USD368.55 million in CDS notional amount rated
Hong Kong, December 12, 2012 -- Moody's Investors Service has assigned definitive ratings to four tranches of an unfunded credit default swap (CDS) pursuant to the Trade Finance Transaction #10, where Standard Chartered Bank ("SCB") is the credit protection buyer and Standard Chartered Bank (Hong Kong) Limited is the credit protection provider:
....USD35 million A Tranche in relation to the 16% to 17% tranche, definitive rating assigned Aaa (sf)
....USD35 million B Tranche in relation to the 15% to 16% tranche, definitive rating assigned A1 (sf)
....USD228.55 million C Tranche in relation to the 8.47% to 15% tranche, definitive rating assigned A3 (sf)
....USD70 million D Tranche in relation to the 6.47% to 8.47% tranche, definitive rating assigned Baa3 (sf)
The ratings measure the risk, on an expected loss basis, that the credit protection provider will be required to make payments in respect of credit events under the terms of the transaction. The ratings also address any premiums due but not paid by the credit protection buyer, up until an early termination date, if any.
The ratings do not address the potential losses resulting from an early termination of the transaction, nor any market risk associated with the transaction.
Moody's ratings address only the credit risks associated with the transaction. Non-credit risks have not been addressed, but these may have a significant effect on the yields to investors.
This is a synthetic balance-sheet collateralized loan obligation (CLO) transaction. It aims to transfer the mezzanine credit risk (from 6.47% to 17%) of a USD3.5 billion reference portfolio to the credit protection provider. The transaction's legal maturity date is in about 4.5 years, and is scheduled to terminate about 1.5 years after the closing date if all credit events (if any) are settled, subject to any early termination events.
The reference portfolio will consist of corporate trade financing obligations that meet certain criteria with respect to creditworthiness and diversity. These obligations are initially originated by SCB and its affiliates mostly in Asia and other emerging market countries.
The credit protection buyer and provider had not executed the CDS contract, which deems the transaction as non-enforceable. However, Moody's has considered the presence of a parallel enforceable transaction, which is expected to share the same reference portfolio throughout the entire transaction term, but references the lower part of capital structure -- the detachment point of the parallel transaction equals the attachment point (6.47%) of the bottom tranche of the rated transaction.
Moody's has evaluated the legal integrity of the parallel transaction, as well as the presence of substantially similar terms and conditions and other features, including the identical portfolio shared by this proposed transaction and the parallel transaction.
Moody's will receive periodic reference portfolio reports and other transaction reports to monitor the credit risk of the portfolio and, hence, arrive at a rating. The parallel transaction is not rated by Moody's.
The credit protection provider will provide credit protection against the occurrence of credit events in the reference portfolio. Credit events in the transaction are defined as bankruptcy, failure to pay, and restructuring.
The occurrence of a credit event, the compliance to the eligibility criteria and replenishment conditions, as well as the computation of any losses, would be verified by the accountant of the transaction.
SCB can replenish loans or other exposures that have been paid or reduced with new exposures by adding new reference obligations or increasing the notional amount of existing reference obligations within the first 15 months from the closing date ("replenishment period"), subject to the satisfaction of eligibility criteria and replenishment conditions including (but are not limited to):
(1) reference obligations with low internal credit ratings not exceeding certain limits
(2) weighted average life of the portfolio is less than 91 days
(3) tenor of any reference obligation not exceeding 366 days
(4) concentration in each of the countries not exceeding the specified amounts
(5) concentration in each of the industries not exceeding the specified amounts
(6) reference entity not being recorded on SCB's early alert review system
(7) H -Score (a measurement of obligor concentration) not being lower than 200
For each defaulting obligation, the actual recovery will be received through the loan workout process in accordance with SCB's standard procedures. SCB will continue the workout process until it is formally concluded or the defaulted obligation is sold. If the workout process is completed before 60 business days prior to the legal maturity date, the loss amount for the defaulted obligation will be based on the actual recovery. Otherwise, it will be calculated based on the loan loss provision per SCB standard provisioning policy and/or the loss determined through the market value quotation process.
The main drivers of Moody's analysis of this transaction are:
(1) 5.4% annualized weighted average default rate assumption of the hypothetical reference portfolio -- Moody's has constructed a distressed hypothetical portfolio based on the eligibility criteria and replenishment conditions. The default rate assumption is primarily determined by credit mapping and stresses that Moody's applies as part of its rating methodology.
(2) 25% weighted average recovery rate assumption of the hypothetical portfolio.
(3) 5.7% weighted-average pair-wise asset correlation assumption of the hypothetical portfolio for simulating the default distribution.
(4) exposure limits to each country based on country ceilings and available credit enhancement to each tranche.
(5) attachment point and the detachment point for each of the four tranches.
(6) structure of the transaction, including the replenishment guidelines, cumulative default triggers, and the legal documentation.
The initial portfolio comprises about 10,950 reference obligations by 1,618 corporate reference entities. Most of the reference obligations are short-term senior unsecured loans.
Only a small portion of the reference portfolio will have Moody's public ratings. For the remaining portfolio, the credit quality of each of the reference entities is assessed based on a credit mapping between SCB's internal rating scale and Moody's public rating scale, which was last updated in May 2011. The initial reference portfolio has a weighted-average credit quality corresponding to a Ba3 rating based almost entirely on credit mapping.
In terms of geographical diversification, approximately 51% of the initial portfolio is concentrated in Asia, and the remainder in the Middle East and North Africa (18%), Europe (11%), Indian Subcontinent (11%). The top five countries are Hong Kong (15%), United Arab Emirates (15%), Singapore (11%), China (9%), and India (9%).
The top four industries in the initial reference portfolio were metals and mining (15%), wholesale (12%), oil and gas (12%), and beverage, food & tobacco (9%).
Moody's CDOROM model was used in conjunction with a separate cash flow model, Moody's ABSROM model, to measure the potential expected loss incurred by the credit protection provider in this transaction.
The CDOROM model performs a Monte Carlo simulation that uses Moody's default probability assumption as input. Each obligor is modeled individually, with a standard multi-factor model incorporating intra- and inter-industry correlations.
The correlation structure is based on the Gaussian copula. In each Monte Carlo scenario, defaults are simulated. The CDOROM model will generate the default distribution of the hypothetical portfolio. The default distribution generated by CDOROM will serve as input in the ABSROM.
The ABSROM can model: (1) the revolving nature of the portfolio, (2) the assumed loss for each default, (3) the loss allocation in accordance with the documented order of priorities, and (4) the effect of the cumulative default trigger to end the replenishment period before its scheduled date.
As such, the ABSROM model calculates the loss incurred by the credit protection seller under each default scenario, which, combined with the probability assigned by the CDOROM model to that default scenario happening, allows for the computation of the expected loss of each tranche.
The ratings for this transaction were assigned in line with Moody's existing methodology entitled "Rating Corporate Collateralized Synthetic Obligations," dated September 2009, and "Moody's Mapping Methodology for Bank Balance-Sheet CLOs," dated January 2011, and as further described above.
Moody's released a press release on 12 October 2012 stating its plans to update certain assumptions used to rate synthetic EM CDOs. This would bring additional volatility to the ratings on this transaction. Please refer to Moody's press release, "Moody's plans to revise its approach to rating emerging market CDOs," for further details regarding the implications of the proposed methodology changes on Moody's ratings.
The V Score for this transaction indicates Medium/High uncertainty about critical assumptions. This is in line with the Medium/High score for the Corporate Synthetic CDO Sector. The V Score for this transaction is driven by a high level of uncertainty of sector performance variability, medium/high level of analytical complexity in accessing risk to exposure in the emerging market countries and a quick turnover of the revolving reference portfolio, and a medium/high level uncertainty in assessing the portfolio credit quality (which is estimated based on credit mapping without knowing the exact credit quality of any individual name), as well as other factors.
Moody's V Score provides a relative assessment of the quality of available credit information and the potential variability of various inputs in a rating determination.
The V Score ranks transactions by the potential for significant rating changes owing to uncertainty about the assumptions due to data quality, historical performance, the level of disclosure, transaction complexity, modelling, and the transaction governance that underlie the ratings.
V Scores apply to the entire transaction, not to individual tranches.
Moody's also ran sensitivities for key parameters of the four rated tranches. For example:
If the assumed annualized weighted average default rate of 5.4% used in determining the initial rating was changed to 7.0%, the model output for the A, B and C Tranches will remain at least at the same level, and not below, their respective initial ratings. However, the model output for D Tranche would change to Ba1 from Baa3.
In addition to this change, if the assumed weighted average recovery rate of 25% were changed to 15%, the model output for B Tranches will remain at least at the same level. However, the model output for A, C and D Tranches would change to Aa1, Baa1 and Ba3 respectively.
Parameter sensitivities are not intended to measure how the rating of the security might migrate over time. Rather, they are designed to provide a quantitative calculation of how the initial rating might change if key input parameters used in the initial rating process differed. The analysis assumes that the deal has not aged, and does not factor structural features such as sequential payment effect. Parameter sensitivities reflect only the ratings impact of each scenario from a quantitative/model-indicated standpoint.
Qualitative factors are also taken into consideration in the ratings process, so the actual ratings that would be assigned in each case could vary from the information presented in the parameter sensitivity analysis.
The transaction is sponsored by SCB (A1/Prime-1/B-). Standard Chartered Bank (Hong Kong) Limited, the credit protection provider, is an established affiliate of SCB.
Standard Chartered Plc (A2) -- including its consolidated subsidiaries (Group) -- is an international banking and financial services group focused on the markets of Asia, Africa and the Middle East. SCB is the main operating subsidiary of Standard Chartered Plc. The Group provides a wide range of financial products and services to its customers through two main business divisions -- consumer banking and wholesale banking.
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