Title[ Part 2: The First Pillar - Minimum Capital Requirements
Section[ 4. Internal ratings-based approach for securitisation exposures
(i) Scope
606. Banks that have received approval to use the IRB approach for the type of underlying exposures securitised (e.g. for their corporate or retail portfolio) must use the IRB approach for securitisations. Conversely, banks may not use the IRB approach to securitisation unless they receive approval to use the IRB approach for the underlying exposures from their national supervisors.
607. If the bank is using the IRB approach for some exposures and the standardised approach for other exposures in the underlying pool, it should generally use the approach corresponding to the predominant share of exposures within the pool. The bank should consult with its national supervisors on which approach to apply to its securitisation exposures. To ensure appropriate capital levels, there may be instances where the supervisor requires a treatment other than this general rule.
608. Where there is no specific IRB treatment for the underlying asset type, originating banks that have received approval to use the IRB approach must calculate capital charges on their securitisation exposures using the standardised approach in the securitisation framework, and investing banks with approval to use the IRB approach must apply the RBA.
(ii) Hierarchy of approaches
609. The Ratings-Based Approach (RBA) must be applied to securitisation exposures that are rated, or where a rating can be inferred as described in paragraph 617. Where an external or an inferred rating is not available, either the Supervisory Formula (SF) or the Internal Assessment Approach (IAA) must be applied. The IAA is only available to exposures
(e.g. liquidity facilities and credit enhancements) that banks (including third-party banks) extend to ABCP programmes. Such exposures must satisfy the conditions of paragraphs 619 and 620. For liquidity facilities to which none of these approaches can be applied, banks may apply the treatment specified in paragraph 639. Exceptional treatment for eligible servicer cash advance facilities is specified in paragraph 641. Securitisation exposures to which none of these approaches can be applied must be deducted.
(iii) Maximum capital requirement
610. For a bank using the IRB approach to securitisation, the maximum capital requirement for the securitisation exposures it holds is equal to the IRB capital requirement that would have been assessed against the underlying exposures had they not been securitised and treated under the appropriate sections of the IRB framework including Section III.G. In addition, banks must deduct the entire amount of any gain-on-sale and credit enhancing I/Os arising from the securitisation transaction in accordance with paragraphs 561 to 563.
(iv) Ratings-Based Approach (RBA)
611. Under the RBA, the risk-weighted assets are determined by multiplying the amount of the exposure by the appropriate risk weights, provided in the tables below.
612. The risk weights depend on (i) the external rating grade or an available inferred rating, (ii) whether the credit rating (external or inferred) represents a long-term or a short- term credit rating, (iii) the granularity of the underlying pool and (iv) the seniority of the position.
613. For purposes of the RBA, a securitisation exposure is treated as a senior tranche if it is effectively backed or secured by a first claim on the entire amount of the assets in the underlying securitised pool. While this generally includes only the most senior position within a securitisation transaction, in some instances there may be some other claim that, in a technical sense, may be more senior in the waterfall (e.g. a swap claim) but may be disregarded for the purpose of determining which positions are subject to the “senior tranches” column.
Examples:
(a) In a typical synthetic securitisation, the “super-senior” tranche would be treated as a senior tranche, provided that all of the conditions for inferring a rating from a lower tranche are fulfilled.
(b) In a traditional securitisation where all tranches above the first-loss piece are rated, the most highly rated position would be treated as a senior tranche. However, when there are several tranches that share the same rating, only the most senior one in the waterfall would be treated as senior.
(c) Usually a liquidity facility supporting an ABCP programme would not be the most senior position within the programme; the commercial paper, which benefits from the liquidity support, typically would be the most senior position. However, if the liquidity facility is sized to cover all of the outstanding commercial paper, it can be viewed as covering all losses on the underlying receivables pool that exceed the amount of over-collateralisation/reserves provided by the seller and as being most senior. As a result, the RBA risk weights in the left-most column can be used for such positions. On the other hand, if a liquidity or credit enhancement facility constituted a mezzanine position in economic substance rather than a senior position in the underlying pool, then the “Base risk weights” column is applicable.
614. The risk weights provided in the first table below apply when the external assessment represents a long-term credit rating, as well as when an inferred rating based on a long-term rating is available.
615. Banks may apply the risk weights for senior positions if the effective number of underlying exposures (N, as defined in paragraph 633) is 6 or more and the position is senior as defined above. When N is less than 6, the risk weights in column 4 of the first table below apply. In all other cases, the risk weights in column 3 of the first table below apply.
RBA risk weights when the external assessment represents a long-term credit rating and/or an inferred rating derived from a long-term assessment
External Rating Risk weights for Base risk weights Risk weights for tranches
(Illustrative) senior positions backed by non-granular pools
and eligible senior
IAA exposures
AAA 7% 12% 20%
AA 8% 15% 25%
A+ 10% 18%
A 12% 20%
A- 20% 35%
BBB+ 35% 50%
BBB 60% 75%
BBB- 100%
BB+ 250%
BB 425%
BB- 650%
35%
Below BB- and unrated Deduction
616. The risk weights in the table below apply when the external assessment represents a short-term credit rating, as well as when an inferred rating based on a short-term rating is available. The decision rules outlined in paragraph 615 also apply for short-term credit ratings.
RBA risk weights when the external assessment represents a short-term credit rating and/or an inferred rating derived from a short-term assessment
External Rating Risk weights for Base risk weights Risk weights for tranches
(Illustrative) senior positions and backed by non-granular pools
eligible senior IAA
exposures
A-1/P-1 7% 12% 20%
A-2/P-2 12% 20% 35%
A-3/P-3 60% 75% 75%
All other ratings/unrated Deduction Deduction Deduction
Use of inferred ratings
617. When the following minimum operational requirements are satisfied a bank must attribute an inferred rating to an unrated position. These requirements are intended to ensure that the unrated position is senior in all respects to an externally rated securitisation exposure termed the ‘reference securitisation exposure’.
Operational requirements for inferred ratings
618. The following operational requirements must be satisfied to recognise inferred ratings.
(a) The reference securitisation exposure (e.g. ABS) must be subordinate in all respects to the unrated securitisation exposure. Credit enhancements, if any, must be taken into account when assessing the relative subordination of the unrated exposure and the reference securitisation exposure. For example, if the reference securitisation exposure benefits from any third-party guarantees or other credit enhancements that are not available to the unrated exposure, then the latter may not be assigned an inferred rating based on the reference securitisation exposure.
(b) The maturity of the reference securitisation exposure must be equal to or longer than that of the unrated exposure.
(c) On an ongoing basis, any inferred rating must be updated continuously to reflect any changes in the external rating of the reference securitisation exposure.
(d) The external rating of the reference securitisation exposure must satisfy the general requirements for recognition of external ratings as delineated in paragraph 565.
(v) Internal Assessment Approach (IAA)
619. A bank may use its internal assessments of the credit quality of the securitisation exposures the bank extends to ABCP programmes (e.g. liquidity facilities and credit enhancements) if the bank’s internal assessment process meets the operational requirements below. Internal assessments of exposures provided to ABCP programmes must be mapped to equivalent external ratings of an ECAI. Those rating equivalents are used to determine the appropriate risk weights under the RBA for purposes of assigning the notional amounts of the exposures.
620. A bank’s internal assessment process must meet the following operational requirements in order to use internal assessments in determining the IRB capital requirement arising from liquidity facilities, credit enhancements, or other exposures extended to an
ABCP programme.
(a) For the unrated exposure to qualify for the IAA, the ABCP must be externally rated. The ABCP itself is subject to the RBA.
(b) The internal assessment of the credit quality of a securitisation exposure to the ABCP programme must be based on an ECAI criteria for the asset type purchased and must be the equivalent of at least investment grade when initially assigned to an exposure. In addition, the internal assessment must be used in the bank’s internal risk management processes, including management information and economic capital systems, and generally must meet all the relevant requirements of the IRB framework.
(c) In order for banks to use the IAA, their supervisors must be satisfied (i) that the ECAI meets the ECAI eligibility criteria outlined in paragraphs 90 to 108 and (ii) with the ECAI rating methodologies used in the process. In addition, banks have the responsibility to demonstrate to the satisfaction of their supervisors how these internal assessments correspond with the relevant ECAI’s standards.
For instance, when calculating the credit enhancement level in the context of the IAA, supervisors may, if warranted, disallow on a full or partial basis any seller- provided recourse guarantees or excess spread, or any other first loss credit enhancements that provide limited protection to the bank.
(d) The bank’s internal assessment process must identify gradations of risk. Internal assessments must correspond to the external ratings of ECAIs so that supervisors can determine which internal assessment corresponds to each external rating category of the ECAIs.
(e) The bank’s internal assessment process, particularly the stress factors for determining credit enhancement requirements, must be at least as conservative as the publicly available rating criteria of the major ECAIs that are externally rating the ABCP programme’s commercial paper for the asset type being purchased by the programme. However, banks should consider, to some extent, all publicly available ECAI ratings methodologies in developing their internal assessments.
• In the case where (i) the commercial paper issued by an ABCP programme is externally rated by two or more ECAIs and (ii) the different ECAIs’ benchmark stress factors require different levels of credit enhancement to achieve the same external rating equivalent, the bank must apply the ECAI stress factor that requires the most conservative or highest level of credit protection. For example, if one ECAI required enhancement of 2.5 to 3.5 times historical losses for an asset type to obtain a single A rating equivalent and another required 2 to 3 times historical losses, the bank must use the higher range of stress factors in determining the appropriate level of seller-provided credit enhancement.
• When selecting ECAIs to externally rate an ABCP, a bank must not choose only those ECAIs that generally have relatively less restrictive rating methodologies. In addition, if there are changes in the methodology of one of the selected ECAIs, including the stress factors, that adversely affect the external rating of the programme’s commercial paper, then the revised rating methodology must be considered in evaluating whether the internal assessments assigned to ABCP programme exposures are in need of revision.
• A bank cannot utilise an ECAI’s rating methodology to derive an internal assessment if the ECAI’s process or rating criteria is not publicly available. However, banks should consider the non-publicly available methodology — to the extent that they have access to such information ? in developing their internal assessments, particularly if it is more conservative than the publicly available criteria.
• In general, if the ECAI rating methodologies for an asset or exposure are not publicly available, then the IAA may not be used. However, in certain instances, for example, for new or uniquely structured transactions, which are not currently addressed by the rating criteria of an ECAI rating the programme’s commercial paper, a bank may discuss the specific transaction with its supervisor to determine whether the IAA may be applied to the related exposures.
(f) Internal or external auditors, an ECAI, or the bank’s internal credit review or risk management function must perform regular reviews of the internal assessment process and assess the validity of those internal assessments. If the bank’s internal audit, credit review, or risk management functions perform the reviews of the internal assessment process, then these functions must be independent of the ABCP programme business line, as well as the underlying customer relationships.
(g) The bank must track the performance of its internal assessments over time to evaluate the performance of the assigned internal assessments and make adjustments, as necessary, to its assessment process when the performance of the exposures routinely diverges from the assigned internal assessments on those exposures.
(h) The ABCP programme must have credit and investment guidelines, i.e. underwriting standards, for the ABCP programme. In the consideration of an asset purchase, the ABCP programme (i.e. the programme administrator) should develop an outline of the structure of the purchase transaction. Factors that should be discussed include the type of asset being purchased; type and monetary value of the exposures arising from the provision of liquidity facilities and credit enhancements; loss waterfall; and legal and economic isolation of the transferred assets from the entity selling the assets.
(i) A credit analysis of the asset seller’s risk profile must be performed and should consider, for example, past and expected future financial performance; current market position; expected future competitiveness; leverage, cash flow, and interest coverage; and debt rating. In addition, a review of the seller’s underwriting standards, servicing capabilities, and collection processes should be performed.
(j) The ABCP programme’s underwriting policy must establish minimum asset eligibility criteria that, among other things,
• exclude the purchase of assets that are significantly past due or defaulted;
• limit excess concentration to individual obligor or geographic area; and
• limit the tenor of the assets to be purchased.
(k) The ABCP programme should have collections processes established that consider the operational capability and credit quality of the servicer. The programme should mitigate to the extent possible seller/servicer risk through various methods, such as triggers based on current credit quality that would preclude co-mingling of funds and impose lockbox arrangements that would help ensure the continuity of payments to the ABCP programme.
(l) The aggregate estimate of loss on an asset pool that the ABCP programme is considering purchasing must consider all sources of potential risk, such as credit and dilution risk. If the seller-provided credit enhancement is sized based on only credit-related losses, then a separate reserve should be established for dilution risk, if dilution risk is material for the particular exposure pool. In addition, in sizing the required enhancement level, the bank should review several years of historical information, including losses, delinquencies, dilutions, and the turnover rate of the receivables. Furthermore, the bank should evaluate the characteristics of the underlying asset pool, e.g. weighted average credit score, identify any concentrations to an individual obligor or geographic region, and the granularity of the asset pool.
(m) The ABCP programme must incorporate structural features into the purchase of assets in order to mitigate potential credit deterioration of the underlying portfolio. Such features may include wind down triggers specific to a pool of exposures.
621. The notional amount of the securitisation exposure to the ABCP programme must be assigned to the risk weight in the RBA appropriate to the credit rating equivalent assigned to the bank’s exposure.
622. If a bank’s internal assessment process is no longer considered adequate, the bank’s supervisor may preclude the bank from applying the internal assessment approach to its ABCP exposures, both existing and newly originated, for determining the appropriate capital treatment until the bank has remedied the deficiencies. In this instance, the bank must revert to the SF or, if not available, to the method described in paragraph 639.
(vi) Supervisory Formula (SF)
623. As in the IRB approaches, risk-weighted assets generated through the use of the SF are calculated by multiplying the capital charge by 12.5. Under the SF, the capital charge for a securitisation tranche depends on five bank-supplied inputs: the IRB capital charge had the underlying exposures not been securitised (KIRB); the tranche’s credit enhancement level (L) and thickness (T); the pool’s effective number of exposures (N); and the pool’s exposure- weighted average loss-given-default (LGD). The inputs KIRB, L, T and N are defined below. The capital charge is calculated as follows:
(1) Tranche’s IRB capital charge = the amount of exposures that have been securitised
times the greater of (a) 0.0056 x T, or (b) (S [L+T] – S [L]), where the function S[.] (termed the ‘Supervisory Formula’) is defined in the following paragraph. When the bank holds only a proportional interest in the tranche, that position’s capital charge equals the prorated share of the capital charge for the entire tranche.
624. The Supervisory Formula is given by the following expression:
where
625. In these expressions, Beta[L; a, b] refers to the cumulative beta distribution with parameters a and b evaluated at L.96
626. The supervisory-determined parameters in the above expressions are as follows:
? = 1000, and ? = 20
Definition of KIRB
627. KIRB is the ratio of (a) the IRB capital requirement including the EL portion for the underlying exposures in the pool to (b) the exposure amount of the pool (e.g. the sum of drawn amounts related to securitised exposures plus the EAD associated with undrawn commitments related to securitised exposures). Quantity (a) above must be calculated in accordance with the applicable minimum IRB standards (as set out in Section III of this document) as if the exposures in the pool were held directly by the bank. This calculation should reflect the effects of any credit risk mitigant that is applied on the underlying exposures (either individually or to the entire pool), and hence benefits all of the securitisation exposures. KIRB is expressed in decimal form (e.g. a capital charge equal to
15% of the pool would be expressed as 0.15). For structures involving an SPE, all the assets of the SPE that are related to the securitisations are to be treated as exposures in the pool, including assets in which the SPE may have invested a reserve account, such as a cash collateral account.
628. If the risk weight resulting from the SF is 1250%, banks must deduct the securitisation exposure subject to that risk weight in accordance with paragraphs 561 to 563.
629. In cases where a bank has set aside a specific provision or has a non-refundable purchase price discount on an exposure in the pool, quantity (a) defined above and quantity
(b) also defined above must be calculated using the gross amount of the exposure without the specific provision and/or non-refundable purchase price discount. In this case, the amount of the non-refundable purchase price discount on a defaulted asset or the specific provision can be used to reduce the amount of any deduction from capital associated with the securitisation exposure.
Credit enhancement level (L)
630. L is measured (in decimal form) as the ratio of (a) the amount of all securitisation exposures subordinate to the tranche in question to (b) the amount of exposures in the pool. Banks will be required to determine L before considering the effects of any tranche-specific credit enhancements, such as third-party guarantees that benefit only a single tranche. Any gain-on-sale and/or credit enhancing I/Os associated with the securitisation are not to be included in the measurement of L. The size of interest rate or currency swaps that are more junior than the tranche in question may be measured at their current values (without the potential future exposures) in calculating the enhancement level. If the current value of the instrument cannot be measured, the instrument should be ignored in the calculation of L.
631. If there is any reserve account funded by accumulated cash flows from the underlying exposures that is more junior than the tranche in question, this can be included in the calculation of L. Unfunded reserve accounts may not be included if they are to be funded from future receipts from the underlying exposures.
Thickness of exposure (T)
632. T is measured as the ratio of (a) the nominal size of the tranche of interest to (b) the notional amount of exposures in the pool. In the case of an exposure arising from an interest rate or currency swap, the bank must incorporate potential future exposure. If the current value of the instrument is non-negative, the exposure size should be measured by the current value plus the add-on as in the 1988 Accord. If the current value is negative, the exposure should be measured by using the potential future exposure only.
Effective number of exposures (N)
633. The effective number of exposures is calculated as:
where EADi represents the exposure-at-default associated with the ith instrument in the pool. Multiple exposures to the same obligor must be consolidated (i.e. treated as a single instrument). In the case of re-securitisation (securitisation of securitisation exposures), the formula applies to the number of securitisation exposures in the pool and not the number of underlying exposures in the original pools. If the portfolio share associated with the largest exposure, C1, is available, the bank may compute N as 1/C1.
Exposure-weighted average LGD
634. The exposure-weighted average LGD is calculated as follows:
? i iLGD ??EAD
(4)
LGD ??? i
? iEAD
i
where LGDi represents the average LGD associated with all exposures to the ith obligor. In the case of re-securitisation, an LGD of 100% must be assumed for the underlying securitised exposures. When default and dilution risks for purchased receivables are treated in an aggregate manner (e.g. a single reserve or over-collateralisation is available to cover losses from either source) within a securitisation, the LGD input must be constructed as a weighted-average of the LGD for default risk and the 100% LGD for dilution risk. The weights are the stand-alone IRB capital charges for default risk and dilution risk, respectively.
Simplified method for computing N and LGD
635. For securitisations involving retail exposures, subject to supervisory review, the SF
may be implemented using the simplifications: h = 0 and v = 0.
636. Under the conditions provided below, banks may employ a simplified method for calculating the effective number of exposures and the exposure-weighted average LGD. Let Cm in the simplified calculation denote the share of the pool corresponding to the sum of the largest ‘m’ exposures (e.g. a 15% share corresponds to a value of 0.15). The level of m is set by each bank.
w If the portfolio share associated with the largest exposure, C1, is no more than 0.03 (or 3% of the underlying pool), then for purposes of the SF, the bank may set LGD=0.50 and N equal to the following amount
1?
???????????????????????????????????????????????????????????????????????????????
(5)
N C C
m 1C C
?????????????mC
1 1??????????????? max 1???????????????? ,0???????????????????????????????????????????????????????????????
m m ??1????????????????
??????????????????????????????????????????????????????????????
? Alternatively, if only C1 is available and this amount is no more than 0.03, then the bank may set LGD=0.50 and N=1/ C1.
(vii) Liquidity facilities
637. Liquidity facilities are treated as any other securitisation exposure and receive a CCF of 100% unless specified differently in paragraphs 638 to 641. If the facility is externally rated, the bank may rely on the external rating under the RBA. If the facility is not rated and an inferred rating is not available, the bank must apply the SF, unless the IAA can be applied.
638. An eligible liquidity facility that can only be drawn in the event of a general market disruption as defined in paragraph 580 is assigned a 20% CCF under the SF. That is, an IRB bank is to recognise 20% of the capital charge generated under the SF for the facility. If the eligible facility is externally rated, the bank may rely on the external rating under the RBA provided it assigns a 100% CCF rather than a 20% CCF to the facility.
639. When it is not practical for the bank to use either the bottom-up approach or the top- down approach for calculating KIRB, the bank may, on an exceptional basis and subject to supervisory consent, temporarily be allowed to apply the following method. If the liquidity facility meets the definition in paragraph 578 or 580, the highest risk weight assigned under the standardised approach to any of the underlying individual exposures covered by the liquidity facility can be applied to the liquidity facility. If the liquidity facility meets the definition in paragraph 578, the CCF must be 50% for a facility with an original maturity of one year or less, or 100% if the facility has an original maturity of more than one year. If the liquidity facility meets the definition in paragraph 580, the CCF must be 20%. In all other cases, the notional amount of the liquidity facility must deducted.
(viii) Treatment of overlapping exposures
640. Overlapping exposures are treated as described in paragraph 581.
(ix) Eligible servicer cash advance facilities
641. Eligible servicer cash advance facilities are treated as specified in paragraph 582.
(x) Treatment of credit risk mitigation for securitisation exposures
642. As with the RBA, banks are required to apply the CRM techniques as specified in the foundation IRB approach of Section III when applying the SF. The bank may reduce the capital charge proportionally when the credit risk mitigant covers first losses or losses on a proportional basis. For all other cases, the bank must assume that the credit risk mitigant covers the most senior portion of the securitisation exposure (i.e. that the most junior portion of the securitisation exposure is uncovered). Examples for recognising collateral and guarantees under the SF are provided in Annex 5.
(xi) Capital requirement for early amortisation provisions
643. An originating bank must use the methodology and treatment described in paragraphs 590 to 605 for determining if any capital must be held against the investors’ interest. For banks using the IRB approach to securitisation, investors’ interest is defined as investors’ drawn balances related to securitisation exposures and EAD associated with investors’ undrawn lines related to securitisation exposures. For determining the EAD, the undrawn balances of securitised exposures would be allocated between the seller’s and investors’ interests on a pro rata basis, based on the proportions of the seller’s and investors’ shares of the securitised drawn balances. For IRB purposes, the capital charge attributed to the investors’ interest is determined by the product of (a) the investors’ interest, (b) the appropriate CCF, and (c) KIRB.
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