Korea Housing Finance Corp. Social Covered Bonds

Presale:

Korea Housing Finance Corp. Social Covered BondsJune 17, 2021

This presale report is based on information as of June 17, 2020. The ratings shown are preliminary. This report does notconstitute a recommendation to buy, hold, or sell securities. Subsequent information may result in the assignment of finalratings that differ from the preliminary ratings.

€1 Billion Social Covered Bonds Due 2026

Major Rating Factors

Strengths

- Dual recourse to both the highly-rated issuer KHFC and the cover pool comprising Koreanmortgage loans with weighted-average current loan-to-value ratio of 59.2%.

- Protection provided by the KHFC Act.

- The committed credit enhancement supports two notches of collateral-based uplift to achieve

Presale:

Korea Housing Finance Corp. Social Covered BondsJune 17, 2021

PRIMARY CREDIT ANALYST

Yalan Tao

Hong Kong

+ 852 2532 8033

[email protected]

SECONDARY CONTACTS

Jerry Fang

Hong Kong

+ 852 2533 3518

[email protected]

Annie Wu

Hong Kong

+ 852 2532 8077

[email protected]

www.standardandpoors.com June 17, 2021 1

© S&P Global Ratings. All rights reserved. No reprint or dissemination without S&P Global Ratings' permission. See Terms of Use/Disclaimeron the last page.

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mailto: [email protected]






a 'AAA' rating.

- Potential structural mitigants such as liquidity reserve and swap advance payment should therating on the issuer fall below 'A' enhance the short-term liquidity of this transaction.

Weaknesses

- Hard bullet principal repayment profile might limit time and options to use the cover pool torepay the maturing covered bonds should the issuer become insolvent around the maturity dateof the covered bonds.

- The rating on the covered bonds is susceptible to the sovereign credit rating on Korea or therating on KHFC.

- Market value of the fixed-rate loans included in the cover pool are susceptible to interest ratemovement, specifically if the loans are used to raise funds to pay the covered bonds at a timewhen the interest rate is much higher than today's.

- As of the initial cut-off date, 0.4% of the pool will reset the interest rates every five years sinceorigination in 2020 and 2021. The potential risk of negative carry, resulting from lower interestrate reset on the next interest rate reset dates in 2025 and 2026, is partially mitigated by theshort exposure period between the next reset dates in 2025 and 2026 and the maturity date ofthe covered bond in June 2026. Most importantly, due to the dual-recourse nature, KHFC willbe first in line to cover senior expenses and interest payments to the bond holders or anypotential negative carry generating from the cover pool.

Rationale

S&P Global Ratings today assigned its preliminary 'AAA' rating to the covered bonds issued byKorea Housing Finance Corp. (KHFC; AA/Stable/A-1+). The outlook is stable.

The transaction is a €1 billion, fixed-rate, five-year maturity bond with a hard bullet principalrepayment profile.

Our covered bond rating process follows the methodology and assumptions outlined in our"Covered Bonds Criteria," published on Dec. 9, 2014, and "Covered Bond Ratings Framework:Methodology And Assumptions," published on June 30, 2015. From our analysis of the coveredbonds to be issued by KHFC, we have concluded that the assets in the cover pool are appropriatelyisolated from the risk of KHFC insolvency. This asset isolation allows us to potentially assign ahigher rating to the covered bonds than our long-term issuer credit rating (ICR) on KHFC.

In accordance with our covered bonds criteria, we have determined the reference rating level (RRL)of the issuer, and attributed notches of uplift from this level through determination ofjurisdictional support and collateral-based support. We assess the RRL at 'aa', based on KHFC'slong-term ICR and its characteristics of a government-related entity.

Furthermore, we assess the jurisdiction-supported level at 'aa', which is mainly driven by ourassessment of weak systemic importance and the sovereign credit capacity, i.e., the foreigncurrency sovereign rating of 'AA' on Korea.

The transaction benefits from up to two notches of collateral-based uplift, based on our coveredbonds criteria. There are no notches deducted for liquidity issues or lack of overcollateralizationcommitment.



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Presale: Korea Housing Finance Corp. Social Covered Bonds

We analyzed the residential mortgage assets in the cover pool, based on our "Principles Of CreditRatings" criteria, published on Feb. 16, 2011. As of April 29, 2021, the pool cut-off date, the assetsbacking the transaction comprise Korea residential mortgages totaling approximately Korean won(KRW) 1.59 trillion. For these assets, our measure of the weighted-average foreclosurefrequency--the level of assumed defaults--is 17.02% and the assumed weighted-average lossseverity--estimated losses given default--is 35.93%, based on a 'AAA' stress level.

Based on our analysis, the minimum credit enhancement needed for the two notches ofcollateral-based uplift is 5.6%. Credit enhancement in the context of covered bonds is calculatedas a percentage of the covered bond principal amount.

Our preliminary rating is based on our expectation that KHFC will commit to maintainovercollateralization at a percentage that meets or exceeds the requirement for the two notchesof collateral-based uplift. The covered bonds to be issued therefore can reach a 'AAA' rating from acredit and cash-flow perspective. The available credit enhancement is 15.69%, as a percentage ofthe covered bond principal amount, based upon the applicable foreign exchange rate and thecover pool as of April 29, 2021, the pool cut-off date.

There are no rating constraints relating to counterparty, legal, country, or administrative andoperational risks. We assess country risk based on our "Incorporating Sovereign Risk In RatingStructured Finance Securities: Methodology And Assumptions" criteria, published on Jan. 30,2019. Under these criteria, we may rate the covered bonds up to two notches above the rating onthe sovereign, Korea (AA/Stable/A-1+). As a result, country risk does not constrain the 'AAA'ratings on the covered bonds.

Outlook

The stable outlook on the covered bonds to be issued reflects the outlook on the sovereign ratingson Korea and the rating outlook on KHFC. We may downgrade the covered bonds if we lower thesovereign ratings on Korea or ICR on KHFC.

Transaction Overview

At deal close

KHFC will issue the covered bonds to raise proceeds in order to acquire mortgage loans fromparticipating banks. The mortgage loans to be acquired will be included in the initial cover pool asan alternative repayment source to the covered bonds to be issued at closing.



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Chart 1

Stand-alone issuance

The covered bonds to be issued will be a single issuance and not part of an issuance program.

Five-year tenor with bullet principal repayment

The transaction will pay fixed rate coupon annually and make full principal repayment five yearsfrom deal close.

Dual recourse nature

The covered bonds to be issued by KHFC are full recourse obligations of the issuer. In addition, theholders of the covered bonds will have a priority claim on the specific mortgage loans and othereligible assets designated by the issuer.



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The cover pool

The initial cover pool will comprise mortgage loans originated by three participating banks, namelyKEB Hana Bank, Woori Bank, and KB Kookmin Bank, in accordance with the underwriting criteriaset out by KHFC.

Shinhan Bank, Industrial Bank of Korea, and Standard Chartered Bank Korea Ltd. are alsoparticipating banks that KHFC may acquire loans from in the future. On an ongoing basis,additional mortgage loans originated by all participating banks may be included in the cover pool.The loans prior to acquisition are subject to, among others, a loan-by-loan audit as per an agreedupon procedure to ensure information accuracy, the satisfaction of certain eligibility criteria, andin compliance with the underwriting criteria set out by KHFC.

Cover pool servicing

KHFC will be responsible for ensuring that the mortgage loans are properly serviced and has theability under the transaction documents to delegate its servicing responsibility to the participatingbanks.

Each participating bank will undertake servicing the mortgage loans sold by it to KHFC, in eachcase pursuant to an approved servicing agreement between KHFC and each participating bank.

Before the occurrence of an issuer event of default

KHFC is obligated to pay interest and principal to the covered bondholders and manage the coverpool. Cross-currency swaps are in place to mitigate any currency mismatch to which KHFC and thecovered pool are exposed. The swaps are liability based.

Following the occurrence of an issuer event of default

The covered bond administrator is appointed to manage the cover pool to eventually meetpayment obligations of the covered bonds. The cross-currency swaps are structured to continuevia automatic novation following the occurrence of an issuer event of default until the coveredbonds are fully repaid or the occurrence of a covered bond event of default.

Table 1

Covered Bond Transaction Participants

Role Name RatingRatingdependency

Issuer Korea Housing FinanceCorp.

AA/Stable/A-1+ Yes

Swap provider To be determined Appropriately rated in accordance withour counterparty criteria

Yes

Collection and reserve bankaccount provider

KEB Hana Bank A+/Stable/A-1 Yes

Designated foreign exchangebank account provider

Standard Chartered BankKorea Ltd.

A/Stable/A-1 Yes

Swap delegate Korea Housing FinanceCorp.

AA/Stable/A-1+ No



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Table 1

Covered Bond Transaction Participants (cont.)

Role Name RatingRatingdependency

Covered bond administrator Citibank Korea Inc. NR No

Asset monitor Deloitte Anjin LLC NR No

Bond trustee Citicorp International Ltd. NR No

NR—Not rated.

Rating Analysis

Legal and regulatory risks

The covered bonds are governed as per the KHFC Act.

We believe that the KHFC Act addresses the main legal aspects that we assess when looking atcovered bond legislation, in particular the isolation of the covered pool assets from the risk ofbankruptcy or insolvency of KHFC. As a result, in our opinion, the rating on the covered bonds canbe higher than the ICR on KHFC.

When assessing the underlying legal framework of a covered bond issuance, we focus primarilyon: (1) the degree to which the cover pool assets are isolated from the risk of bankruptcy of theissuer for the benefit of the covered bond holders; and (2) whether the bankruptcy is likely to haveother detrimental effects on the timely and full satisfaction of the covered bond holders' claims.

In line with our criteria, we have reviewed the following five key aspects of the KHFC Act andtransaction arrangement: (1) the segregation of the cover pool assets and cash flows; (2) the riskof acceleration of payments to bondholders, a payment moratorium, or forced restructuring of thecovered bonds; (3) limits to the amount of overcollateralization; (4) the treatment of hedgingarrangements; and (5) access to funding after the issuer's bankruptcy.

With respect to the asset isolation analysis and access to funding after issuer's bankruptcy, thefollowing key provisions from the KHFC Act underpin our conclusion:

- KHFC to manage assets separately; not in bankruptcy estate. Article 30 stipulates that KHFCshall manage the mortgage loans by separating them from other assets and according to therespective securitization plans. The mortgage loans managed separately shall not constitute abankruptcy estate of KHFC.

- Third party service providers to manage assets separately; not in bankruptcy estate. Article 45stipulates that the administrators (like servicers such as KHFC and the relevant participatingbanks) of the cover pool shall manage the cover pool (including monies obtained from themanagement and disposal of the mortgage loans) separately from their own assets and shallseparately prepare and maintain books regarding the management of the cover pool. Moreover,where the administrator of the cover pool goes bankrupt, the cover pool entrusted andmanaged shall not constitute the administrator's bankruptcy estate.

- Dual recourse; priority right. Article 31 stipulates that KHFC may issue the covered bonds,which have recourse to KHFC, and secured by mortgage loans, which are classified andmanaged by the respective mortgage securitization plans. The covered bond holders have a



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priority right of payment in respect of mortgage loans held by KHFC and registered andmanaged in accordance with the respective mortgage securitization plans.

In addition, pursuant to the transaction documents, the covered bonds will not accelerate due tothe occurrence of an issuer event of default, and the swap novation set out at closing is designedto take effect automatically without additional cost following the occurrence of an issuer event ofdefault. As such, the swap will remain in place and will not be terminated upon the insolvency ofthe issuer.

In our consideration of legal risks, we look to our "Covered Bond Ratings Framework: MethodologyAnd Assumptions," published on June 30, 2015.

Two following provisions in the KHFC Act are noteworthy as they are unique in relation to KHFCand Korean covered bonds market:

- Article 2 stipulates that KHFC can issue covered bonds backed by mortgage loans acquiredfrom other financial institutions.

- Article 23 stipulates that KHFC is required to register a mortgage securitization plan (whichincludes the details stipulated in the same article) and update of material changes with theFinancial Services Commission.

Operational and administrative risks

In our opinion, there is no operational risk from the cover pool's management and loan originationthat would constrain the covered bond rating to the same level as the long-term ICR on KHFC. Ouranalysis of operational and administrative risks follows the principles laid out in our covered bondratings framework.

We believe potential operational risk, if any, could arise from two fronts:

- As the issuer, KHFC plays the key role in managing the covered bonds while they areoutstanding. Our analysis focuses on whether or not the covered bonds have operationalarrangements in place to continue to perform should an issuer event of default occur.

- KHFC will act as the servicer for the loans originated by it and participating banks will act assub-contracted servicers for the loans underwritten by the respective participating banks andsold to KHFC. Our analysis focuses on whether or not these banks have the capability to serviceloans properly or if any structural arrangement exists to mitigate operational risk.

Management of the covered bond transaction. In our view, potential operational risk arisingfrom covered bond management following an issuer event of default is mitigated by thearrangement that the covered bond administrator is appointed at deal close.

In this transaction, the issuer will appoint the bond trustee to act as trustee for the benefit of thecovered bondholders pursuant to the bond trust deed at deal close. The bond trustee will appointthe covered bond administrator at deal close to provide certain services, acting for the benefit ofthe covered bondholders.

The issuer will concur with the appointment of the covered bond administrator and is required toco-operate with the covered bond administrator in its provision of relevant services, including butnot limited to aspects listed below:

- Information such as securitization plans and cover pool in electronic form;



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- Back-up servicing arrangement;

- Reporting, calculation, and audit requirements;

- May, but not required to, dispose of the cover pool in order to enable the issuer to meet itspayment obligations under the covered bonds;

- Maintenance of records in respect of the collection account, the reserve account, and thedesignated foreign exchange account;

- Following an issuer event of default, monitor the receipt of the aggregate mortgage loancollections on a daily basis; and

- Following the occurrence of an issuer event of default, all mortgage loan collections shall beexercised solely by the covered bond administrator in accordance with the relevant transactiondocuments.

Potential operational risk due to KHFC as the servicer. We consider KHFC's servicing capabilityto be satisfactory based our analysis on the materials provided to us and our on-site visit with thecompany.

KHFC was established in 2004 and has a long operating history focusing on the residentialmortgage loan segment. It has good experience with mortgage-backed securities and coveredbond issuance, and is the largest originator of mortgage-backed securities in Korea. KHFC's loanprocessing and management system from loan application to loan collection and servicing ishighly automated and is considered robust. There is proper segregation of roles andresponsibilities and the process to ensure the quality of servicing and reporting is in place.

No back-up servicer is appointed at close. Should we downgrade KHFC below 'BBB-', candidatesof a back-up servicer will be identified. Should the rating on KHFC be further below 'B',appointment of the back-up servicer from the identified candidates would take place in astep-by-step manner so that a back-up servicer can take over servicing should an issuer event ofdefault occur.

Potential operational risk due to servicing delegation. In our view, the subject risk is mitigatedby factors such as that KHFC remains responsible following servicing delegation, participatingbanks delegated agree to a standardized servicing agreement, and KHFC receives, verifies andmonitors the data and performance the mortgage loans on a daily basis.

Resolution regime analysis

Resolution regime analysis is to consider whether or not an effective resolution regime is in placeso as to increase the probability that an issuer could service its covered bonds even following adefault on its senior unsecured obligation. In this transaction, we consider the RRL to equal to theICR on KHFC. This is because the ICR already reflects the expectation of external governmentsupport. According to our criteria, we typically don't elevate the RRL above the ICR for issuers forwhich the ICR incorporates expectation of external government support. In particular, if an issueris a government-related entity like KHFC, the RRL is typically equal to the ICR.

Jurisdictional support analysis

In our jurisdictional support analysis, we assess the likelihood that a covered bond program facingstress would receive support from a government-sponsored initiative instead of from the



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liquidation of collateral assets in the open market.

We base the overall jurisdictional support assessment on the weakest of three factors: legislativeframework, systemic importance, and sovereign credit capacity. Using a four-point scale of verystrong, strong, moderate, and weak, we assess Korea's legislative framework as very strong,systemic importance as weak, and sovereign credit capacity as very strong.

These assessments reflect several factors. We consider Korea has a robust legal framework forcovered bonds based upon our understanding of the KHFC Act and the Covered Bond Act based onpublic information. We also incorporate our view of the role of covered bonds as a funding sourcefor the Korean financial system and their importance to the economy. In addition, we assess thatthe sovereign has sufficient financial resources to support covered bonds.

As a result, we assess the jurisdictional support in Korea as weak mainly due to the limited role ofcovered bonds as a funding source for the Korean financial system and their importance to theeconomy. Therefore, we consider the rating level achieved based upon jurisdictional support (JRL)to be 'aa', same as the RRL and the foreign currency rating on Korea.

Collateral support analysis (1) -- Cover pool composition

Cover pool characteristics

Tables 2, 3, and 4 contain summaries of the characteristics of the cover pool as of the cut-off date.

Table 2

Cover Pool Composition*

Asset type Value (tril. KRW) Percentage of cover pool (%)

Residential mortgages 1.59 100.0

Other assets 0 0.0

Total 1.59 100.0

As of April 29, 2021. KRW—Korean won.

Table 3

Mortgage Pool Profile

Number of loans 9,409

Total current balance (KRW) 1,588,122,824,274

Max. current balance (KRW) 399,874,824

Average current balance (KRW) 168,787,631

Total original balance (KRW) 1,601,541,900,000

Min. original balance (KRW) 10,000,000

Max. original balance (KRW) 400,000,000

Average original balance (KRW) 170,213,827

Weighted average original term (months) 336.48

Weighted average stated remaining term (months) 334.01

Weighted average seasoning (months) 2.48

Weighted average original LTV 59.6%



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Table 3

Mortgage Pool Profile (cont.)

Weighted average current LTV 59.2%

Weighted average current loan to original loan 99.4%

Max LTV 70.0%

Min DTI 1.7%

Weighted average DTI 27.2%

Min. age of borrower at origination (years) 20.0

Average age of borrower at origination (years) 39.2

Minimum fixed coupon (%) 1.20

Weighted average interest rate (%) 2.30

Table 4

Mortgage Pool Characteristics

Current loan balance % of initial cover pool

Participating bank

KEB Hana Bank 34.32

Kookmin Bank 40.77

Woori Bank 24.90

Product type

Didimdol 11.61

Bogeumjari (Aggim e) 63.74

Bogeumjari (U) 24.65

Conforming 0

Type of collateral

Apartments 95.23

Row houses 1.38

Multiplex house 3.39

Detached house 0

Loan type

Equal P + i 63.05

Equal P 15.77

Increasing P 21.17

IO period (years)

0 93.68

1 6.32

Coupon (fixed rate loans)

<=1.25% 0.26

1.25%<, <=1.50% 2.47



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Table 4

Mortgage Pool Characteristics (cont.)


1.50%<, <=1.75% 4.38

1.75%<, <=2.00% 6.40

2.00%<, <=2.25% 19.15

2.25%<, <=2.50% 52.71

2.50%<, <=2.75% 14.63

2.75%<, <=3.00% 0.00

Original LTV

0-<=10% 0.04

10%<, <=20% 0.69

20%<, <=30% 2.10

30%<, <=40% 4.63

40%<, <=50% 8.40

50%<, <=60% 34.94

60%<, <=70% 49.21

Current LTV

0-<=10% 0.05

10%<, <=20% 0.73

20%<, <=30% 2.24

30%<, <=40% 4.81

40%<, <=50% 8.67

50%<, <=60% 34.73

60%<, <=70% 48.76

Remaining term (years)

<=10 3.35

10<, <=15 3.74

15<, <=20 7.29

20<, <=25 0.00

25<, <=30 85.62

DTI

0-<=10% 3.65

10%<, <=20% 27.59

20%<, <=30% 33.23

30%<, <=40% 19.48

40%<, <=50% 11.77

50%<, <=60% 4.25

60%<, <=70% 0.03



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Table 4

Mortgage Pool Characteristics (cont.)


Original loan amount (mil. KRW)

0-50 1.01

50-100 7.87

100-150 18.44

150-200 24.59

200-250 18.93

250-300 28.90

300-350 0.22

350-400 0.05

400+ 0.00

Eligibility criteria. Some of eligibility criteria for mortgage loans to be included in the cover poolare:

- A valid, enforceable, first ranking, and fully perfected mortgage secures the mortgage loan overthe relevant property.

- The property securing the mortgage loan is a private residential property in Korea.

- The loan-to-value ratio (LTV) of the mortgage loan is not more than 70% using the currentprincipal amount outstanding of the mortgage loan.

- The amounts payable in respect of the mortgage loans are payable in won only.

- No payment in respect of the mortgage loan has been rescheduled, amended, re-aged, orotherwise changed in order to avoid a delinquency or default or following a delinquency ordefault as at the relevant cut-off date.

Collateral support analysis (2) -- Assess the credit quality of the cover pool

Archetypical pool. We analyzed KHFC's mortgage pool based on our "Principles Of CreditRatings" criteria, published on Feb. 16, 2011. In assessing the credit quality of a Koreanresidential mortgage pool, our approach is to ensure the methodology applied is consistent withour approach to rating residential mortgage-backed securities (RMBS) across markets, with theportfolio benchmarked against a defined archetypical pool.

When available, we used performance data from the local Korea market as the basis for ouranalytical approach. In the absence of such data, we have adopted the approach as outlined in our"Australian RMBS Rating Methodology And Assumptions" criteria, published on Sept. 1, 2011, ifthe loan characteristics are comparable.

With the Australian RMBS criteria forming the initial framework, we made adjustments torecognize features that might be unique or applicable to the Korea market.

The Korea archetypical pool reflects some market and product characteristics unique to Korea.However, when possible, archetypical pools aim to be as uniform as possible across markets for



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comparability reasons.

If the characteristics of a pool vary from the archetypical pool, we make adjustments to the creditenhancement. We might also make an adjustment to the credit enhancement to account for anyproduct-specific features as well as originator and servicer practices.

Compared with our Australian RMBS criteria, the following are the archetypical poolcharacteristics that are specific to Korea:

- Non-recourse loan. If a loan has a recourse limited to the property securing the loan, we apply a1.5x multiple to our benchmark foreclosure frequency.

- Residency. When the borrower is not a Korean citizen, the credit enhancement for collateralanalysis is increased by a factor of 1.5x. This reflects the difficulty of managing arrears orrecovery action should a nonresident borrower default. The adjustment factor is the same asthat applied for Australian residents under the Australian RMBS criteria. That said, weacknowledge that the borrower is required to be a Korean citizen per KHFC's underwritingcriteria.

- Mortgage-ranking and land-holding status. First-registered mortgage over freehold real estatein Korea.

- Geographic diversity – regional concentration limit (identified by local government). We apply a1.8x multiple to regional concentration exceeding the thresholds outlined in table 5.

- Geographic adjustment – nonmetropolitan. In addition to region (local government)concentration limits, we also apply a 1.5x multiple for nonmetropolitan concentration limits forKorea, based on the administrative division classification of the local government. (see table 6)

- Property type. The archetypical pool assumes a security property as one of the following typesof residential properties: apartments, detached houses, row houses, and multiplex houses.

- Maximum property value and market value decline. We applied an adjustment factor of 1.25x tothe market-value decline assumptions for property value larger than KRW1 billion. Thisadjustment factor reflects the view that high-value properties are susceptible todemand/supply pressure that may lead to more volatility in resale value.

- Foreclosure period. We applied a foreclosure period of 18 months on typical loans, and aforeclosure period of 24 months on loans in excess of the archetypical pool's maximumproperty value.

Table 5

S&P Global Ratings' Region (Local Government) Concentration Limit

Concentration limit

Seoul 40.0%

Busan 14.0%

Daegu 10.0%

Incheon 12.0%

Gwangju 6.0%

Daejeon 6.0%

Ulsan 5.0%

Sejong 3.0%



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Table 5

S&P Global Ratings' Region (Local Government) ConcentrationLimit (cont.)

Concentration limit

Gyeonggi-do 49.0%

Gangwon-do 6.0%

Chungcheongbuk-do 7.0%

Chungcheongnam-do 9.0%

Jeollabuk-do 8.0%

Jeollanam-do 8.0%

Gyeongsangbuk-do 11.0%

Gyeongsangnam-do 14.0%

Jeju 3.0%

Table 6

S&P Global Ratings' Metropolitan Classification For Korea

Seoul Metropolitan

Busan Metropolitan

Daegu Metropolitan

Incheon Metropolitan

Gwangju Metropolitan

Daejeon Metropolitan

Ulsan Metropolitan

Sejong Metropolitan

Gyeonggi-do Nonmetropolitan

Gangwon-do Nonmetropolitan

Chungcheongbuk-do Nonmetropolitan

Chungcheongnam-do Nonmetropolitan

Jeollabuk-do Nonmetropolitan

Jeollanam-do Nonmetropolitan

Gyeongsangbuk-do Nonmetropolitan

Gyeongsangnam-do Nonmetropolitan

Jeju Nonmetropolitan

Summary of WAFF and WALS. In assessing the credit assumptions required to conduct cash flowanalysis, we compare the characteristics of the cover pool with an archetypical pool and applymultiples as a way to increase or decrease weighted-average foreclosure frequency (WAFF) andweighted-average loss severity (WALS) to reflect higher or lower credit risk compared with thecharacteristics of the archetypical pool.

A summary of WAFF and WALS based on a 'AAA' stress level of the initial cover pool is shown in



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table 7.

Table 7

Summary Of Weighted-Average Foreclosure Frequency And Weighted-Average LossSeverity

'AAA'

Weighted-average foreclosure frequency (%) 17.0

Weighted-average loss severity (%) 35.9

Weighted-average foreclosure frequency and weighted-average lossseverity (%)

6.11

Assumptions

Benchmark foreclosure frequency for the Korea archetypical pool(%)

10.0

Market value decline (%) 45.0

Weighted-average recovery period (months) 18.0

Interest rate through recovery period (%) 7.85

Fixed selling and legal costs (KRW) 5,000,000

Variable selling and legal costs (% of stressed market value) 3

Collateral support analysis (3) -- Cash-flow analysis

Cash flow modeling assumptions. We conduct cash flow analysis to assess collateral-baseduplift. Our analysis focuses on collateral-based uplift up to two notches in part because the targetrating requested is AAA.

In this transaction, to assign the first two notches of rating uplift above the covered bond's JRL fortransactions that receive no jurisdictional support, we analyze the covered bond assets under a'AAA' rating scenario and assuming no asset-liability mismatch according to our covered bondcriteria.

We analyze to what extent overcollateralization enhances the creditworthiness of the coveredbonds to be issued by considering the credit risk only, which reflects expected losses incurred bythe cover pool in a stressed scenario with certain key assumptions. The analysis does not considerthe refinancing costs, that is, the additional collateral required to raise funds against its assets torepay maturing covered bonds.

A summary of some of our key rating stresses and assumptions modeled at the 'AAA' rating level isas follows:

- The liability profile assuming no asset-liability mismatch, and assumptions (where applicable)based upon cross-currency swap arrangement for this transaction.

- WAFF and WALS assumed at the 'AAA' rating level.

- Timing of defaults (see table 8).

- Foreclosure period and time to recover sale proceeds from defaulted loans.

- Prepayment rates assumed during the stress period (see table 9), and normalized prepaymentrate post-stress period.



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Table 8

Assumed Default Curves

Month Front-loaded default curve (%) Standard default curve (%) Back-loaded default curve (%)

7 10 10

12 25 15 5

18 15

24 30 25 25

36 20 25 25

48 10 15 15

60 5 10 10

72 5

Table 9

Assumed Constant Prepayment Rates

Transaction seasoningLow CPR scenario (% per

year)Constant CPR scenario (%

per year)Fast CPR scenario (% per

year)

Up to month 12 3 20 20

Month 13 to month 18 3 20 35

Month 19 to month 36 3 20 45

Month 37 to end of assumed stressperiod

3 20 55

CPR--Constant prepayment rate. Total CPR shown includes of voluntary and involuntary (default) prepayments. Assumed normalized CPR afterassumed stress period is 10%.

Collateral support uplift before adjustments. Based upon information provided to us, theminimum credit enhancement, which would allow the covered bonds to receive two notches ofcollateral-based uplift, is 5.6%, as a percentage of the covered bond principal amount, before thetwo potential adjustments in following section.

Collateral support analysis (4) -- Two adjustments

In terms of liquidity risk adjustment, we consider it is not applicable for this transaction accordingto our covered bonds criteria as the two-notch collateral uplift is purely based upon the coverageof credit risk (that is, pass-through cash flow run assuming no asset-liability mismatch andrefinancing costs).

With respect to adjustment for uncommitted overcollateralization, it is not applicable as thetransaction does not lack overcollateralization commitment.

Collateral support analysis (5)--Determine the collateral support uplift

Since there is no notch adjustment, the result of our analysis of the covered bonds' paymentstructure shows that the overcollateralization level needed by the transaction to receive atwo-notch collateral-based uplift to achieve a 'AAA' rating is 5.6%, as a percentage of the covered



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bond principal amount. Our preliminary rating is based on our expectation that KHFC will committo maintain overcollateralization at a percentage that meets or exceeds our requirement for thetwo notches of collateral-based uplift.

Table 10

Collateral Uplift Metrics

As at cut-off date

Asset weighted-average maturity (years) 27.83

Liability weighted-average maturity (years) 5

Credit enhancement commensurate with rating (%)* 5.6%

Adjustment for liquidity (Yes/No) No

Adjustment for committed overcollateralization (Yes/No) No

*As a percentage of the covered bond principal amount.

Counterparty risk

We have identified various counterparty risks to which the covered bonds are exposed. However,as these are structurally addressed in line with our counterparty criteria, we believe that they donot constrain the rating from a counterparty risk perspective (see "Counterparty Risk Framework:Methodology And Assumptions," published on March 9, 2019).

Bank account providers. At deal close, KHFC will open a collection account and reserve accountunder its name with the account bank. The two accounts are to keep collections of mortgage loansin the cover pool and cash reserve set aside should we downgrade KHFC below 'A'.

KHFC will also open a designated foreign exchange account at deal close with the designatedforeign exchange bank to receive non-won proceeds to pay KHFC's non-won obligation.

The transaction's exposure to the bank account providers is adequately mitigated throughreplacement and remedy mechanisms in the transaction documents that are consistent with ourcriteria to support maximum rating of 'AAA'. According to the transaction documents, should theICR on the bank account provider fall below 'BBB', the issuer, or the covered bond administrator(following the occurrence of an issuer event of default), shall find a replacement account bankprovider within 30 days.

Swap providers. In our view, the transaction's exposure to the swap providers is mitigatedthrough replacement and remedy mechanisms in the transaction documents that are consistentwith our criteria to support maximum rating of 'AAA'.

Compared to structured finance issues, the holder of a covered bond benefits from dual recourse,first to the issuer and then to the cover pool assets. This recourse to the issuer is an additionalfactor to consider when assessing counterparty risk in covered bond programs.

We believe a 'BBB' or higher replacement trigger to support 'AAA' is compatible with our criteria. Todetermine the minimum replacement rating trigger to support the maximum rating of AAA', our keyconsideration and rationale are:

- We consider whether counterparties are related or unrelated to the covered bond issuer andhow much this may influence the issuer's ability and willingness to manage counterparty riskbefore a default. In our view, the swap providers are unrelated to KHFC.



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- We also consider the covered bond issuer's RRL, which is 'aa' in this transaction. In our view,the higher the RRL, the greater the issuer's ability to mitigate counterparty risk.

- Our criteria differentiate the maximum supported rating by assessing the concentration ofexposures to derivative counterparties unrelated to the covered bond issuer. Our criteriagenerally consider that counterparty exposures are concentrated if there is exposure to a singlecounterparty for which the total net notional amount is greater than 25% of the total netnotional amount of derivatives with unrelated counterparties. In this transaction, we considerthe exposure to the swap providers to be concentrated given the number of swap providers is tobe decided.

- KHFC intends to structure swap arrangements to meet "moderate" collateral framework forcollateral posting in accordance with S&P Global Ratings' criteria.

According to the transaction documents, should the applicable rating on a swap provider fallbelow 'BBB', the swap provider shall be replaced within 90 days and post collateral within 10business days. Together with other swap arrangements, we view that the transaction's exposureto the swap providers is mitigated through structures that are consistent with our criteria tosupport maximum rating of AAA.

Country risk

In our view, we may rate the covered bonds up to two notches above the rating on the sovereign,Korea. As a result country risk does not constrain the ratings on the covered bonds.

We analyze country risk based upon our "Incorporating Sovereign Risk In Rating StructuredFinance Securities" criteria. One of the key aspects we consider for a covered bond rated abovethe sovereign is the impact of refinancing risk on the covered bond's sensitivity to sovereigndefault.

The covered bonds to be issued in Korea, which is not a member of a monetary union, where thecentral bank is a supranational institution and rated higher than the respective sovereign. Hence,the cover pool administrator of this transaction has no access to refinancing sources such as repofacilities from a supranational institution.

Also, the covered bonds with bullet maturity payment don't include a structural mechanism thatcover refinancing needs over a 12-month period in a sovereign default scenario. Therefore, weconclude that we may rate the covered bonds up to two notches above the sovereign rating onKorea. By contrast, if an issuer is based in a country that is not a member of a monetary union andif the refinancing risk is mitigated over a 12-month period, then we can rate mortgage-backedcovered bonds up to four notches above the sovereign rating.

Other risks

T&C risk. Transfer and convertibility (T&C) risk materializes when a sovereign restricts access toforeign exchange needed for debt service. Our T&C assessment on Korea is 'AAA'. Hence T&C riskdoes not constrain the rating on this transaction.

Super senior claims and mortgage insurance in regulatory LTV calculation. The mortgage loansto be included are first ranking. However, potential claims arising from key deposits placed bytenants pursuant to lease agreements may be protected by regulations if conditions are met. Thussuch potential claims from tenants would still rank ahead of the mortgage claims under Korean



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regulations.

According to regulatory guideline, Korean mortgage lenders include super senior claims, net of theamount covered by mortgage insurance to calculate regulatory LTV ratio when underwritingmortgage loans.

When we estimated loss severity in our stress rating scenario, we factored in a potential supersenior claim amount without deducting the mortgage insured/guaranteed amount. We did not givecredit to the mortgage insurance/guarantee.

Servicer commingling risk. Typically, should a servicer become insolvent, collections of theunderlying assets are exposed to the bankruptcy estate of the insolvent servicer. Consequently,such collections may be either unable to be recovered or be recovered after the legal final maturityof the associated transaction.

In our view, the potential servicer commingling risk is largely mitigated in light of the transactionstructure in accordance with the KHFC Act. As such, we don't incorporate any servicercommingling loss in our cash flow analysis.

In this transaction, KHFC is the servicer for the mortgage loans it originates and included in thecover pool, while delegating such servicing to each participating bank for the mortgage loans thatthe respective participating bank originates and are included in the cover pool.

KHFC in terms of loan servicing is required to manage the cover pool separately from its ownassets in accordance with the transaction documents to meet Articles 30 and 31 of the KHFC Act.

With respect to participating banks in the capacity of servicer, they are required in accordancewith the transaction documents to manage the cover pool separately from their own assets tomeet Article 45 of the KHFC Act.

According to the Korean legal counsel, the cover pool serviced by KHFC and managed separatelyfrom KHFC's own assets will be considered bankruptcy remote pursuant to Article 45 of the KHFCAct. The covered pool serviced by the participating banks and managed separately from assets ofrespective participating banks will not be included in the insolvency estate of the respectiveparticipating bank.

Deposit set-off risk. KHFC is not a deposit-taking institution. Hence there is no deposit set-offrisk arising from the mortgage loans originated by KHFC.

With respect to the mortgage loans originated by participating banks, the deposit amountoutstanding on the date of loan transfer may be subject to set-off risk if, at the time of transfer,there is a cause for such claims, while future deposit amount will not, according to the Koreantransaction legal counsel.

In our view, potential set-off risk is manageable and can be largely moderated by the supportprovided by KHFC to make any payments due on the covered bonds from its own funds, for long asKHFC is solvent, should the participating banks become insolvent.

Environmental, social, and governance (ESG) credit factors

We have not observed material changes in the exposure to ESG credit factors in the covered bondtransactions since we published "ESG Industry Report Card: Covered Bonds," on Nov. 9, 2020.

We consider the social factor to be relatively strong in the global context, considering KHFC is astate-run agency with a mandate and social responsibilities to provide affordable housing on a



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long-term and sustainable basis. Committed to serving low- and middle-income families, KHFChas wide-ranging housing finance operations, including the supply of policy loans and otherhousing related operations. The government is legally obligated to maintain KHFC's solvency inaccordance with Article 51 of the KHFC Act. KHFC developed the KHFC Social Covered BondFramework in 2018 and revised it in 2019 as a Social Financing Framework, under which it willissue social covered bonds and social mortgage-backed securities, and use the proceeds underthe affordable housing eligibility category.

On the governance side, the transaction has a contractual commitment to maintain minimumcredit enhancement commensurate with our rating. We note that the transaction does not benefitfrom liquidity support but this does not affect our ratings on the covered bonds.

We do not see any environmental factor that could affect our analysis of KHFC's cover pool.

Potential impact of COVID-19

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about theevolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping upand rollouts are gathering pace around the world. Widespread immunization, which will help pavethe way for a return to more normal levels of social and economic activity, looks to be achievableby most developed economies by the end of the third quarter. However, some emerging marketsmay only be able to achieve widespread immunization by year-end or later. We use theseassumptions about vaccine timing in assessing the economic and credit implications associatedwith the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves,we will update our assumptions and estimates accordingly.

Appendix: Further Details Of The Transaction Structure

Transaction arrangement before the occurrence of an issuer event of default



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Chart 2

Flow of mortgage loan collections. On a daily basis, payments from mortgage loans in the coverpool are remitted to the collection account in the name of the issuer with the rating dependentaccount bank (see chart 3).

In respect of KHFC mortgage loans serviced by participating banks, on a daily basis KHFC receivesdata electronically from, and synchronizes data with, participating banks. A dedicated KHFC teamis required to follow up with participating banks should any issue be observed.

Prior to the occurrence of an issuer event of default, the issuer has full operational control of thecollection account.



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Chart 3

Cross currency swap. Cross currency swaps will be entered prior to the deal close to mitigatecurrency mismatch in this transaction.

KHFC in its own capacity, the covered bond administrator, and KHFC in the capacity of the swapdelegate will also enter into a novation agreement with each swap provider before the closing datein respect of the relevant swap agreement. Upon issuer default, the novation agreements willautomatically become effective and the rights and obligations of the issuer under thecross-currency swap transactions will be automatically transferred by novation to the swapdelegate.

Occurrence of an event of default or a termination event under pre-novated swap agreementswould lead to an issuer event of default, which subsequently trigger automatic novation of swaps.

Transaction arrangement following an issuer event of default occur



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Chart 4

Flow of mortgage loan collections. Upon the earlier of the ICR on KHFC falling below 'B' and anissuer event of default, accumulation accounts shall be opened with a substitute account bank.The covered bond administrator will notify the servicer to ensure mortgage collections to be paidinto the accumulation accounts. Only the covered bond administrator can exercise control over theaccumulation accounts.

Upon an issuer event of default, the covered bond administrator will assume control of KHFC'sbank accounts related to the assets included in the cover pool. The covered bond administratorwill apply collections on the mortgage loans to repay covered bonds or may arrange the disposal ofthe mortgage loans and other assets in the cover pool for such purpose.

Cross currency swap. Each of the swap providers will enter into, with the swap delegate, theswap agreements that are substantially identical to the swap agreements on the closing date.

Upon the insolvency of the issuer, its rights and obligations under cross-currency swaptransactions will be automatically transferred by novation to the swap delegate (KHFC).

Any amounts received by the swap delegate (or the covered bond administrator on its behalf)under the novated swap agreements are held for the benefit of the bond trustee and the coveredbondholders and will be paid into the designated foreign exchange account and used to payamounts then due and payable to the covered bondholders. The payment obligations of the swap



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delegate under the novated swap agreements are limited to the sums available to pay the swapproviders under the applicable priority of payments in respect of the cover pool assets.

Other key structural features

Asset cover test (ACT). The asset cover test specified in the asset monitor agreement isdesignated to ensure that the ratio of assets in the cover pool to the principal outstanding amountof the covered bonds is maintained at a certain level. The asset cover test is determined by aformula that adjusts the current balance of each mortgage loan to take into account, among otherthings, fluctuations in house prices and mortgage loans' arrears status. The formula alsoincorporates an asset percentage, which determines the minimum amount of creditenhancement.

The asset monitor will verify the ACT annually while KHFC will test it on a monthly basis. There arecertain circumstances that will also trigger the asset monitor's verification of the test on a moreregular basis.

If the ACT is breached, the issuer may add additional mortgage loans to the cover pool to cure thebreach. A failure to cure the test by the second following calculation date will result in theoccurrence of an issuer event of default.

Liquidity reserve. If KHFC is downgraded below 'A', a reserve account will be topped up to anamount (reserve account target balance) equal to:

- the sum of three months of servicing fees;

- a single period's payment (i.e. one year's worth) of other senior fees incurred by the transaction(the above two are collectively "reserve account general balance"); and

- an amount (Reserve Account Specific Balance) equal to: the expenses associated with sendingnotifications to the underlying obligors of KHFC serviced loans upon an issuer event of default,plus the expenses associated with preparing the backup servicer for servicing the KHFCserviced loans.

The reserve account specific balance is subject to a floor of KRW400 million.

The funds in the reserve account may be used to make transfers into the interest accumulationaccount and to pay the costs of serving re-direction notices to the obligors of KHFC servicedmortgage loans to require them to make payments into the collection account.

Swap advance payment. In respect of the swap agreements, KHFC is required to pay to the swapproviders a swap advance payment equal to about half of the interest-related payment obligationunder the swap agreements on the following payment date, if the ICR on KHFC falls below 'A'.

In our view, the rating-trigger-based swap advance payment helps mitigate the risk in relation toroughly half of one upcoming interest-related payment under the swap agreement.

Related Criteria

- Criteria | Structured Finance | General: Global Framework For Payment Structure And CashFlow Analysis Of Structured Finance Securities, Dec. 22, 2020

- Criteria | Structured Finance | General: Counterparty Risk Framework: Methodology AndAssumptions, March 8, 2019



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- Criteria | Structured Finance | General: Incorporating Sovereign Risk In Rating StructuredFinance Securities: Methodology And Assumptions, Jan. 30, 2019

- Criteria | Structured Finance | General: Foreign Exchange Risk In StructuredFinance--Methodology And Assumptions, April 21, 2017

- Legal Criteria: Structured Finance: Asset Isolation And Special-Purpose Entity Methodology,March 29, 2017

- Criteria | Structured Finance | Covered Bonds: Covered Bond Ratings Framework: MethodologyAnd Assumptions, June 30, 2015

- Criteria | Structured Finance | Covered Bonds: Covered Bonds Criteria, Dec. 9, 2014

- Criteria | Financial Institutions | Banks: Assessing Bank Branch Creditworthiness, Oct. 14, 2013

- Criteria | Structured Finance | General: Global Derivative Agreement Criteria, June 24, 2013

- General Criteria: Global Investment Criteria For Temporary Investments In TransactionAccounts, May 31, 2012

- Criteria | Structured Finance | RMBS: Australian RMBS Rating Methodology And Assumptions,Sept. 1, 2011

- General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

- Criteria | Structured Finance | RMBS: Methodology And Assumptions For Analyzing The CashFlow And Payment Structures Of Australian And New Zealand RMBS, June 2, 2010

- Criteria | Structured Finance | General: Methodology For Servicer Risk Assessment, May 28,2009

Related Research

- Economic Outlook Asia-Pacific Q2 2021: Three-Speed Recovery Will Benefit From Faster GlobalGrowth, March 24, 2021

- Republic of Korea 'AA/A-1+' Ratings Affirmed; Outlook Stable, April 28, 2021

- ESG Industry Report Card: Covered Bonds, Nov. 9, 2020

- Korea Housing Finance Corp., July 17, 2020

- Glossary Of Covered Bond Terms, April 27, 2018

- Global Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top FiveMacroeconomic Factors, Dec. 16, 2016

- Global Covered Bond Characteristics And Rating Summary, published quarterly

- Assessments For Target Asset Spreads According To Our Covered Bond Criteria, publishedannually

- Assessments For Jurisdictional Support According To Our Covered Bonds Criteria, publishedannually



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Korea Housing Finance Corp. Social Covered Bonds

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Transcript of Korea Housing Finance Corp. Social Covered Bonds