWCE thenabsorbs the excess loss. Thus, the transaction-speci c credit enhancement acts as a rst-loss enhancementand the PWCE is typically regarded as second-loss enhancement.

DBRS views PWCE as an additional layer of protection much like a subordinated tranche of a CDO. Thesize of the PWCE relative to the risks inherent within the conduits portfolio of transactions is importantto the overall risk pro le of the conduit.

PWCE can take many forms but is typically an LOC, a surety bond, a third-party guarantee, a credit assetpurchase agreement or an irrevocable loan facility. The entities providing the PWCE instrument shouldprovide an irrevocable commitment, have an appropriate rating, and possess the capability of providingsame-day funding. If same-day funding presents a problem, an entity with an appropriate short-termrating must contractually agree to front the necessary funds for the program enhancer. The rating of theprovider of the credit enhancement and/or any entity fronting the necessary funds for that entity typicallydetermines the maximum rating that can be assigned to the ABCP.

PWCE RationalePWCE is an integral part of the risk pro le of an ABCP conduit for the following reasons:

First, for transactions that are internally assessed, DBRS relies on the sponsors review of each sellerand the related assets. This includes the sponsor banks ongoing reviews of such seller. PWCE providesprotection for the variation, if any, between the banks evaluation of a seller and what DBRSs opinion

is or may have been had it reviewed the seller.

The second reason, substantially more complex, addresses how the growth of a CP conduit affects itsrisk pro le. As the number of transactions increases within the conduit and the conduit grows in size,there are factors that counterbalance one another (see Risk Factors, Risk-Mitigating Factors andNet Effects below) and thus affect the risk pro le of the conduit.

Risk FactorsAs the number of transactions within a conduit increases, the probability that any one or more of thosetransactions will default also increases. Further, there is a correlation between the transactions within aconduits portfolio, increasing the likelihood that if one transaction defaults, so will another. DBRS con-siders the effect of these risk factors when analyzing the risk pro le of a CP conduit.

Risk-Mitigating FactorsIn contrast, increasing the number of transactions will likely increase the size of the PWCE. Increasingthe size of the PWCE has positive effects on a conduits risk pro le. These positive effects counter theaforementioned corrosive factors. First, as the size of the PWCE increases, the smaller each transactionbecomes relative to the PWCE available to it. Therefore, the probability of any one transaction havinga negative impact on a CP investor is decreased. Thus, as the PWCE grows with the CP conduit, moretransactions will have to default simultaneously to reach the threshold that would affect the CP investornegatively. Also, to the extent that the number of transactions increases the diversity across asset andindustry lines, the reduction in default correlation among such transactions decreases the risk to the CPinvestor.


16/33


16

Net EffectsThe overall net effect of the counterbalancing factors on the conduits risk pro le will vary depending onthe composition of the portfolio and the relative size of the PWCE. Nevertheless, PWCE is in place toabsorb the potential net negative effects, if any, of increasing the number of transactions within a con -duits portfolio.

Sizing PWCEAs described above, PWCE is the fungible layer typically available to all transactions within the conduitsportfolio when rst-loss protection has been exhausted. DBRS evaluates the amount of PWCE consider -ing the projected composition of transactions within a conduits portfolio to ensure that the total riskpro le of the conduit is commensurate with the rating on the CP. Generally 5% is the minimum amountof PWCE provided but conduits often provide more. In any case, DBRS will expect the greater of 5% or,in the case of under 10 transactions within a conduit, covering off the any transaction or transactionsentirely that may be below the rating of the conduit. It should be noted that aforementioned minimumsmay or may not be adequate as a credit quality portfolio assessment is part of the analysis.

Excess PWCEDBRS believes that the size of the PWCE relative to the composition of the portfolio of transactionswithin a CP conduit is an important factor in assessing the overall risk pro le to the CP investor. Forexample, the difference between a CP program that has 5% PWCE and 10% PWCE is material andshould be re ected in the rating of the CP, all else being equal. For example, if a conduits portfolio com -prised A, AA and AAA transactions and had 5% PWCE, that conduit may command a rating of R-1(low). However, if that conduit had the same portfolio with 10% PWCE, an R-1 (middle) or R-1 (high)may be more accurate (depending on the rating level of the liquidity support). DBRS believes ratingsthat more accurately re ect the overall risk pro le of a CP program will provide CP investors with moreinformation and more transparency.

PROGRAM-LEVEL STRUCTURAL FEATURES

Key CP Cease Issuance/Asset Purchase TestsKey tests at the program level include, but are not limited to, the following:

Program Asset Test : The principal of the non-defaulted assets of all the transactions within the con-duits portfolio should be greater than or equal to the principal of all of the conduits liabilities at anytime.

Program Liquidity Test : The total available liquidity commitments must exceed the principal andinterest of all outstanding CP at any time.

Remedies for Breach of Key Program Tests : Any failure to satisfy these tests typically prohibits the

conduit from issuing CP and purchasing additional asset interests, until cured. If left uncured for aspeci ed period of time (usually a very short time frame), the cease issuance may become permanentor a program termination event will be of cially invoked. Either way, the program will wind downif breach is left uncured.

Program Waterfall Often there are two distinct priority of payment sections for conduits that are in the revolving phase andamortizing phase. DBRS reviews whether in either scenario, contingent, un-sized, and uncapped fees aresubordinated to the CP Investor in the program waterfall.

Minimum PWCE Test The PWCE may be reduced if the program size decreases. Nonetheless, erosion of the PWCE below


17/33


a particular level as a result of defaulted assets may invoke a CP cease-issuance trigger or, if severeenough, may cause the program to wind down. If a program wind-down occurs, PWCE typically issubject to a xed oor amount to mitigate the potential for losses resulting from adverse selection 5

from within the conduits portfolio of transactions.

Other General Program-Level Structural FeaturesThe key material triggers that will wind down a conduit if left uncured for a short period of time include,but are not limited to, the following:

The program documents cease to be in full force and effect.A breach of any material representation or warranty by the conduit as per the program documents.

Other Risks

The following are various other conduit risks and their respective mitigants. They are present at both thetransaction and program level. Liquidity facilities play a large role in covering many of these risks.

INTEREST RATE RISK

Interest rate risk arises when the interest collected from the conduits underlying assets may be insuf -cient to pay the conduits cost of funds on a timely basis. The transactions in the conduits portfolio aremade up of xed, oating and non-interest-bearing assets. CP interest rates, although typically xed forthe term of the CP, uctuate as new CP is issued. Therefore, the potential for variability in the conduitstransactions as well as in CP rates over time represents interest rate risk.

Interest Rate Mitigant Transaction-Level

Liquidity Facility : Generally, the transaction liquidity banks are required to fund the interest accruedat the time of funding and the interest that will accrue to the maturity of the CP. Thus, the risk tothe CP investor re ects the rating on the transaction liquidity provider. Typically, the sponsor bankprovides the liquidity facility for each transaction.

Additional Interest Rate Mitigant Transaction-Level

DBRS reviews other features that may serve to mitigate this risk. The following are examples:

Reserve Account : Conduit sponsors generally have incentive to properly address interest rate riskbecause in cases where the sponsor bank is also the liquidity provider, the bank does not want totake a loss if liquidity funds. As a result an interest rate reserve account may be established such thatif liquidity is drawn, cash will be available from the interest rate reserve to reimburse the liquidityprovider. If liquidity does not fund, which is unlikely, cash is available from the reserve fund to payCP.

Additional Safeguards : Other safeguards to the CP investors include the following:

Typically, the conduit assets are structured to pay, at a minimum, the conduits cost of funds.

5. Adverse selection may occur when the conduits portfolio is negatively affected because as shorter-term transactions payoff, the conduit may be left with a longer-dated, less-diversi ed portfolio of transactions. Generally, the longer a portfo -lio of transactions is exposed to losses, the lower the credit quality of such a portfolio, all else being equal.


18/33


18

The conduits oating-rate assets are generally hedged. That is, the conduit will typically swapout the assets yield and receive the conduits cost of funds.

Rather than rely on the above safeguards, DBRS typically relies on the liquidity support to cover interestrate risk on the transaction level.

Interest Rate Mitigants Program-Level

PWCE : Any losses on the transaction level (namely, a liquidity bank not funding) will be covered tothe extent there is available program-wide credit enhancement.

Program Liquidity Tests : DBRS relies on program-level tests that are designed so that the liquiditywill always be suf cient to pay the principal and interest on the outstanding CP in full. As describedunder Key CP Cease Issuance/Asset Purchase Tests on page 16, there is a liquidity program testthat will prohibit any CP from being issued if, after considering such issuance, the available liquidityis less than the principal and interest on the then outstanding CP. (Please see Is 102% Enough toCover Interest?)

Is 102% Enough to Cover Interest?Typically, liquidity facilities are sized at 102% of the transaction limit. The extra 2% is designed to coverthe interest component of ABCP. Is this enough? In a high-interest economic cycle and/or CP issued withlonger maturities, interest due on the CP may be more than 2%. Therefore, DBRS does not rely on theactual size of the liquidity facility, but rather on the program-level liquidity test. This test prohibits theconduit from issuing any ABCP if, after such issuance, the available liquidity amount cannot cover theprincipal and interest on all of the outstanding CP. Therefore, DBRS relies on the program liquidity testand thus the liquidity facilities to cover interest rate risk. For those few programs that issue oating-rateCP, a transaction-by-transaction analysis is required to assess interest rate risk.

FOREIGN EXCHANGE RISK

Foreign exchange risk arises when a conduit has assets that pay in a currency other than the currency inwhich the CP is issued. If the assets currency were to weaken relative to the CP currency, the cash owfrom those assets would lose value and could be insuf cient to pay the CP.

Foreign Exchange Mitigants Transaction-Level Foreign exchange risk is typically addressed at the transaction level, although the program documentswill set forth the general approach that will be taken. There are three primary ways to mitigate this riskon the transaction level: hedging, liquidity support and reserve account. For the rst two, the goal of the

administrator is to transfer the foreign exchange risk to an appropriately rated entity. The third mitigantis a reserve, based on an evaluation of the foreign exchange risk. The following are summaries of thesecommon mitigants.

Hedging : A conduits administrator may hedge foreign currency exchange (FX) risk by entering intoa FX rate swap with an acceptably rated counterparty. See Legal Criteria for US Structured FinanceTransaction and/or Derivative Criteria for European Structured Finance Transactions. The riskre ects the rating of the hedge counterparty for payment.

A conduits administrator may hedge FX risk by matching spot and forward contracts. Matchingthe spot and forward contracts will shore up full payment when the CP matures.


19/33


Liquidity Support : Sometimes liquidity will fund in the currency of the CP and thus liquidity will takethe foreign exchange risk. The risk re ects the rating of the liquidity bank for payment. Behind thescenes, and irrelevant to the CP investor, the liquidity bank will most likely hedge the risk for its owninternal risk management.

Reserve Account : Another mitigant is a reserve account based on the evaluation of the possibleforeign exchange movement between the currencies, the exposure period to such movement and theenvironment of the applicable currencys sovereign location. The key factors modeled when DBRSanalyzes F/X reserves are, possible variances between the relevant currencies, the time exposure ofsuch currencies, and the rating level sought.

Foreign Exchange Mitigant Program-Level Any losses on the transaction level in excess of the transaction-speci c enhancement will be covered to theextent there is available program-wide credit enhancement.

COMMINGLING RISK

Commingling risk arises in the event that the seller, acting as the servicer on a transaction, becomesbankrupt and the collections due to the conduit are commingled with its general funds. In this situation,the amounts due to the conduit are at risk.

Commingling Mitigant Transaction-Level

Liquidity Facility : Commingling risk is typically covered by the transactions liquidity facility. Theliquidity funding formula, via document language, will include funds due from the seller that have notbeen received. Typically, liquidity funding formulas only reduce for defaulted assets. The de nitionof a defaulted asset generally does not include funds collected by the seller, but not remitted to the

conduit. Therefore, liquidity banks typically take commingling risk. Thus, the risk to the CP investorre ects the rating of the liquidity bank.

Where commingling risk is not covered by the transactions liquidity facility, DBRS reviews the structureto determine whether other mitigants exist. These might include:

Additional Commingling Mitigant Transaction-Level

Lockboxes : In the US, lockboxes are very common. Lockboxes are segregated accounts speci cally setup to separate the sellers funds from those due to the conduit. Setting up accounts in the name of theconduit is a typical safeguard used to mitigate commingling risk.

Other Mitigants : Different jurisdictions in Europe mitigate commingling risk in varying ways. DBRSlooks at each mitigant carefully with respect to probability and severity of risk considering the char-acteristics of the underlying assets. It should be noted, that if liquidity is covering this risk, which istypically the protocol, this analysis is inconsequential.

Conduits have incentive to properly address commingling risk because in cases where the sponsorbank is also the liquidity provider, the bank does not want to take a loss if liquidity funds andcom- mingling risk is not properly addressed.


20/33


20

Commingling Mitigant Program-Level Any losses on the transaction level (namely, a liquidity bank not funding) will be covered to the extentthere is available program-wide credit enhancement.

DILUTION RISK

Primarily relevant in trade receivable and credit-card transactions, dilutions are non-cash adjustments tothe receivables. These include, but are not limited to, discount incentives to customers for early payment,errors in invoice amounts and returned goods. Dilutions are a normal recourse item back to the seller. Ifthe seller becomes bankrupt, these amounts owed to the conduit by the seller are in jeopardy. When dilu -tions occur, they reduce the amount of receivables and thus can leave the conduit short of funds.

Dilution Mitigant Transaction-Level

Liquidity Facility : Similar to commingling risk, dilution risk is also typically covered by the conduitsliquidity facility. The liquidity funding formula, via document language, will include funds due fromthe seller that have not been received. Liquidity funding formulas typically only reduce for defaultedassets. The de nition of a defaulted asset typically excludes any diluted items. Therefore, liquiditywill take dilution risk. Thus, the risk to the CP investor re ects the rating of the liquidity bank.

Where commingling risk is not covered by the transactions liquidity facility, DBRS reviews the structureto determine whether other mitigants exist. These might include:

Additional Dilution Mitigant Transaction-Level

Reserve Account : Conduit sponsors generally have an incentive to properly address dilution riskbecause in cases where the bank sponsor is also the liquidity provider, it does not want to take aloss if liquidity funds and the dilution risk is sized improperly. As a result a dilution reserve account

may be established such that if liquidity is drawn, cash will be available from the dilution reserve toreimburse the liquidity provider. If liquidity does not fund, which is unlikely, cash is available fromthe reserve fund to pay the CP investors. In rare cases, some transactions may not cover this riskvia liquidity. In these cases, DBRS will review the reserve to ascertain risk is commensurate with theinternal assessment of the transaction.

Dilution Risk Mitigant Program-Level Any losses on the transaction level (namely, a liquidity bank not funding) will be covered to the extentthere is available program-wide credit enhancement.


21/33


Liquidity Risk

GENERALLiquidity support is vital to an ABCP conduit. Most CP conduits do not match the maturity of their assetsto the maturity of their liabilities. Therefore, there may be mismatches between the cash ow from theassets and the requirements to pay CP in whole and on time. Should the conduit be unable to roll CP forany reason, such as during a period of market disruption, the liquidity is available to pay outstanding CPas it matures. This is the main reason for liquidity support in ABCP programs.

Liquidity agreements are typically an integral part of each transaction. They generally fund for the good(non-defaulted) assets before PWCE is drawn. PWCE is designed to cover the defaults in excess of thetransactions rst-loss credit enhancement.

Liquidity support is typically a facility provided by liquidity banks, predominantly sponsor banks, thatsupport transactions within the ABCP program. They are typically sized up to 102% of the transaction.Liquidity risk is one of the primary areas of focus when analyzing ABCP transactions.

FORMS OF LIQUIDITY AGREEMENTS

Liquidity support can take many forms and is typically provided on the transaction level for ABCPprograms. The following are common forms:

Liquidity Asset Purchase Agreement : The most prevalent form of liquidity facility is the LiquidityAsset Purchase Agreement (LAPA). LAPA banks purchase the entire asset interest and thus takethe transaction out of the conduit and onto its own balance sheet. The LAPA bank will fund forthe funding formula, which is reviewed by DBRS for inclusion of the transaction into the conduit.Assuming the credit is sized properly, the funding formula will be adequate to retire CP in wholeand on time. This is because the liquidity funding formulas typically cover everything but defaults. Ifcredit enhancement is adequate to cover defaults, then the amount the LAPA bank funds should beample.

Liquidity Loan Agreement : A Liquidity Loan Agreement (LLA) differs from a LAPA in that theprovider agrees to lend to the conduit in the amount of the funding formula. The conduit must paythe liquidity bank back for this loan. Any outstanding liquidity loans should be properly counted asa liability of the conduit for both the program asset test and the program liquidity test.

Other Liquidity Facilities : Total return swaps and repurchase agreements are examples of other formsof liquidity facilities that can support transactions within a CP conduit.

The counterparties providing these facilities must be appropriately rated or otherwise assessed by DBRSto be of a credit quality commensurate with the risk pro le of the CP conduit.

SAME-DAY FUNDING

Liquidity facilities must fund on a same-day basis and thus the provider must have an adequate short-termrating (See the Rating Thresholds for Liquidity Support section below). Same-day funding mitigatesany timing mismatches and market disruption risk.


22/33


22

LIQUIDITY FUNDING FORMULA

The liquidity funding formula describes the amount that a liquidity provider will fund when asked to doso. Typically, liquidity funding formulas exclude defaulted assets. This formula is analyzed by DBRS tounderstand how the funding formula works in concert with the credit enhancement for that particulartransaction.

There are three prevalent types of funding formulas: asset-based, capital-based and liquidity-event. Therst two are commonly used in internally assessed transactions; the last is often used in explicitly rated

transactions.

Asset-Based Liquidity Funding Formula : Asset-based formulas typically provide for the funding ofthe good (non-defaulted) asset balance. Defaults are usually accumulated from the last good borrow -ing base test. The initial balance as of each good borrowing base test report includes the requisitereserves appropriate to the rating level commensurate with the CP issued.

Capital-Based Liquidity Funding Formula : Capital-based formulas typically provide for the fundingof the capital that is equivalent to the principal and the interest on the CP minus the defaults that arein excess of the necessary credit enhancement for that speci c transaction.

RATING THRESHOLDS FOR LIQUIDITY SUPPORT

The rating of the liquidity provider typically determines the maximum rating that can be assigned to theABCP. In cases where DBRS does not maintain a public or private rating in respect of an institution, theDBRS Financial Institutions Group may provide an internal assessment of the relevant institution (whichwill be monitored over the life of the transaction). In certain cases, DBRS may rely on public ratingsassigned and monitored by other credit rating agencies.

LIQUIDITY COVERING OTHER RISKS

In many transactions, particularly non-explicitly rated transactions, external-liquidity support coversmore than market disruption risk and timing mismatches. These risks are detailed in the Other Riskssection beginning on page 17.

LIQUIDITY COVERING CREDIT RISKS

In addition to covering market disruptions, timing mismatches and other risks, liquidity is sometimesused to cover credit risks. The degrees to which liquidity will cover credit risk can vary. In some instances,the liquidity facility may elect to cover more of the credit risk, as detailed in Short-Tail Exposure onpage 23. In other instances, liquidity will cover the entire credit risk by wrapping the transaction. In thiscase, liquidity will fund for the principal and interest on the outstanding CP under all circumstances

except for the acceptable bankruptcy related, exceptions to Liquidity Funding listed below.

EXCEPTIONS TO LIQUIDITY FUNDING

Liquidity facilities are committed and obligated to fund upon request except under remote circumstances.Generally, the only exception to liquidity funding, other than with respect to defaulted assets, is the bank -ruptcy of the conduit.


23/33


Short-Tail ExposureWhether transactions are revolving or amortizing, the exposure horizon is the maximum time thecollateral pool can be subject to losses. However, the exposure horizon can be shortened by the use ofliquidity facilities. This is explained and illustrated below.

A transactions structural features may shorten the time period during which the underlying assets aresubject to losses. This is referred to as short-tailing the exposure horizon. A common way to short-tailthe exposure horizon is via a funding mechanism within the Liquidity Asset Purchase Agreement (LAPA).For example, if a revolving transaction* were to amortize in five months and had a monthly reportingperiod (borrowing base test) then the exposure horizon would be 180 days (equal to the underlyingassets amortization plus the reporting period). If, however, the CP tenor were limited to 30 days andhad a liquidity funding mechanism tied to a monthly borrowing base test, then the exposure would beshortened to approximately two months. This is so because upon a borrowing base breach, CP could nolonger be issued and liquidity would be invoked. The example below illustrates this concept.

Structural Features of Short-Tail ExampleWithout the following structural features, the exposure to losses on this collateral pool would have been180 days.

CP tenor will be limited to 30 days. A borrowing base breach will invoke a cease-issuance trigger on the CP. Liquidity will fund the CP (excluding defaults) upon maturity.

Worst Case Scenario Timeline

Exposure to losses is from day 2 to day 60.

The exposure to losses on the transaction in this example has been reduced from 180 days to approxi-mately 60 days because of the short-tail feature. It is important to note that there are various ways toshort-tail exposure. The above example is among the more common ways used.

* Assuming that the tenor of the CP can be up to 150 days or more.


24/33


24

Legal Risk

Legal Risk is one of the primary risks that must be analyzed when rating an Asset Backed Commercial

Paper (ABCP) program. Risk of bankruptcy of parties involved in conduit transactions, the effectivetransfer of assets, and the security interest in the securitized assets are at the forefront of risk analysis andcontemplation of mitigants in the review process.

The unique feature of ABCP programs is the disbursement of the allocation of risk among conduit parties.In this report, in the Credit Risk and Other Risk Sections, it is demonstrated how liquidity facilities canbe structured to absorb some of these risks. Legal risks can also be partly mitigated by liquidity facilities.

This report will describe Legal Risk as it pertains to ABCP conduits and some of the mitigants to thoserisks. This section classi es the risks by conduit level and transaction level.

BANKRUPTCY RISKBankruptcy risk arises if either the conduit or a particular transactional seller goes bankrupt. The follow -ing structural risks and mitigants are therefore discussed from those varying viewpoints: Conduit Leveland Transaction Speci c Level.

With respect to bankruptcy risk, DBRS generally:

Conducts a bankruptcy remoteness analysis of the ABCP conduit. Analyzes the organizational documents of the conduit. Analyzes Preference and Stay Risk with respect to each transaction that enters the conduit. Reviews speci c legal language in the conduit documents and with each transaction that enters the

conduit, namely, limited recourse, non-petition, excess funds and rating agency condition (RAC)language for material amendments.

Reviews legal opinions as necessary.

CONDUIT-LEVEL RISK

Conduit Level Structural Risk: If the conduit itself were to become insolvent, a bankruptcy court wouldlikely impose an automatic stay on all payments from the conduit. The court would then assess thevalidity and priority of claims against the conduit. The result would likely be late or non-payment fromthe conduit to the CP investors. The occurrence of either of these events would constitute a default.Further, if the payments from the conduit were stayed, and the CP holders could potentially be paid infull at some time in the future, the conduits liquidity facilities would not be there to make up the timingmismatch as liquidity is typically not compelled to fund upon a conduit bankruptcy. Therefore, it isimperative that the conduit is structured as a bankruptcy remote special purpose vehicle. The design ofthe conduit must contemplate both involuntary and voluntary bankruptcy petitions as well as potentialconsolidation into a bankrupt third party.

Conduit Level Structural Mitigants:

Voluntary bankruptcy risk is the risk that the conduit will le a bankruptcy petition on its own behalf.


25/33


Mitigants : Typically the conduit has a requirement that the board of directors must unanimously vote the vehicle

into bankruptcy.

At least one member of the board of directors should be independent and not af liated with any partythat has an economic interest in the conduit.

To the fullest extent permitted by law, the independent member is charged with considering the inter -ests of the conduit and its investors when voting on the bankruptcy issue.

Involuntary bankruptcy risk is the risk that a third party les a bankruptcy petition against the conduit.

Mitigants : Restricting the scope of the operations of the conduit generally limits the conduit to issuing and

paying CP, buying particular types of assets and engaging in activities that support these functions.

Limiting the debt the conduit may incur generally means that the conduit is restricted from incurringdebt beyond that which is contemplated in the program documents.

Ensuring that all parties agree not to le a bankruptcy petition for at least one year and one day afterthe outstanding CP of the conduit has been retired. This is what is commonly referred to as a non-petition clause.

Ensuring that all parties agree that amounts owed to them can only constitute a claim in a bankruptcypetition if the conduit has funds in excess of that required to pay CP. This is commonly known asexcess funds language.

Consolidation of the conduit into the conduit owner is the risk that the owner of the conduit entersinto bankruptcy and the conduit, by virtue of court order, becomes part of the bankruptcy estate via

consolidation.

Mitigants:

The owner of the conduit must also be structured as a bankruptcy remote entity. This greatly dimin -ishes the risk of the owner becoming bankrupt.

The ownership structure of the conduits are typically structured as orphan entities.

The conduit must establish and maintain itself as a separate entity from its owner (as well as sellersand service providers to avoid consolidation upon their bankruptcy also). When considering consoli -dation, historically the courts have considered the separateness of the two entities as a key factor in

their decisions.

It should be further noted that there are a handful of management companies speci cally in the businessof owning conduits. Generally DBRS will review a non-consolidation opinion from a law rm if theowner is a party that hasnt been reviewed in prior transactions.


26/33


26

REVIEW OF ORGANIZATIONAL DOCUMENTS

U.S. special purpose vehicles often are organized in the state of Delaware. They generally take the formof one of the following:

Corporation Limited Liability Corporation Partnership Limited Partnership

With respect to non-US entities, different geographic locations dictate and in uence the legal consider-ations and the form the conduit may take. While Delaware based entities are preferred in the UnitedStates, Jersey Channel Islands and other off shore jurisdictions are often used depending on the tax rami -

cations and securities law considerations. The above legal forms are also generally used internationally.

CONDUIT & TRANSACTION LEVEL RISK

Preference RiskPreference Risk, in general, is the risk that upon a seller bankruptcy, a bankruptcy court would rule thatthe creditor (conduit) received funds that constitute a preference payment within the applicable preferenceperiod 6 due to its preferential position. The payments can then be avoided under section 547 of the bank -ruptcy code and therefore required to be clawed back (returned to the bankruptcy estate of the seller). Theconduit would therefore suffer a loss and its bankruptcy remoteness and the ability to pay the CP in fulland on time, could then be in jeopardy. For conduits organized outside the US, preference considerationsare also addressed consistent with insolvency laws of such jurisdiction.

Mitigants to Preference RiskThe Issuers being fully collateralized and having a First Priority Perfected Security Interest (FPPSI) 7 is

important in mitigation of preference risk. DBRS will generally place reliance typically on any of the fol -lowing to verify the issuers status as a fully secured creditor:

The Issuer can submit an Of cers Certi cate which certi es that the issuer (collateral agent or trustee)has obtained its own counsel and counsel has advised that there is either a true sale and/or a FirstPriority Perfected Security Interest (FPPSI) at each level of transfer.

DBRS will rely on Article 9 representations and warranties. In most cases, they adequately addressconcerns that the issuer (collateral agent or trustee) has a valid, perfected, rst priority securityinterest in, and is fully secured by, the underlying collateral.

An opinion as to Preference Risk.

STAY RISK

If a seller, at the transaction speci c level, were to become insolvent, a bankruptcy court would likelyimpose an automatic stay on all payments from the seller and review any preferential payments poten-tially paid by the seller. The impact to the conduit would include:

All collections on the receivables due to the conduit could be stayed (delayed).

6. The US preference period is 90 days unless the seller and the issuer are af liated, in which case it is 1 year.7. Under US Law or its equivalent under non-US law.


27/33


All payments already owed to the conduit, including any dilution amounts, would also be stayed. Any payments made within the preference period, could possibly be clawed back to the bankrupt

seller estate as a preferential payment. (See Preference Risk & Mitigants).

Mitigants to Stay Risk:The liquidity facility typically absorbs stay risk. Typically the liquidity funding formula will fund foreither an asset base or a capital base minus the excess of defaulted receivables over credit reserves. Bothformulas, via document language, include funds due from the seller that have not been received, butdeemed received. Thus, liquidity funding formulas fund for deemed collections. Said differently, sinceliquidity funding formulas typically only reduce for defaults, and the de nition of defaults will not includedeemed collections of receivables, liquidity facilities will fund amounts stayed but not defaulted.

REVIEW OF EXCESS FUNDS, LIMITED RECOURSE, NON-PETITION ANDRATING AGENCY CONDITION LANGUAGE

Excess Funds / Limitation on PaymentsThis generally states that the conduit shall not be obligated to pay a particular party unless it has excessfunds over and above those required to retire CP. DBRS reviews whether all conduit counterparties (otherthan CP holders) have agreed to this excess funds language.

Limited RecourseThe recourse that the liquidity bank has to the conduit is typically limited to the assets in the case ofa Liquidity Asset Purchase Agreement (LAPA) and the cash ows from the receivables in the case of aLiquidity Loan Agreement (LLA). The limitation is present to provide a disincentive for liquidity banksto le a claim against the conduit.

No Proceeding / Non PetitionThis generally states that counterparties (other than CP holders) agree not to institute or join any ling ofthe conduit into bankruptcy for one year and one day after the last maturing CP is retired.

Rating Agency Notifcation (RAN)DBRS reviews whether all material amendments are required to be reviewed by DBRS before they becomeeffective. DBRS will ask for an appropriate lead time to ensure a proper review while maintaining anef cient execution for the CP issuer. This noti cation is a protection against the risk that program amend -ments could be to the detriment of the CP investors.

LEGAL OPINIONS

Conduit Level The type of legal entity the conduit is will dictate the type of opinions DBRS expects. Nonetheless, atthe forefront are the formation of the conduit, its authority to enter into conduit business, jurisdictional

issues, and any other opinions DBRS deems necessary to ensure the integrity of the conduits structure.

Transactional Level As stated prior in this report, DBRS will typically ask for an Of cers Certi cate with respect to eachtransaction that enters the conduit. The Of cers Certi cate certi es that the issuer (collateral agent ortrustee) has obtained its own counsel and counsel has opined that there is either a true sale and/or a FirstPriority Perfected Security Interest (FPPSI) at each level of transfer.

Necessary Legal OpinionsIt is common for ABCP conduits to have a diversi ed portfolio of transactions. Each transaction isreviewed considering all risks that may jeopardize full and timely payment of the CP. DBRS will consider


28/33


28

each asset and each transaction on a case by case basis and ask for the legal opinions it deems necessaryto ensure full and timely payment of the liability rated.

Operational RiskOperational risk arises if the procedures described in the program documents are not properly adheredto. There are many moving parts in managing an ABCP Program. The administrator oversees, enforces,and is ultimately responsible for all parties carrying out their respective support duties. The duties ofthe administrator are outlined below. The skill and experience of the administrator is of paramountimportance in mitigating operational risk. The outcome of the operational risk review must adhere to thestandards that DBRS expects in high quality sponsors of ABCP programs.

REVIEW OF THE ADMINISTRATOR/SPONSOR

One of the primary goals in the review of the structure of the vehicles is to ensure that the administratorhas the experience and expertise to carry out its extensive responsibilities. The administrator/sponsorplays a vital role in the success of the conduit. Therefore, DBRS conducts a thorough on-site visit with theadministrator/sponsor. Some of the key topics covered are:

Business strategy of conduit team and purpose of vehicle. Originating and underwriting policies and procedures. Experience and acumen of the executive team of professionals. Resources dedicated to the conduit operation. Prospective asset mix of portfolio. Compliance procedures with program documentation, including the procedures for repaying CP. Information Systems capabilities and back-up systems.

In cases where the administrator and sponsor are separate entities, DBRS conducts a separate on-sitebusiness review for each. In such cases, DBRS considers the following:

The experience and capabilities of the third party administrator.

Third party administrators may not have the same level of incentive to ensure success of the conduit.While their very business relies on their skills as an administrator, and in that sense, they have a nan -cial stake in the conduits success, they typically do not provide credit enhancement and/or liquidity.DBRS is therefore particularly mindful of the resources that are allocated to the conduits operation.

The conduit is typically indemni ed for losses arising from the third party adminstrators negligence.DBRS considers the credit quality of the party providing such an indemnity. In some cases the sponsorwill provide an indemni cation to the conduit for third party negligence.

REVIEW OF THE PROGRAM DOCUMENTS

The primary document in the conduit review phase is the administrative agreement. The extensive dutiesof the program administrator generally include:


29/33


Origination & Execution Advisory Services

Originating, structuring and executing new deals. Obtaining and maintaining credit and liquidity facilities. Obtaining and maintaining any credit support facilities that are necessary (i.e. hedging). Providing all necessary information to rating agencies. Monitoring the performance of each deal within the conduit.

Issuing & Paying Advisory Services

Paying CP via rolling new CP or paying from assets. In the absence of suf cient cash ows from assets or from rolling CP, paying CP via liquidity, program

wide credit enhancement or other available facilities. Enforcing agreements with respect to paying CP on a timely basis. Ensuring procedural adherence to program documents.

Day to Day Operational Services

Preparing monthly portfolio reports. Safeguarding all program documents. Preserving all accounting records. Preparing nancial statements and arranging for audits. Maintaining all operating accounts. Ensuring all parties adhere to all program documents.

OPERATIONAL RISK MITIGANTS

DBRS conducts an Operational Review with each new conduit. DBRS will conduct periodic business reviews as necessary for each conduit it rates.

DBRS expects surveillance reports at least monthly for review. Administrators are expected to notifyDBRS of any material breach of triggers, downgrade of any sellers, servicers or support providers forany deal within the conduit immediately.

DBRS has ongoing interaction with program administrators via new transactions and amendmentswithin the conduit.

DBRS considers whether any entity that provides support services to the conduit has indemni ed theconduit for negligence or misconduct on its part. Typically there is also a broad stroke performanceindemnity supplied by the administrator as the responsible party for the overall operation of theconduit.

Surveillance

MONTHLY REVIEW

DBRS monitors each conduit on a monthly basis, based on reports submitted by the respective conduitadministrators. The key elements of the monthly report are designed to identify any weaknesses within aconduits portfolio in order to ascertain whether any rating action is necessary. These elements include,but are not limited to, the following:

Each transactions name and rating. Conduit liabilities outstanding.


30/33


30

Seller concentrations. Portfolio mix, including concentrations. Actual transaction-speci c credit enhancement levels. Actual program-wide credit enhancement levels. Liquidity bank commitments and ratings. Any changes to support facilities. The ratings on support counterparties, if applicable. Portfolio performance as related to deal-speci c amortization triggers. Conduit performance as related to program amortization triggers.

ONGOING PERIODIC REVIEWS

Periodic operational reviews, along with monthly surveillance, are important elements that support theongoing rating of the ABCP conduit.

Rating Process and Documentation ReviewRATING PROCESS INITIATION

The initial review of a new conduit usually begins with a proposal phase. The proposal phase is useful inorder to uncover any unusual or complex issues with respect to any credit, liquidity, legal or operationalrisks. Thereafter, documentation is prepared and DBRS conducts its initial operational review of the pro -spective sponsor bank.

CONDUIT RATING PROGRAM ANALYSIS

After the proposal phase, the administrator, typically the sponsor bank, delivers the program documents.These are the documents to which the administrator of a conduit must adhere. DBRS analyzes thesedocuments in order to issue a rating on the CP program. Typical program documents include, but are notlimited to, the following:

Administration Agreement. The conduits corporate documents. Management Agreement. Depositary or Issuing and Paying Agency Agreement. Placement Agency Agreement. Any insurance or LOC agreement. Any Liquidity Agreement. De nitions (summary of terms).

CONDUIT CONFIRMATION TRANSACTION ANALYSIS

After reviewing the conduit program documents, DBRS will review the operative documents for eachtransaction that the conduit acquires. Speci cally, DBRS will analyze the documents that govern eachlevel of asset transfer as well as the liquidity agreement and any other documents that are salient to thetransaction rating. Upon the satisfactory completion of the document review together with the credit


31/33


analysis of the transaction, a formal rating committee is conducted to consider whether the addition ofthe transaction to the conduits portfolio might change the current rating of the CP issued by the conduit.

Asset Transfer Agreement / Receivable Purchase Agreement The document that governs the transfer of asset interests from the seller (or special-purpose vehicle (SPV))to the conduit will be reviewed. Key factors analyzed include, but are not limited to, the following:

Transaction-level conditions precedent to issuing CP (e.g., borrowing base test). Eligible receivables. Credit enhancement. Key de nitions. Legal aspects of the transaction.

Liquidity Agreement The other essential document on the transaction level is the liquidity agreement. The most prevalentforms of liquidity agreements are the Liquidity Loan Agreement (LLA) and the Liquidity Asset PurchaseAgreement (LAPA). Key factors analyzed include, but are not limited to, the following:

Circumstances by which the liquidity bank will fund. The liquidity funding formula. Circumstances by which liquidity is not obligated to fund. Timing of payment in order to retire the CP timely. The other risks covered by the liquidity provider (see the Other Risks section on page 17) Legal aspects of the document.


32/33

Copyright 2010, DBRS Limited, DBRS, Inc. and DBRS Ratings Limited (collectively, DBRS). All rights reserved. The information upon which DBRS ratings and reports are based is ob-tained by DBRS from sources DBRS believes to be accurate and reliable. DBRS does not audit the information it receives in connection with the rating process, and it does not and can-not independently verify that information in every instance. The extent of any factual investigation or independent verication depends on facts and circumstances. DBRS ratings,reports and any other information provided by DBRS are provided as is and without representation or warranty of any kind. DBRS hereby disclaims any representation or warranty,express or implied, as to the a ccuracy, timeliness, completeness, merchantability, tness for any particular purpose or non-infringement of any of such information. In no event shallDBRS or its directors, ofcers, employees, independent contractors, agents and representatives (collectively, DBRS Representatives) be liable (1) for any inaccuracy, delay, loss of data, in-terruption in service, error or omission or for any damages resulting therefrom, or (2) for any direct, indirect, incidental, special, compensatory or consequential damages arising fromany use of ratings and rating reports or arising from any error (negligent or otherwise) or other circumstance or contingency within or outside the control of DBRS or any DBRS Repre-sentative, in connection with or related to obtaining, collecting, compiling, analyzing, interpreting, communicating, publishing or delivering any such information. Ratings and otheropinions issued by DBRS are, and must be construed solely as, statements of opinion and not statements of fact as to credit worthiness or recommendations to purchase, sell or holdany securities. A report providing a DBRS rating is neither a prospectus nor a substitute for the information assembled, veried and presented to investors by the issuer and its agentsin connection with the sale of the securities. DBRS receives compensation for its rating activities from issuers, insurers, guarantors and/or underwriters of debt securities for assigningratings and from subscribers to its website. DBRS is not responsible for the content or operation of third party websites accessed through hypertext or other computer links and DBRSshall have no liability to any person or entity for the use of such third party websites. This publication may not be reproduced, retransmitted or distributed in any form without theprior written consent of DBRS. ALL DBRS RATINGS ARE SUBJECT TO DISCLAIMERS AND CERTAIN LIMITATIONS. PLEASE READ THESE DISCLAIMERS AND LIMITATIONS AT http://www.dbrs.com/about/disclaimer . ADDITIONAL INFORMATION REGARDING DBRS RATINGS, INCLUDING DEFINITIONS, POLICIES AND METHODOLOGIES, ARE AVAILABLE ON http://www.dbrs.com.


33/33

www.dbrs.com

DBRS, Inc.140 Broadway

Asset Backed Commercial Paper Criteria Report

Documents

Transcript of Asset Backed Commercial Paper Criteria Report