Global CBO/CLO Criteria

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Kulp, Michelle McFarquhar (Senior Production Assistants) Subscription Information Hong Kong, (852) 2533-3535 London, (44) 171-826-3510 Melbourne, (61) 3-9631-2000 New York, (1) 212-208-8830 Tokyo, (81) 3-3593-8700 Subscriber Services New York (1) 212-208-1146 Web Site www.standardandpoors.com/ratings Published by Standard & Poor 9s, a Division of The McGraw-Hill Companies, Inc. Executive offices: 1221 Avenue of the Americas, N ew York, N.Y. 10020. Editorial offices: 25 Broadway, New York, N.Y. 10004. Copyright 1999 by The McGraw-Hill Companies, Inc. All rights reserved. Officers of The McGraw-Hill Companies, Inc.: Joseph L. Dionne, Chairman; Harold W. McGraw, III, President and Chief Executive Officer; Kenneth M. Vittor, Senior Vice President and General Counsel; Frank Penglase, Senio r Vice President, Treasury Operations. Information has been obtained by Standard & Poor 9s from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, Standard & Poor 9s, or others, Standard & Poor 9s does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Global Collateralized Bond And Loan Obligation (CBO/CLO) Criteria Global CBO/CLO Product Overview . . . . . . . . . . . . . . . . . . . . . . . 3 Product Basics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Cash Flow CBOs/CLOs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Differences Between CBOs And CLOs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Key Areas Of Risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Outlook. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 The Rating Process, Asset Management, And Surveillance For CBOs/CLOs . . . . . . . . . . . . . . . . . . . . . . . . . 11 Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Sponsor/Asset-Manager Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Surveillance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Evaluating Credit Risk For CBO/CLO Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 Determining Credit Enhancement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 Credit Enhancement Level: Cash Flow Analysis And Default Estimation . . . . . . .30 Risk Factors: Structure And Collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Other Considerations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Legal Considerations For CBO/CLO Transactions . . . . . . . . . 69 Bankruptcy-Remote Entities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 Transfer Of Assets And Perfection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 Selected Specific Criteria. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 Master Trust And Synthetic CLO Structures . . . . . . . . . . . . . . . 79 Overview Of The Master Trust Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Master Trust Structural Issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 1 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria 2 Credit Considerations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 Credit-Linked Notes And Synthetic CLOs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Multi-jurisdiction/Emerging Market CBO Criteria . . . . . . . . . 99 Sovereign Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 Concentration Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 Recovery And Loss Severity Assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 Appendix A Mapping Bank Loan Scoring Models To Standard & Poor 9s Ratings In CBO/CLO Transactions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107 Appendix B Structured Finance Interest Rate And Currency Swap Criteria . . . . . . . . . . . . . . 111 Appendix C 8AAAt 9 Swaps Approved In Structured Finance Transactions . . . . . . . . . . . . . . . 117 Appendix D Swap Agreement Criteria For CBO/CLO Transactions. . . . . . . . . . . . . . . . . . . . 121 Appendix E Interest Rate Assumptions For Structured Ratings . . . . . . . . . . . . . . . . . . . . . . . 135 Appendix F Structured Financing Without True Sale: English Secured Loans. . . . . . . . . . . . . 143 Global CBO/CLO Product Overview Product Basics The genesis of the CBO (collateralized bond obligation) and CLO (collateralized loan obligation) market occurred in the late 1980s with the repackaging of high-yield, speculative-grade bonds or loans into highly rated paper. By the late 1990s, the market had expanded into far more diverse product applications, and beyond U.S. borders in terms of issuers and investors alike. Participation by sponsors outside the U.S. increased, most notably, by European and Japanese financial institutions through 3 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria C BO s and CLO s are securities backed or colateralized by a diversified pool of corporate bonds or loans, respectively. CDO s are securities backed or collateralized by a diversified pool of both corporate bonds and loans. A CBO is backed by a portfolio of secured or unsecured senior or junior bonds issued by a variety of corporate or sovereign obligors. A CLO is backed by a portfolio of secured or unsecured loans made to a variety of corporate commercial and industrial loan customers of one or more lending banks. A CDO is backed by a portfolio which is a combination of bonds and loans described above. Cash flows from the asset pool plus credit enhancement to cover credit risk in the portfolio provide payment to the CBO or CLO investor. Credit enhancement or credit support often comes in the form of excess assets over rated CBO/CLO liabilities. This is achieved by subdividing the CBO or CLO into senior and subordinated tranches or classes, each with different ratings, different loss positions and different levels of excess asset cbuffers. d For example, depending on an issuer 9s underlying portfolio characteristics, $100 million in assets can back $80 million 8AA 9 rated senior notes, and $20 million unrated subordinated and equity classes. Arbitrage or cspread d CBO/CLO transactions can realize the positive spread between a portfolio of higher-return, higher-risk assets, often rated below 8BBB- 9, and lower-cost, highly rated CBO/CLO securities issued to purchase that portfolio. Example: Asset manager-sponsored high-yield bond CBO Balance sheet CBO/CLO transactions can reduce regulatory capital requirements and enhance lending capacity and return on equity by using the proceeds of the CBO/CLO securities to cspin off d bonds or loans from corporate commercial and industrial lending portfolios. Example: Lending bank-sponsored CLO. CBO/CLO Definitions 4 their overseas U.S. branches as well as on their domestic fronts in Europe and in the Asia-Pacific region. Cash Flow CBOs/CLOs Cash flow transactions comprise the bulk of the global CBO/CLO market. In turn, the cash flow CBO/CLO market is comprised of three main sectors, or products: arbitrage, balance sheet, and emerging market. The arbitrage sector of the CBO/CLO market is the largest in terms of the number of transactions completed. Arbitrage deals are designed to capture the positive spread between relatively higher yielding assets and lower cost, highly rated liabilities. Arbitrage CBOs represent most of this sector (see chart 1 cSample CBO Transaction d) . However, arbitrage CLOs and CDOs (collateralized debt obligations) are growing subsectors (unless otherwise noted, any references in this book to CBOs/CLOs includes CDOs). The balance sheet sector is the largest in terms of the dollar volume of transactions completed. Balance sheet deals were initially designed to reduce regulatory capital requirements for the selling institution on the assets transferred into the transaction. Chart 1 Sample CBO Transaction Asset Manager (Manages issuer's assets) Trustee (Protects investor's security interest in the collateral and performs other fiduciary duties) Investors (Buy rated ABS) Seller/Servicer (Sells a portfolio of bonds to the issuer of rated securities) Guarantee ABS Proceeds of rated securities Interest and principal on rated securities Issuer Special-Purpose Entity (Buys bonds from the seller and issues ABS using the bonds as collateral) Portfolio of bonds Proceeds of rated securities Interest and principal on bonds Swap Counterparty (Provides interest rate swap to hedge against interest rate-related risk) Swap agreement Interest and principal on bonds Credit Enhancer (Guarantees payment of interest and principal on ABS) Bond Portfolio (Collateral for ABS) Additional motivations include increased lending capacity and lower cost of funding. Balance sheet CLOs represent most of this sector, and many sponsors in the late 1990s have used the master trust vehicle (see chart 2 cSample CLO Transaction d). Other subsectors of the balance sheet CLO market are on the rise. Synthetic CLOs or credit derivative structures, such as credit swap and credit-linked note (CLN) securitizations, have gained popularity. They can potentially provide regulatory relief and hedge credit exposures, without legal transfer of the underlying assets. In addition, CBOs seeking off-balance sheet treatment have been on the rise, for example, in the U.S. under accounting standard FASB 125. The remainder of the cash flow CBO/CLO market is largely made up of the emerging market sector. Emerging market CBOs (EMCBOs) are arbitrage transactions backed by portfolios of sovereign debt and/or emerging market high-yield corporate bonds. Finally, project finance securitizations of infrastructure debt represent the newest product sector. Global CBO/CLO Product Overview 5 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria Chart 2 Sample CLO Transaction Asset Manager (Manages issuer's assets) Trustee (Protects investor's security interest in the collateral and performs other fiduciary duties) Investors (Buy rated ABS) Seller/Servicer (Assigns a portfolio of loans to the issuer of rated securities) Guarantee ABS Proceeds of rated securities Interest and principal on rated securities Issuer Special-Purpose Entity (Buys loan assignments and issues ABS using the loans as collateral) Portfolio of bank loans Proceeds of rated securities Interest and principal on loans Swap Counterparty (Provides interest rate swap to hedge against interest rate-related risk) Swap agreement Credit Enhancer (Guarantees payment of interest and principal on ABS) Obligor #1 Obligor #1 Loan agreements Bank #1 Bank #2 Assignment agreements Loan agreement Bank #3 Agent Bank Bank #3 Assignment agreement Assignment agreement 6 Differences Between CBOs And CLOs It is important to note that while the criteria for CBO and CLO transactions share similarities, loan assets have features that can make the analysis more complicated than that of bond assets. Certain credit, legal, and cash flow analyses of CLOs differ from those of CBOs due to the following factors: s The loan type and loan documentation can affect the degree to which rights and obligations can be transferred from the sponsor to the transferee. For example, a loan may in part be a participation. The lead bank transfers all or part of its interest in a loan (which also may include a pro rata interest in any collateral securing the loan) to one or more participants. Analysis of participations often entails an evaluation of the credit risk of the seller bank, whose insolvency may interrupt payments from the borrower to, ultimately, the issuer, as transferee. s Loan terms vary widely, such as different amortization schedules, payment dates, rate indices, index reset dates, tenors, and so on, which impact the cash flow analysis. s The lack of uniformity in the manner in which rights and obligations are transferred also results in a lack of standardized documentation for these transactions. Therefore, loan documents require a more detailed legal review. s Loan portfolios can be restructured to accommodate the diminished or declining repayment capacity of borrowers. s Markets for bank loans are less liquid than bond markets. This increases the risk of not being able to purchase eligible loans during the ramp-up and revolving periods, as well as not being able to sell defaulted loans. In addition, disposition of defaulted loans via sale into the market may lower the ultimate recovery relative to disposition via a gradual workout. Key Areas Of Risk This analysis describes Standard & Poor 9s rating approach to CBOs/CLOs and the key risk areas, which are the focus here of a brief review. The key areas include sovereign risk, default risk, recovery and loss severity estimation, currency and interest rate hedging, as well as legal risk. Sovereign Risk Both the overall credit profile for an obligor and its rating can be impacted and possibly constrained by the sovereign rating of the country in which the obligors are domiciled. Standard & Poor 9s has modified its ctraditional, d or single-jurisdictional, CBO/CLO default model to take into account such factors when determining a multi-jurisdictional or emerging market pool 9s credit profile at a given rating level. Single-jurisdiction CBOs/CLOs are collateralized by sovereign debt or corporate bonds or loans from a single country. If all obligors in the collateral pool are from the same country, that country 9s local currency or foreign currency issuer credit rating will most likely limit the transaction 9s rating to that of the sovereign, regardless of the portfolio 9s underlying credit quality or the amount of credit enhancement. cTraditional d single-jurisdiction CBOs/CLOs are collateralized by corporate bonds or loans from a single, typically developed, country. These transactions can achieve a rating as high as 8AAA 9 with a collateral pool comprised, for example, of all U.S. obligors, based in part on the 8AAA 9 local currency or foreign currency issuer credit rating of the United States. In CBOs/CLOs with significant exposures in the collateral pool to a single or multiple less developed or emerging market countries, solutions for structuring a transaction with a rating higher than that sovereign 9s issuer credit rating become important. One example is obtaining a 100% guarantee or an insurance policy, in either case from a highly rated third-party credit enhancer. However, there is still a practical problem for issuers seeking such third-party support arrangements in emerging market regions, particularly in those nations whose ratings have been recently downgraded. The reason is that both the investors and the monoline insurers who typically cwrap, d or insure, such transactions have taken a cautious approach. This can hinder issuance activity for pools with large, relatively undiversified exposures to single countries or individual regions where there is economic stress. Another analytical challenge related to sovereign risk involves the quantification of the incremental risk associated with cregional correlation. d This involves analyzing the extent to which countries in a given region or subregion may tend to be impacted by the same economic cycles at the same time. Standard & Poor 9s will continue to examine this issue case by case when analyzing asset pools with regional concentrations. Default Risk The issuer credit rating (ICR) is the fundamental tool to assess obligor credit risk in Standard & Poor 9s default models. However, due to the lack of a well-developed bond market in certain regions, such as Southeast Asia, and even in some mature European markets, unrated credits can become a substantial component of CBO/CLO asset pools. In order to assess credit risk in such collateral pools, analysts can apply alternative measures of obligor default risk, such as credit estimates, for the unrated obligors. Due to the general lack of transparency in many developing countries, it is difficult to perform accurate credit assessments due to a lack of information and different financial reporting standards. In many portfolios, there is a preponderance of small and mid-size commercial obligors whose financial profiles do not lend themselves to traditional corporate ratings analysis. In some nations where central government Global CBO/CLO Product Overview 7 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria 8 intervention historically has been mixed with open market economies, it is difficult to analyze the stand-alone credit strength of a given company. In some cases, where the number of unrated credits precludes credit estimates or rating assessments on each individual obligor, analysts can correlate a financial institution 9s internal credit scoring system with the rating scale, and develop proxies to be used in the default model. However, this approach is not feasible in situations in which the institution does not have a well-developed and validated internal scoring system. Another challenge of many emerging market portfolios is that in certain countries there may be a lack of industry diversification. In these cases, the rating inputs into the default model must be adjusted downward to account for these industrial concentrations. Recovery And Loss Severity Estimation Accurate and detailed historical data on post-default recoveries on loans and bonds for issuers in emerging market regions generally is sparse or nonexistent. Any analysis of recoveries must factor in, on a country-specific basis, the legal and practical issues involved in realizing such recoveries, and the likely impact on timing of recoveries. Currency And Interest Rate Hedging Local currency denominated CBO/CLO issuance is still not feasible in developing countries due to the lack of a deep investor market, as well as legal and regulatory issues. In the aftermath of various emerging market currency crises, currency hedge providers may not have the desire to position the risk of certain currencies, or may price their products at levels that are not economical for a CBO/CLO. While interest rate risk can often be sized and covered with internal credit enhancement, such as cash reserves or overcollateralization, the economics of this strategy may not be favorable with respect to currency risks. Legal Risk Evaluation of the legal structure of CBO/CLO transactions is done in light of applicable laws and regulations governing all aspects of the structure. Problems that typically arise relate to the legal transfer/assignment of assets from the seller/originator to the securitization vehicle; bankruptcy remoteness of the issuer or other special-purpose entities; commingling, and set-off risk. Obtaining local legal expertise is critical to evaluating the legal integrity of any CBO/CLO structure. In addition, Standard & Poor 9s has concluded that contingent transfer or perfection mechanisms cannot be relied on to rate CLO/CBO transactions higher than the issuer credit rating of the originator of the assets. Outlook Analysis of CBO and CLO securities increasingly demands a multidisciplinary approach, in which objective criteria are combined with portfolio-specific information to provide flexible solutions. Standard & Poor 9s has responded by working with CBO/CLO market participants through its offices worldwide to develop new rating approaches and analytical solutions in challenging environments. Global CBO/CLO Product Overview 9 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria The Rating Process, Asset Management, And Surveillance For CBOs/CLOs Procedures As dynamic, multivariate structures, CBOs/CLOs demand a flexible yet disciplined approach. This section provides: s An overview of the process for obtaining a transaction rating, s A general description of asset manager and seller/servicer review procedures, and s A summary of the surveillance process to maintain a transaction rating. A rating addresses the likelihood of full and timely payment of interest and principal to noteholders. Specifically, it addresses the likelihood of the first dollar of default. The objective of a structured finance rating is to assign a rating higher than that of the sponsor (asset manager or seller/servicer). Structured rating analytical criteria focus on how much credit enhancement is needed to achieve such a rating, and accompanying legal criteria focus on isolation of the assets from the credit risk of the seller. The rating process begins with a request in writing for a rating from the issuer, which can be made on its behalf by its investment banker or legal counsel. The key items necessary to facilitate the CBO/CLO rating process are the following: s Execution of a rating contract to confirm the rating(s) request and relevant terms; s Submittal of a detailed term sheet laying out the anatomy of the transaction (as further described below); s Submittal of a detailed transaction book, and presentation at a meeting to elaborate on transaction specifics as well as address any rating concerns; s An on-site meeting with the asset manager or seller/servicer to review management, investment/underwriting guidelines and operational aspects ( see sponsor/asset manager review section ); and 11 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria 12 s Submittal of complete transaction legal documentation, portfolio data, and default/ cash flow stress analyses (including detailed assumption summary for each cash flow run). The detailed term sheet is critical to launching an efficient and effective rating analysis, particularly in view of the complexity of and variations in CBO/CLO structures. It is especially important in giving the issuer feedback on material issues that may require additional analysis or criteria decisions. A term sheet should at least explain the main aspects of a CBO/CLO (see box, CBO/CLO Term Sheet Summary) . A primary analyst is assigned to each transaction. In order to analyze the main elements of the transaction 4credit, structure, cash flow and legal analysis 4the primary analyst is joined by legal counsel, and other members of the CBO/CLO analytical team as necessary. If there are material issues in the transaction that require clarifi- cation, the analyst(s) may hold meetings to resolve them and, if necessary, involve a larger body made up of senior members of the Structured Finance Ratings department. Not surprisingly, the parties to the transaction are most interested in determination of the credit enhancement level. The challenge, however, is that there are many cmoving parts d to CBOs/CLOs, and credit enhancement is sensitive to structure and collateral. In order to begin the assessment of proposed credit enhancement levels, the analyst needs two essential ingredients: portfolio data and the issuer 9s finalized transaction structure. The investment banker or issuer should send the portfolio file to the analyst, A sample term sheet laying out the anatomy of a CBO/CLO transaction is as follows: s Capital structure and requested ratings for each tranche; s cWaterfall d or priority of payments; s Proposed credit enhancement levels; s Eligible asset definition (eligible collateral and investments, including cbaskets d such as emerging market debt and other bivariate risk assets); s Portfolio parameters and collateral quality tests; s cSurrogate d ratings (e.g., correlated ratings or credit estimates); s Substitution/asset addition, reinvestment, restructuring/modification and trading criteria (including any proposed use of the CBO/CLO default model); s Ratio tests (coverage tests, maturity tests, triggers); s Ramp-up and revolving/reinvestment periods; s Amortization/redemption triggers and periods; s Interest rate/currency hedging; s Legal aspects (special-purpose entity bankruptcy remoteness, collateral transfer, etc.); and s Regulatory issues. Sample CBO/CLO Term Sheet Summary along with the results from the applicable (single-jurisdictional or multi-jurisdictional) CBO/CLO default model as a structuring model (see Evaluating Credit Risk section). After the appropriate CBO/CLO model calculates the portfolio 9s potential default frequency at the targeted rating level for the CBO/CLO, and the analyst has reviewed that calculation, it can be input into the investment banker 9s cash flow model. If the transaction structure is finalized, the cash flow analysis and credit enhancement assessment can begin. This part of the rating process is complex, involving multivariate stress runs. Although the variables to be stressed can be identified (for example, recovery levels, default scenarios, and interest rate stresses), the cdominating d stress runs to test credit enhancement cannot be easily identified a priori, and are often predicated on the results of other cash flow scenarios. In addition, if the structure evolves during the cash flow stage, the stress runs and, possibly, the proprietary cash flow model itself may need to be changed by the investment banker. The analyst should be provided with independent accountant verification of the proprietary cash flow model, its representation of the transaction structure, and the cash flow stress run results. A rating committee makes the final decision on the sufficiency of credit enhancement. After the analytical team performs its review of the issuer 9s operations and analyzes the structure (as represented in the transaction documents and cash flow analyses), a rating committee comprised of senior analysts is assembled. The primary analyst is responsible for ensuring that all pertinent information received is presented to the rating committee. The committee presentation also includes information from the sponsor review process, and covers the structural, collateral, and legal aspects, as well as default/cash flow stress and credit enhancement analysis. A rating is based on the representations of the parties to the transaction. However, documentation 4offering memorandum, private placement memorandum or prospectus 4 is usually prepared by the issuer 9s counsel before a transaction is priced. However, Standard & Poor 9s relies on the binding legal agreements to determine the likelihood that the structure will provide timely payment. The most important of these documents is the pooling and servicing agreement in a typical balance sheet CLO, and the trust indenture in a typical arbitrage CBO/CLO, including supplements. These documents should be, and usually are, drafted by the time a transaction is priced. The primary analyst ordinarily presents the structure of a transaction to a rating committee after a transaction is priced, but in any event, as soon as practicable after the team receives a draft of the binding legal documents. Once the rating committee process is complete and all open issues have been addressed, a rating letter will be issued. The Rating Process, Asset Management, And Surveillance For CBOs/CLOs 13 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria 14 Sponsor/Asset-Manager Review As part of the CBO/CLO rating process, analysts conduct a review of the asset manager or originator/servicer. The primary responsibility of the asset manager or servicer is to manage the portfolio in order to minimize losses due to the actual default or bankruptcy of the underlying obligors. Both the senior noteholders and junior or equity investors rely on the ability of the manager to identify, or the servicer to originate and maintain, creditworthy investments. CBO/CLO transactions are more sensitive to the performance of each obligor than are much larger, more homogenous traditional ABS portfolios. The asset manager 9s and servicer 9s breadth of responsibilities reflects that. Even with respect to measuring the default risk of an obligor, the asset manager or servicer must monitor credit quality changes, and facilitate annual updates by Standard & Poor 9s of csurrogate d measures such as credit estimates or correlated bank scores. Therefore, the performance of the asset manager plays a large role in the ultimate return to investors. The review covers the company 9s management and operations, past historical performance, and other factors that may impact the asset manager or servicer 9s abilities ( see box, Asset Manager And Originator/Servicer Review ). Surveillance Rating surveillance of CBO/CLO transactions is becoming increasingly important. Master trust structures with multiple series takedowns, higher asset turnover, and cross-collateralization increase the surveillance burden. The higher amounts of T he following information, modified for each transaction, should be assessed in an asset manager and originator/servicer review: Overview of the Company s Background of the company; s Organizational structure and staffing; s Financial strength; s Rated CBO/CLO history and management of multiple rated CBO/CLO transactions; s Competitive position in managing high yield bonds, bank loans, emerging markets assets and asset-backed securities; s Prior experience as servicer, manager and/or investor, including volume and history of high yield bond, bank loan, emerging market assets and asset-backed securities under management; s Number of high yield, bank loans and emerging markets funds under management; s Industries covered and not covered; s Number of credits/industries covered by each analyst (credit generalist versus industry specialists); s Ability to expand expertise to cover industries required in a diversified CBO/CLO; s Regions covered in emerging markets; s Types of asset-backed securities; s Performance results relative to peer group and indices; Asset Manager And Originator/Servicer Review The Rating Process, Asset Management, And Surveillance For CBOs/CLOs 15 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria s Experience of the company in corporate lending or managing portfolios of high yield bonds, bank loans, emerging markets debt and asset-backed securities; s Experience of staff in corporate lending or investing in and managing portfolio of high yield bonds, bank loans, emerging markets assets and asset-backed securities including experience and performance results prior to joining the company; s Similarities and differences in managing CBOs and existing funds; s Strategic objectives of the company in extending credit or managing CBO portfolios; and s Compensation arrangements for portfolio managers/servicers. Underwriting/Investment Strategy And Objectives s Credit and approval policy; s Underwriting guidelines; s Investment strategy (credit versus yield); s Investment style (buy and hold versus high turnover); s Decision-making, selection and approval process for buy/sell/trade/lend decisions; s Breakdown of loan book (bilateral vs. syndicated loans; agent bank role) and transaction book; s Research methodology and capabilities; s Sample credit and research reports; s Credit processes; s Presence of any subservicers on any of the lender 9s portfolio or sub-advisors on any of the company 9s managed funds; s Depth and breadth of research; s Audit status of the company 9s financial state- ments, and if audited, whether auditors issue any report on internal control; s Hedging Strategy for interest rate and currency risks (Asset-specific vs. aggregate portfolio); s Pricing sources; and s Policies and procedures regarding securities valuation, segregation of duties, etc. Servicing And Credit Monitoring Capabilities s Procedures in place to service, administer and monitor the CBO/CLO securitization, and to ensure compliance with the CBO/CLO transaction documents; s Identification of who performs the above servicing, administration, monitoring and compliance functions, along with whether they are contracted solely to the trustee or third party servicer, or are they jointly performed by the CBO/CLO sponsor (issuer asset manager or originator/servicer); s Portfolio administration and report generation (credit/underwriting package and surveillance); s Frequency and scope of credit review; s Frequency of credit reviews for determining credit deterioration, improvement, change in risk standing or increase of credit line; s Handling collection and disbursements; s Managing Revolving Credit Facilities And Liquidity; s Handling delinquencies (forbearance vs. write-off, loan modification and restructuring); s Handling problem credits (Disposition: workouts vs. secondary market sale history); s Handling ccredit risk securities d and defaulted assets (liquidation strategy: transfer of assets to a workout specialist or ccradle to grave d philosophy); s Historical portfolio performance (delinquencies/ defaults/recoveries/timing); s Systems and back-up capabilities; s Conversion problems: actions and contingency plans; and s Conversion problems for service providers such as trustee, etc. Asset Manager And Originator/Servicer Review (continued) 16 unrated assets in collateral pools also necessitate more frequent surveillance. Portfolio turnover and trading, particularly in actively managed transactions, also demand close surveillance. Additionally, the participation of credit enhancement providers, such as bond insurers, or other parties providing support to these structured transactions, represent cdependent ratings d whose credit rating may impact the CBO/CLO rating. In general, Standard & Poor 9s reviews the rating it has assigned to determine whether the rating continues to reflect the likelihood of timely payment of interest and principal to investors. Analysts review and monitor various aspects of the transaction, including portfolio credit risk, coverage test results, and cash flow stress results ( see box, Basic CBO/CLO Surveillance Information ). Each category of transaction data should provide a very detailed snapshot of performance at the appropriate CBO/CLO rating category. The first item is the collateral portfolio itself, separate from downgraded, delinquent, or defaulted assets (which must be separately reported in detail). Current portfolio data should include three main categories of information: individual collateral securities; portfolio composition by relevant parameters and asset categories; and all portfolio transactions since the last reporting date. First, a complete schedule of individual collateral securities should include at least the following data: s Issuer, s Par amount, s Interest rate (if floating rate, index and spread), s Maturity date, s Amortization schedules, s Industry classification by Standard & Poor 9s suggested categories, and s Issuer credit rating by Standard & Poor 9s, or csurrogate d assessment. Surrogate assessments, such as credit estimates or cshadow ratings d, should be noted in the report. In addition, the trustee or servicer should indicate in the report when the credit estimates are due for annual surveillance, and should provide Standard & Poor 9s updated financial information on each credit. Second, a complete disaggregation of the portfolio should include a breakdown by relevant parameters and asset categories, such as the following: s Issuer concentrations; s Industry concentrations; s Regional concentrations; s Country concentrations; s Rating distribution; s Zero coupon or assets paying less frequently than liabilities; s Baskets: bivariate risk assets (credit derivatives, participations, emerging market debt) structured finance securities (ABS), other (unrated or 8CCC 9 or lower rated assets), etc.; s Maturity buckets; s Fixed interest rate versus floating interest rate collateral; s Bonds versus loans; s Senior secured, senior unsecured and subordinated classes; and s Term versus revolving debt or loans (for revolvers, utilization or funding rates). In addition to the collateral portfolio, all other assets, support agreements, counterparty arrangements, and forms of credit enhancement should be reported in detail. For example, account and reserve inflows, outflows, balances, and investment of same in highly rated eligible investments should be reported, and draws on a support agreement quantified. Third, all portfolio transactions since the last reporting date should be reported. Designated assets to be traded, such as ccredit risk d or ccredit improved d securities, asset sales, purchases, or additions should all be identified. Analysts rely on the servicing report for necessary surveillance information. The frequency of servicing reports depends on transaction-specific parameters (for example, the absence or presence of trading restrictions, ramp-up period, and increasing or decreasing credit/liquidity support). Critical transaction dates, which should be flagged in all reports, are the end of the ramp-period, at which time the rating may be affirmed, and the end of the revolving period. In balance sheet transactions, whether the vehicle is a discrete trust or a master trust, regular reporting is important, given the heterogeneity of the assets. In general, the servicer should run the CBO/CLO model at least quarterly during the life of the transaction, and report those results to the Surveillance Group. If there has already been an asset addition during the calendar quarter and the addition was reviewed by Standard & Poor 9s, then the quarterly reporting condition is considered met. If a bank has correlated its own risk grade system to Standard & Poor 9s rating scale, this correlation should be refreshed annually. Under most circumstances, a monthly or quarterly reporting cycle is appropriate. The Rating Process, Asset Management, And Surveillance For CBOs/CLOs 17 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria T he following basic transaction data will be requested as part of the rating review process: s Current portfolio data, s Defaulted asset information, s Portfolio composition changes , s Current obligor ratings or csurrogate d assigned for unrated assets, s Mapping matrix between internal bank and Standard & Poor 9s ratings, s Updated transaction cash flows, s Trigger events, s Coverage tests, and s Default model results. Basic CBO/CLO Surveillance Information 18 In addition to the periodic performance reports, portfolio and transaction performance data will be reviewed. Analysts also request and review new cash flow runs reflecting current portfolio CBO/CLO default model results as input for default frequency, with other portfolio and transaction parameters set at then current levels. Analysts may also request additional information on an ad hoc basis, based on performance data or on developments in the transaction. Generally, the servicer, trustee or investment banker should provide additional information in the following situations: s Provision of all necessary information in order for Standard & Poor 9s to affirm in writing that any proposed changes that should satisfy the crating agency condition d (often called cRAC events d) do not have an adverse impact on the ratings on the CBO/CLO liabilities; s Prompt notification of any transaction amendments 4even if they are not specifically cRAC d events 4or any change in the parties to the transaction, for example, replacement of the collateral manager, loan servicer or trustee; s Prompt notification if the transaction fails certain tests, such as coverage ratios or applicable CBO/CLO model thresholds (for example, the scenario loss rate for the portfolio transaction exceeds the break-even loss rate for the rating of the transaction); s Provision of changes to a bank 9s internal scoring system (for example, due to a merger or a risk management policy revision) that occur between annual updates, and of a revised mapping or correlation matrix; s Additional independent testing and agreed-upon procedures before and after the closing of the transaction; and s Additional transaction cash flow runs if CBO/CLO model thresholds are breached, the cash flow characteristics of the assets change from those assumed in the original cash flow runs, or transaction data show potential deterioration in the portfolio credit risk profile or in the level of credit enhancement. Asset cash flows could change, for example, due to asset additions, portfolio com- position differences from closing assumptions (for example, if the ratio of fixed vs. floating assets with a certain index changes csubstantially d), or appointment of a replacement manager replacement with a new fee arrangement. Portfolio credit quality could change or available credit enhancement could be depleted from high or spiking default experience in a short time period, or from substantial concentration shifts or increased clumpiness d in the pool. Standard & Poor 9s should be informed promptly of any changes concerning the original parameters of the transaction including management, investment policies, system changes, or any change that may materially affect the transaction. Evaluating Credit Risk For CBO/CLO Transactions T he approach to rating CBOs and CLOs is similar to that of rating other structured transactions. The three main areas of CBO/CLO rating analysis are described in this section: s The credit analysis of the asset pool, alternative forms of credit enhancement, appropriate credit enhancement level for the desired transaction rating, and cash flow analysis; s The analysis of the risks related to the transaction structure, collateral, and management considerations; and s The legal analysis of the transaction. The rated structured securities usually are issued by a special-purpose entity (SPE). Determining Credit Enhancement Obligor credit risk in the asset portfolio is at the heart of all cash flow CBO and CLO transactions. The credit risk of the portfolio is evaluated based on several factors, including the credit quality of each obligor, tenor of each underlying asset, obligor concentration, industry concentration, as well as the adequacy of the credit enhancement. Default frequency or probability can be defined as the likelihood that a loan or debt instrument of a particular obligor will default. To determine default frequency or probability, several alternative measures of obligor credit risk can be used. If Standard & Poor 9s has assigned an issuer credit rating (or ICR, sometimes called the ccorporate d or ccounterparty credit rating d), then that rating will be used. In the absence of an issuer credit rating, the default probability may be estimated in several ways. Loss severity can be defined as the expected loss upon default after factoring in or netting any recovery proceeds on the defaulted asset. To determine loss severity, analysts primarily use the ranking of the debt in an insolvency and the existence of collateral, if any, to estimate recovery levels and resulting loss severity. Each pool, however, 19 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria 20 contains unique credit risks arising from the specific obligor and industry risks that may vary the analysis (see Recovery And Loss Severity Assumptions). A transaction may also involve swaps, and/or other hedging or support arrangements. If so, the credit risk of the swap counterparty or support provider also is taken into account, generally as a linked or dependent rating high enough to support the CBO/CLO 9s seniormost rating (see Interest Rate And Currency Risks). Alternative Credit Risk Measures Many banks worldwide have realized that they can significantly improve their returns and their regulatory reserve status by selling off large portions of their loan portfolios to SPEs and concentrating on loan origination and servicing. The securitization of these loans in CLOs uses the familiar techniques of CBOs. A great deal of innovation has taken place to accommodate differences in individual bank portfolios and differences in banking systems. The distinguishing feature of this type of CLO is the limited information about the specific assets (the individual loans) that are sold into the issuing vehicle. In some instances, the identity of the individual borrowers is not disclosed. Generally, the reason is either for client confidentiality that the lender must conform to secrecy laws, which apply in several countries outside the U.S., or based on logistical constraints, such as the portfolio 9s inclusion of many hundreds of names. In addition, the lender may be concerned with client sensitivity to having its loan sold into a securitization vehicle and its cbanker relationship d disrupted. Unlike credit card or home mortgage receivables, corporate loans are not sufficiently homogenous to be analyzed as a pool. Nonetheless, rating techniques have been developed that enable transactions to be analyzed without a full rating of each asset in the securitized portfolio. These techniques can be applied to bonds in CBOs and loans in CLOs alike. Standard & Poor 9s, working with banks, has developed several options to allow a bank 9s loans to be assessed for securitization. The following is a brief description of six different methodologies used to quantify a portfolio 9s credit risk. The approaches are discussed in descending order in terms of analytical knowledge of the assets being sold. In a given transaction, there can be a combination of methods applied to different pieces of the portfolio. Ratings On Each Obligor. The rating on each loan obligor is considered. In the U.S., for example, many bank loan obligors are corporations already rated by Standard & Poor 9s. The level of credit quality of the obligor is expressed as an ICR, rather than a rating on a specific debt issue. The assigned ICR should be used as the measure of that obligor 9s creditworthiness, instead of the debt-specific senior secured rating or subordinated rating. The issuer credit rating is the functional rating for the default and rating transition studies that underlie the calculations used in the CBO/CLO models for estimating cumulative default rates in CLO portfolios and requisite credit support levels. Often the bank is lending to a parent or subsidiary of a rated entity. If there is no unconditional guarantee, the rating of the parent cannot automatically be transferred to the affiliate. But, in some cases, with additional analysis, the affiliate rating evaluation can be based on the rating of the entity that has already been done. The bank loan itself may be rated. Standard & Poor 9s rates a substantial number of syndicated bank loans. Loan ratings take into account the superior recovery potential of well-secured loans. This can benefit the securitization in terms of assessing the recovery levels associated with defaulted loans. To the extent analysts have assessed an individual loan to have superior recovery characteristics, they would assign the higher end of the recovery level range for secured and unsecured loans (see table 1, Recovery Range Assumptions). The issuer credit rating would still be used as the measure of the obligor 9s default risk. If the structure allows for addition and replacement of loans, the new loans must have similar recovery characteristics, that is, if the recovery assumption for the CLO had been enhanced due to the presence of rated loans. If a bank wants to include a portion of unrated loans in a portfolio in which most loans are rated, a basket can be carved out for these. Public Information Ratings And Credit Estimates. In the absence of issuer credit ratings, Standard & Poor 9s may still provide analytic products or use its own resources to assess the loans in the portfolio. In some countries, public information ( 8pi 9) ratings are assigned, which may rely entirely on publicly available information. These are always identified with the 8pi 9 subscript, and do not have the plus/minus refinements within rating categories. Alternatively, in most countries, rating or credit estimates, commonly referred to as cshadow ratings, d can be provided. Based on essential data about the operations Evaluating Credit Risk For CBO/CLO Transactions 21 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria Table 1 Recovery Range Assumptions As A Percent Of Default Amount* Loans Recovery range assumptions (%) Recovery Timing Senior secured bank loans 50 to 60 2-3 years after default Senior unsecured bank loans 25 to 50 2-3 years after default Subordinated loans 15 to 28 2-3 years after default Bonds Senior secured bonds 40 to 55 1 year after default Senior unsecured bonds 25 to 44 1 year after default Subordinated bonds 15 to 28 1 year after default *Using the example from table 5, the default amount is assumed to equal $100 million in collateral. If all collateral consisted of senior secured bonds, then the assumed total recovery amount could range from $40 million to $55 million, depending on the recovery ti me period and sponsor workout history. 22 and finances of the borrower, which the bank could provide, the analyst would estimate what ratings would likely result if the entire rating process were carried out. The assignment of credit estimates is a very abbreviated process. While a credit estimate is not the equivalent of a rating, the estimate can be used appropriately in the context of assessing a commercial loan portfolio. An annual update is necessary as long as that obligor remains in the securitized portfolio. It may be possible to assign an estimate on a no-name basis. However, if the specific name is not known, analysts would probably be more conservative, which could be reflected in a lower estimate. Ratings From Other Nationally Recognized Statistical Rating Organizations (NRSROs). If ratings from other rating agencies 4specifically NRSROs designated by the U.S. Securities and Exchange Commission 4are available, they may be able to be used. However, Standard & Poor 9s distinguishes among rating agencies and rating products, based on its own knowledge and perception of the standards of other rating agencies. Those with similar standards are accepted in certain cases with a small reduction of one or two notches. Rating or credit estimates, or public information ratings of other rating agencies, generally receive a significant adjustment downward. It is not clear what the standards of due diligence are with respect to such ratings. Since some rating agencies assign unsolicited ratings without disclosing the distinction from ratings requested by the obligor, it may be hard to discern if a rating is based only on public information. Nonetheless, analysts would ordinarily be aware of such situations. Quantitative Models. Quantitative models have been available for many years, are widely in use, and can be deployed to assess obligor default risk. Applications and extensions to default estimation models employ regression analysis, discriminant analysis, or neural networks. Quantitative model output should be correlated with the Standard & Poor 9s ratings scale. Generally, the correlations of these models with Standard & Poor 9s ratings, plus or minus two rating notches, range from 65%-80%, depending on the quality of the model and the breadth of application to various industries. For portfolio assessments, the rating analyst is prepared to accept the output of these models with an appropriate downward adjustment. Correlation with ratings for the specific model must be established, which is not an insignificant task. At that point, a discount to reflect the extent of the correlation and the comfort with the model can be calculated. Bank Internal Credit Scoring Systems. Most banks have a credit scoring or rating system that reflects a combination of ratio evaluation and qualitative assessment. If a bank wants rating analysts to rely on that bank 9s own credit scoring, as opposed to assessing each obligor name, then its internal credit scoring system may be cmapped d or correlated to equivalent ratings. The process of determining the cmapping d requires a team of corporate and bank analysts endeavoring to learn, in depth, the bank 9s credit underwriting capabilities. This involves understanding the resources, organization, and processes used. A team of corporate and bank analysts reviews the depth of credit reviews and the extent of surveillance. The team aims to determine the selectivity of the process in terms of rejection rates at the various approval stages. Random sampling of credit files helps to provide a sense of how stated policies are implemented. However, this review in and of itself is insufficient to gauge the credit quality of the portfolio. A cmapping d exercise is conducted to establish correlation between the bank 9s credit assessments and those of Standard & Poor 9s. In general, a statistically significant random sample of corporate borrowers who have both a bank rating and an ICR is examined, and the bank 9s ratings are compared with Standard & Poor 9s ratings or credit estimates. This exercise can be used to compute rating equivalents at various confidence levels. As the percentage of the portfolio that relies on this method increases, so does the level of conservatism introduced into the calculation. If a bank simply employs NRSRO public ratings, in lieu of independent credit scoring, the mapping exercise would be meaningless. But the very existence of public ratings on the borrower could also bias the bank 9s credit evaluation. Accordingly, the bank must demonstrate that its judgment is independent. In the end, evaluation through multiple economic cycles indicates the consistency and robustness of the bank 9s scoring system. The result of the mapping exercise allows analysts to rely on the bank 9s internal assessments. Furthermore, there may be no need to even identify the specific loans that are being sold into the securitization, but merely the bank 9s rating for the particular asset, its size, and its tenor. However, this assessment usually would apply only to the type of loan and only to the office or country that was involved in the exercise, and could not be transferred to the bank 9s other units. Indeed, it might be difficult to perform the necessary sampling and mapping exercise for portfolios that include middle-market loans or loans to borrowers in countries where there was an insufficient universe of ratings to form a reliable comparison. If the bank 9s internal credit scoring system is relied upon in the CLO, the cmapping d exercise must be repeated at least annually to monitor the consistency of the bank 9s credit scoring or rating system over the life of the securitization (see Appendix A, cMapping Bank Loan Scoring Models to Standard & Poor 9s Ratings in CBO/CLO Transactions d) . Bank Track Record. Some issuers have proposed relying on extrapolation from the sponsoring bank 9s historical record for loan losses and charge-offs. Some have dubbed this the cactuarial method. d However, this analytical approach raises certain issues in its application to relatively heterogeneous assets such as corporate loans. Typically, the record for the bank 9s portfolio in its current configuration does not extend over a long enough time span. Accordingly, this track record may not cover Evaluating Credit Risk For CBO/CLO Transactions 23 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria 24 any serious stress period, and may be misleadingly benign. In addition, the bank 9s overall results may not be representative of its experience with the subportfolios that will be securitized. Moreover, banks have demonstrated great flexibility and creativity regarding the recognition of loan quality problems. For example, a bank may avoid classifying a loan by practicing forbearance 4extending additional credit that allows the borrower to remain current. Apart from the difficulties this poses for getting an accurate view of the past, the presumption is that the bank would be less inclined in the future to bail out or rescue borrowers whose loans have been sold into the securitization. Finally, the rating on the securitization would inevitably be closely linked to the bank 9s rating on an ongoing basis. Nonetheless, the potential for rating a transaction on this basis has not been ruled out. However, several important conditions must be met with respect to the applicable loan book and securitized portfolio, in terms of size and diversification, uniformity, and historical performance data . Specifically, the conditions that must be met include: s The number of individual obligors in the pool exceeds 500, and no single obligor accounts for more than 1% of the pool balance. s The pool is meaningfully diversified, and the bank demonstrates that the pool is fully representative of the loan book csubportfolio d that is analyzed. In order to avoid the potential for adverse selection, the pool would likely have to include all of the bank 9s loans of a certain type, or a random share of those loans. s The loan characteristics of the portfolio are relatively uniform in terms of amount, tenor, amortization, pricing, collateral security, and covenants. s The institution provides accurate, detailed, and extensive historical information that demonstrates a long track record for its specific line of business. This information includes monthly and annualized delinquency, default, recovery, and charge-off amounts and rates. Similar information would be needed for payment, purchase, and draw rates. Static pool analysis that tracks credit performance and payment history for specific loan pools by date of origination is strongly preferred. The data must be detailed enough to show the differences, if any, between the amount of loans that were nonperforming versus the amounts actually charged off. s The number of years of history provided is sufficient to demonstrate the credit and payment performance of the portfolio through different economic cycles, and that history spans a time period (or periods) of stress for each particular loan or asset type and its market. The bank 9s loss performance for the loan type covers an extended period, and includes at least one serious stress period for the particular asset class and market sector. As a result, historical data requirements on the performance of particular loan or asset types will be case-specific. In general, analysts rely on information on the bank 9s historical loss experience for a minimum of ten years, and for a number of years sufficient to demonstrate the performance of the portfolio through a full economic cycle of the bank 9s gross provisioning, releases and actual write-offs. A detailed account of any relevant losses suffered by the bank on its corporate loans in the last five years should also be provided. s Historical information on the specific loan type is disaggregated and categorized in a meaningful way for risk analysis, at least in terms of industry, size, and risk classification. The extensive performance, delinquency, and loss data mentioned above should be similarly disaggregated for risk analytical purposes. s Management has applied transparent and consistent underwriting standards and write-off policies throughout the period(s) being analyzed. The impact of bulk asset sales and acquisitions on the historical performance data, as well as cbailout d practices that might obscure the numbers, can be ascertained. s There are no fundamental changes occurring in the environment that might adversely affect the willingness or ability of financial institutions to service the loans in the same manner as they have in the past. It has been difficult for sponsoring banks to meet the extensive information standards necessary to implement the actuarial approach with a high degree of confidence. To date, most loan portfolios securitized have been relatively heterogeneous and small in size, and typically contain some large obligor concentrations. Some institutions are not able to provide more than five years of detailed historical portfolio performance data. In general, the information management systems most institutions have in place to capture portfolio performance data have not been designed with securitization in mind. If an institution is able to meet these conditions, however, it is not clear that an actuarial approach will yield a lower default rate versus the obligor-specific approach used in the CBO/CLO default model. The combination of an asset portfolio 9s characteristics, applicable historical data limitations, and actual historical performance could well result in a higher default rate and credit support level under the actuarial approach. When an actuarial approach is used in rating a CLO, the historical loss experience of the institution is an important consideration. In addition, securitized portfolio and structural strengths will be important complements to the underwriting and credit policy factors in the CLO rating. Examples include short tenor asset portfolios, as there is a lower probability that losses will arise in such a short time, or the provision of liquidity facilities or advance mechanisms. In the end, however, it is important to note that should there be a change in the bank 9s underlying underwriting or credit management policies, this could have an impact on the potential loss level and CLO rating. Given the complexity of actuarial analysis, the scarcity of requisite data, and the nature of bond/loan assets, analysts will generally apply the actuarial approach in conjunction with the more traditional obligor-specific approach. Evaluating Credit Risk For CBO/CLO Transactions 25 Standard & Poor 9s Structured Finance s Global CBO/CLO Criteria 26 Assets of obligors that cannot be evaluated under the six methodologies outlined above may be treated as 8CCC- 9 assets. This simplifying assumption can work in portfolios with a very small portion of such assets, although it can quickly become prohibitively expensive. Apart from the six main methodologies, there will always be unique situations that analysts will evaluate on their particular merits. Sizing Default Risks And Credit Enhancement Levels Analysts use various techniques to determine the potential loss characteristics of an asset pool in a structured financing. The analytical method may vary, depending on the size of the pool being examined. For example, the cweak link d approach, which assumes the default of all assets rated lower than the structured financing, is often employed when the asset pool is comprised of a small number of credits. By contrast, an actuarial approach may be appropriate for extremely large asset pools that have relatively homogenous performance characteristics. Tradit

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