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SPECIAL REPORTDuff & Phelps Credit Rating Co.
DCRCHICAGO
u
NEW YORKu
LONDONu
HONG KONG
International
DCRs Approach to RatingExisting Trade Receivables
Transactions
in Emerging Markets
April 1999
EXECUTIVE SUMMARY
xisting trade receivables securitization hasevolved over the
last few years. Althougha reasonably mature product in the
devel-
oped markets of the United States and Europe, itis still in the
developmental stage in theemerging markets. Nonetheless, trade
receivablessecuritization can provide an attractive fundingavenue
to the cash-strapped emerging market is-suers. Unlike future-flow
securitization, the reli-ance is on the existing assets and not on
future, yet-to-be-generated assets in existing trade
receivablessecuritization. Therefore, the rating is not
inextri-cably linked to the originator’s performance,thereby
providing a fundraising route for those is-suers whose credit
quality constrains them fromusing the future-flow securitization
route. Tradereceivables securitization can enable access to
in-vestment-grade funding even if the corporate doesnot have an
investment-grade rating.
This report details DCR’s approach to rating
single-seller trade receivables securitization,based on its
well-established framework for rat-ing such transactions in
developed markets andfor adopting the methodology to its
experiencesand exposures to such transactions in emergingmarkets.
DCR does acknowledge that each tradereceivables securitization is
unique in its own re-spect and that the methodology may require
cer-tain adjustments depending on the specifics ofeach transaction.
However, DCR perceives thatthe following general approach can be
used as aguideline for all transactions.
As in virtually all of its rating methodologies,DCR considers
both qualitative and quantitativefactors in its approach. In
addition to the review ofseller/servicer and underlying
collateral/obligorcharacteristics, DCR analyzes the legal,
structuraland sovereign issues in determining the requiredcredit
enhancement and rating of a trade receiv-ables transaction.
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Duff & Phelps Credit Rating Co. DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
StructureIn a typical trade receivables transaction,
the existing trade receivables of the origina-tor are assigned
to a special-purpose vehicle(SPV), which issues securities backed
by suchassigned receivables. As the trade receiv-ables are of a
short-term nature, the typicalpaydown of the underlying assigned
receiv-ables should be approximately one to sixmonths (exact
paydown period will dependon the payment terms). However, the
tradereceivables securitization may be structuredto last as long as
two to five years—possiblylonger—through use of a revolving
period.In the revolving period, the collections re-ceived from the
receivables are used to payinterest only to the investors and the
bal-ance is used to repurchase new receivables.
The revolving of short-term assets allowsissuers to use
securitization as part of a long-term funding strategy and allows
trade re-ceivables securities to meet investors tar-geted
maturities. A long revolving periodalso implies assessing the
sustainability ofnew receivables generation capacity of
theoriginator. However, the same is not a con-straint to the
rating, as nongeneration of newreceivables should trigger early
amortizationand, therefore, should initiate paydown
pre-maturely.
The principal amortization can be in theform of uncontrolled
amortization or con-trolled amortization. In the case of
uncon-trolled amortization, all collections are usedfor allocation
toward the interest and princi-pal repayments, and the purchase of
new re-ceivables is ceased. The principal amortiza-tion period is
structured with a sufficientcushion from the normal paydown of
theunderlying receivables (i.e., if the receivablesgenerally pay
down in four months, the
principal amortization period is set at eightmonths to account
for a stressed collectionsscenario). Controlled amortization
involvesa specified schedule of principal paymentsand the purchase
of new receivables not fullyceased. Excess collections, after
paying inter-est and scheduled principal, are partially re-invested
to purchase new receivables. How-ever, the underlying collateral
requirementis usually higher in the case of controlled
am-ortization.
The principal amortization can commenceearlier on, triggering an
early amortizationevent. The early amortization events can
besegregated into performance-based triggerssuch as an increase in
the defaults, delinquen-cies, a change in payment terms and
nonper-formance-based triggers (i.e., bankruptcy oforiginator,
cross default by the originator,commencement of legal proceeding
againstthe originator, etc). Fewer performance-basedtriggers are
needed if a dynamic reserve is in-corporated as credit enhancement
(detailedlater in the section titled “Credit Enhance-ment”). This
also reduces the prepayment riskfor investors who are averse to
early amorti-zation events.
The receivables pool balance may vary overtime because the
collections and new receiv-ables generation are generally not
uniform. Forexample, a seller may generate $10 million innew
receivables, but the receivables collectedare only $6 million in a
specified period. In thiscase, the SPV purchases new receivables of
$6million from the collections account and makeup the difference
with $4 million of seller notesto the seller or issues of variable
funding certifi-cates. The seller notes and variable funding
cer-tificates are not legally subordinated to the in-vestor class,
although they can be structured assubordinated. The fluctuations in
the receiv-
Existing Trade Receivables Versus Future-Flow Trade
Receivables1. In the case of existing trade receivables, the
reliance is on existing receivables that are already generated,
whereas in the case of future-flow receivables, the reliance is
on future, yet-to-be-generated receivables.
2. In existing trade receivables, the transaction rating is not
linked to the underlying corporate’s performance rating.Rating is
decoupled from the originator’s rating, and the underlying
receivables characteristics and performancedetermine the
transaction rating. The transaction rating can be several notches
higher than the originator’s LCrating. In a future-flow
transaction, the transaction rating is strongly tied to the
originator’s performance and istypically constrained by the
corporate’s LC rating.
3.The receivables must be of a minimum critical level to justify
an existing trade receivables transaction.For example, a US$50
million existing trade receivables transaction would require
existing receivablesof at least the same amount and typically
higher (number depends on the rating level and creditenhancement
requirement). The originator should also be in a position to
maintain the same level ofreceivables on a continuous basis in the
future to support the transaction; otherwise the transactioncould
pay down. In a future-flow transaction, there is no such
requirement of a minimum level ofreceivables. However, typically
the annual exports to principal issuance should be approximately
0.75to 1.00, depending on the risks and mitigants of that
particular transaction.
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Duff & Phelps Credit Rating Co.DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
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ables pool balances are absorbed by such selleror variable
funding certificates. Many trade re-ceivables transactions are
structured as mastertrust, providing flexibility to convert or
substi-tute seller certificates (held by originator) intonew
investor certificates, provided reserve re-quirements and rating
agencies’ conditions aremet.
It is important that the receivables poolbalance is maintained
at a certain minimumlevel. One way to ensure a minimum level
ofreceivables is the collateral sufficiency test.That is the
aggregate receivables less re-quired credit enhancement need to be
greaterthan the investor principal outstanding. Thistrigger is
important because if collections de-cline or dilutions or losses
increase, a collat-eral shortfall may occur. If there is
insufficientcollateral, this trigger traps collections in anexcess
funding account until such time as thecollateral is sufficient, or
if the deficiency con-tinues without the cure for a specified
pe-riod, the deal winds down.
Onshore VersusOffshore Trade Receivables
There are two main classifications of tradereceivables
securitization: onshore trade re-ceivables securitization and
offshore trade re-ceivables securitization.
Onshore Trade ReceivablesIn the case of an onshore trade
receivable
securitization, the receivables are generatedin a single country
and are typically denomi-nated in local currency. These receivables
arethen assigned to a domestic or overseas SPV.The funding can be
raised in local currency
(LC) in the concerned country or in foreign cur-rency (FC) in
the overseas markets. The trans-action rating of domestically
raised fundswould be constrained by the sovereign LC rat-ing
(although not necessarily capped), as theonshore receivables are
severely impacted bysovereign macroeconomic conditions and le-gal
constraints, and will reflect the paymentability of the transaction
in the local currency.
Onshore trade receivables in which fund-ing is raised overseas
in FC are subject to ex-change rate, convertibility/transfer risks
andsovereign macroeconomic risks. DCR be-lieves that ratings of
such onshore transac-tions could be constrained by both the
sover-eign FC and LC rating. The sovereign FC ceil-ing can be
exceeded by incorporating aproper cross currency swap covering
ex-change rate and convertibility/transfer risks.In such a swap the
payments in domestic cur-rency are made to an onshore branch of
swapcounterparty whose corresponding offshorebranch agrees to remit
the payment in dollarsabroad.
However, DCR also believes that eventhough the FC ceiling is
pierced with a propercross currency swap, the LC ceiling will,
inmost cases, constrain the transaction rating(although not
necessarily cap it), as the under-lying collateral (domestic
receivables) cannotbe completely insulated from the domestic
eco-nomic, political and the legal environment ofthe concerned
country.
DCR perceives that the onshore trade re-ceivables performance
would be significantlyimpacted by severe macroeconomic condi-tions
such as high inflation and real interestrates, plunging real
incomes, severe recession
Linkage of Trade Receivables Secutitization to Sovereign
Ceilings
Sovereign FC Ceiling Sovereign LC CeilingOnshore trade
receivables, Not applicableOnshore funding(LC obligations backed by
Constrained by sovereign LC rating;LC receivables) difficult to
breach, although possible to
exceed depending on the degree ofinfluence the macroeconomic and
legalenvironment the sovereign has on thetransaction
performance
Onshore trade receivables, Breached if properOffshore funding
cross currency(FC obligations backed by swap is existentLC
receivables)
Offshore trade receivables Automatically breaches Breached, as
offshore generation ofOffshore funding FC ceiling as receivables
receivables and offshore obligors(FC obligations backed by are
generated offshore isolate sovereign risk to a large extentFC
receivables)
Transaction rating capped at certain notches above sovereign
FC,depending on transaction specifics, as sovereign interference
andexpropriation risk cannot be fully ruled out
Table 1
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Duff & Phelps Credit Rating Co. DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
or political and social disturbances. For ex-ample, if country X
is rated ‘BB+’ on FC and‘BBB+’ on LC, then DCR believes that an
exist-ing trade receivables transaction in country Xshould not be
rated much higher than ‘BBB+’(this is assuming the credit
enhancement, col-lateral characteristics, legal issues,
swapmechanism and other transaction features arein conformity with
the level of rating). How-ever, it would be difficult to define a
set bench-mark for the rating level cap, as the influenceof the
sovereign LC rating on potential perfor-mance of the asset-backed
transaction willvary across sovereigns and time periods. De-spite
the LC sovereign rating constraining thetransaction rating, it
still enables anoninvestment-grade originator on an LC ba-sis to
achieve an investment-grade transactionrating.
Offshore Trade ReceivablesIn offshore transactions, the
receivables
are basically export receivables denomi-nated in hard currencies
that are generatedoffshore, such as the U.S. dollar. These
receiv-ables automatically provide a natural hedgeagainst the
exchange rate, convertibility andtransfer risks and, therefore, are
not con-strained by the FC ceiling of the country.Also, as the
receivables are generated off-shore and obligors are in other
countries,these receivables are also, to a large extent,isolated
(although not completely) from themacroeconomic and legal risks of
the origi-nating country, enabling the transactionrating to be
higher than the LC sovereignceiling.
Nonetheless, DCR perceives that the
Diagram 1Onshore Trade Receivables Securitization
Funding Raised Overseas in FC(With Cross Currency Swap)
Ons
hore
SPVP&I Payments
INVESTORS
ORIGINATOR CUSTOMERS LOC IssuingBank
LOC NegotiatingBank
Assignment/Sale of
Receivables
ExcessPayments(PurchaseNewReceivables)
Swap Counterparty— offshore
Payments (Domestic Currency)Swap Counterparty— onshore
US$Payments
Sale ofGoods
Payments Payments
PaymentsDomestic Currency
Inter-Companyflows
Ons
hore
Ons
hore
INVESTORSINVESTORS
Payments
ORIGINATOR
CUSTOMERS
SPV
LOC IssuingBank
LOC NegotiatingBank
Saleof
Goods Sale ofReceivables
Excess Payments(Purchase New Receivables)
Payments
P&I Payments
Payments Payments
Ons
hore
Diagram 2Offshore Trade Receivables Securitization
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Duff & Phelps Credit Rating Co.DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
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transaction is still subject to a certain degreeof sovereign
expropriation and interferencerisk. Certain agreements under the
transac-tion, such as the sale/assignment of receiv-ables agreement
(or sale of goods agree-ment) between the originator and the
over-seas SPV, are likely to be governed underdomestic laws. This
provides leeway to thesovereign to take some drastic actions un-der
the color of law to expropriate receiv-ables in an extreme economic
stress situa-tion. DCR will, therefore, cap the transactionrating
at a certain level above the sovereignFC rating, depending on
transaction andsovereign specifics.
The typical onshore and offshore trade re-ceivables structures
are shown on the facingpage.
Other Structural IssuesBesides assignment of receivables
directly
to the SPV, some trade receivables structuresalso incorporate
the sale of goods to an inter-mediary that, in turn, assigns the
receivables tothe SPV. A common reason for having an in-termediary
is to bypass certain tax and regu-latory issues in certain
countries. Sale of re-ceivables directly to an SPV could
attractvalue-added tax and could require obtainingapproval from
regulatory authorities. By hav-ing an intermediary SPV between the
goodsthat are sold (instead of assigning receivables),the
aforementioned tax and regulatory issuesare avoided. This
intermediary, in turn, as-signs the receivables, and such
assignmentdoes not fall under the regulatory laws of theoriginating
country.
Another advantage that can be obtained ifthe intermediary can be
structured as a typicalbankruptcy-remote SPV, with its underlying
as-sets “ring fenced” against the competing claimsof all its
creditors (including the originator sell-ing goods to the
intermediary SPV), is to preventredirection and co-mingling risks.
This interme-diary SPV assigns all the receivables to a trust ora
new SPV. However, as the payment flow in atrade receivables
transaction is quite complex,involving a large number of customers
whouse different modes of payments—letter ofcredit (LOCs),
documents against payment(DPs), documents against acceptance
(DAs),etc.—there is a possibility that some paymentsmay flow back
to the intermediary rather thanto the new SPV or trust, to which
the receiv-ables are assigned. This may occur notwith-standing the
existence of notices and acknowl-edgments (as explained in the
section titled“Legal Considerations”) to obligors with
in-structions to pay directly into a separate ac-count under the
sole domain of the trustee forthe benefit of investors. In this
case, as the in-termediary SPV is a “ring fenced” SPV and
controlled by the trustee, such receivable col-lections can be
structured to be claimed backby the trust, mitigating
redirection/co-min-gling risks.
The SPV or the trust to which the receiv-ables are assigned
(either by the originator di-rectly or through an intermediary SPV)
mustset up a separate collection account to which allthe payments
are directed. Funds held in suchan account should not be subject to
entrapmentin the bankruptcy estate of the originator. Forthis it is
necessary that all the payee obligorshave been given instructions
to pay directly tothe specific trust collection account. The
payeeobligors in a trade receivables transaction arenot only the
customers paying directly but alsocustomers paying through LOCs and
otherbanking instruments. The notices, therefore,need to be served
not only to customers butalso to the LOC negotiating bank (in case
thebeneficiary named in the LOC or other bankinginstruments is not
the designated trust ac-count) through which LOCs and other
bankingchannel payments are routed. The paymentmechanism has to be
carefully analyzed andit must be ensured that payments are
directedonly into the specific trust collection accountby issue of
notices to all intermediaries in-volved like negotiating banks.
Collateral ConsiderationsThe receivables represent indebtedness
of
obligors from the sale of goods. The obligorsare the customers
that pay directly and theLOC issuing banks in cases in which
receiv-ables are backed by LOCs. DCR works withthe seller/servicer
to achieve eligibility re-quirements that are not disruptive to the
nor-mal course of business, yet provide investorprotection. Some
examples of receivablesdeemed ineligible include receivables aged
be-yond a certain number of days; receivablesdue from originator’s
affiliates (although cer-tain structures may allow this);
receivablesdue from certain countries or currencies incase of
cross-border transactions; and receiv-ables due from government or
governmentagencies having a right to offset. These grosseligible
receivables are further adjusted with aconcentration reduction
amount to arrive atthe net eligible receivables or the
borrowingbase. The concentration reduction generallyincludes limits
on receivables by region, coun-try, currency and rating level of
obligors (in-cluding LOC banks).
The purpose of concentration reduction isto ensure the losses or
disputes from largeobligors do not translate into significantlosses
for the pool. The concentration limitwill depend on the specific
transaction andthe rating sought for the transaction. How-ever, as
a broad benchmark DCR will re-
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Duff & Phelps Credit Rating Co. DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
quire that single noninvestment-grade andinvestment-grade
obligors do not exceed 5%and 10% of the aggregate receivables
pool,respectively. Similarly the benchmark limitfor
noninvestment-grade and investmentgrade country is 10% and 20%,
respectively.The net eligible receivables or the borrowingbase is
arrived at after deducting the requi-site concentration reductions.
This is theamount on which the funding is raised andcredit
enhancement is sized to arrive at theissuance amount of the
investor certificates.
Credit EnhancementTwo types of credit enhancements can be
applied for existing trade receivablessecuritization: a dynamic
reserve mecha-nism and static credit enhancement. In atrade
receivables pool, receivables pay outwithin two to three months and
the pool com-position and characteristics could vary con-siderably
from period to period. The dynamicreserve is a formula-driven form
of credit en-hancement that constantly adjusts theamount held in
the reserve fund in responseto changes in pool performance. A
dynamicreserve can be much more preferable com-pared to static
credit enhancement, both frominvestors’ and issuers’
perspective.
From the investor’s perspective, a dy-namic reserve allows for a
continuous creditenhancement in concert with the perfor-mance of
underlying assets, takes into ac-count changes in pool
characteristics andprotects against rapid deterioration of
poolperformance. It also enables investors tomatch their returns to
maturity as it preventsany early wind-down in case of a spike
inlosses above a trigger level. From the issuer’sperspective, a
dynamic reserve provides anenhancement structure more
economicalthan static reserve. It prevents undue penaltyrequiring a
specific amount of cash in the re-
serve account irrespective of the underlyingpool’s performance.
It also considerably re-duces the chances of early amortization of
thetransaction, as fewer performance-basedtriggers are incorporated
in the structure.
Dynamic Reserve Credit EnhancementA dynamic reserve equals the
sum of the
loss reserve and dilution reserves. The loss re-serve sizes the
amount required to cover lossesusing a multiple of past delinquency
as a proxyfor losses. The dilution reserve amount pro-tects the
investor against losses resulting fromdilutions such as returned
items and billingdisputes. DCR uses a sophisticated model
forcalculation of the dynamic reserve. DCR’s dy-namic reserve
calculation also utilizes a vola-tility factor based on standard
deviation forboth the loss and dilution components of thereserve
calculation, which is unique in the in-dustry. The complete details
of dynamic re-serve calculations, along with an illustration,are
attached in the Annex on page 10.
The dynamic reserve is set up along witha minimum reserve floor.
The reserve floorfunctions as protection from credit risk im-plicit
in obligor concentrations and ensuresthat expected levels of
dilutions are coveredat minimum. It mitigates the risk of loss to
in-vestors resulting from the likelihood that atarget number of
obligors will default in theirpayment obligations during an
amortizationperiod. The reserve floor is calculated by add-ing an
amount equal to certain obligor con-centrations. The reserve floor
should at leastcover a certain number of the obligors in dif-ferent
rating categories, depending on thetransaction’s rating. The
reserve floor shouldalso cover expected dilution, and a
stressmultiple of the 12-month average dilutionwill need to be
assessed.
Static Credit EnhancementStatic credit enhancement can be
preferable
for a pool of receivables exhibiting little vola-tility across
various performance parametersin the past. For calculation of the
static creditenhancement, information on the last four tofive years
of historical data on receiv-ables performance, including
delinquencies,losses and dilutions, is required. The histori-cal
data should cover at least one recessioncycle of the concerned
industry, which willgive an indication of the stressed reserve
levelrequirement. DCR will apply its dynamic re-serve calculation
model on the historicalnumbers and will typically assume the
maxi-mum reserve requirement in any month asthe static reserve
level for the transaction.This reserve level may be adjusted
(upwardor downward) if the current operating andexpected
environment of the receivables sowarrant.
A Sample Eligible Receivables andIssuance Amount Calculations
inTrade Receivables Securitization
Gross ReceivablesLess Ineligible Receivables (as per eligibility
criteria)■ Receivables aged beyond a certain number of days■
Receivables due from certain ineligible countries■ Receivables due
from certain ineligible currenciesGross Eligible ReceivablesLess
Concentration Reduction■ Obligor limit by rating category■ Obligor
limit by country/region■ Obligor limit by currencyNet eligible
receivables (borrowing base)Less subordination (or reserve
requirements)Net principal funding amount
Table 2
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Existing Trade Receivables Transactions in Emerging Markets
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If the details on the historical performanceare not available or
historical performancedoes not cover a recessionary cycle, DCR,
insuch circumstances, can use its CBO ap-proach to analyze the
receivables. In thiscase, each rating of each receivable
obligorwill be analyzed, along with its concentra-tion by rating
category, country, region, in-dustry, etc. A box approach will be
used inwhich the receivables always have to satisfya predesignated
rating level, country, regionand other specific concentration
limitsthroughout the term of the transaction.
Stricter concentration limits will beplaced vis á vis
concentration limits placedto cull out ineligible receivables (as
detailedearlier). Receivables in excess of the concen-tration limit
specified will be deemed ineli-gible and in the absence of
sufficient genera-tion of new receivables in the future periods,the
transaction can pay down if the collat-eral sufficiency test is not
met. To arrive atthe targeted transaction rating, this pool
ofreceivables will be analyzed based on CBOmethodology. This method
of calculation ofstatic reserve presupposes that the creditquality
or the ratings of all the receivable ob-ligor is known.
Carrying Cost ReserveThe rating also accounts for the need
of
reserves sufficient to cover the costs associ-ated with the
administration of thesecuritization itself. Because trade
receiv-ables do not have an explicit interest rate, adiscount
sufficient to cover carrying costson stressed basis must be
imputed. The car-rying cost reserve requirement is based onthe
actual interest costs during the time re-quired to wind down the
securitization plustrustee fees, servicing fees and other
admin-istrative costs. This reserve requirement isover and above
the credit enhancement re-quirement on dynamic or static basis,
whichspecifically cover default and dilution risksand not the
administration costs.
Credit enhancement for onshore tradereceivables transactions
DCR’s model for dynamic reserve calcula-tions uses a specific
stress multiple commen-surate with the transaction rating level
(for de-tails on specific stress factors, refer to the An-nex).
This stress multiple is applied to the keyperformance parameters
such as default/di-lution ratio, default/dilution horizon
stress,etc., to arrive at the dynamic reserve amount.However, these
specific stress multiples relateto the receivables generated in a
‘AAA’ (LCrating) country or offshore receivables inwhich no
single-country risk is present. DCRperceives that in the case of
onshore trade re-ceivables, significantly impacted by the
sover-
eign macroeconomic and legal conditions, thestress multiple will
be different from the spe-cific stress multiple typically used for
a ‘AAA’(LC rating) country or offshore trade receiv-ables
transactions.
DCR perceives that the stress multiple is afunction of the
sovereign macroeconomic andlegal environment of the underlying
collateral.Therefore, the stress multiple used if the receiv-ables
are generated in a ‘AAA’ (LC rating)country such as the United
States and in any‘BBB’-rated (LC rating) emerging market coun-try
has to be different. The degree of differencewill be
transaction-specific and will criticallydepend on the targeted
transaction rating andthe concerned sovereign’s domestic
economicsituation and legal environment, with thesovereign’s local
currency rating as the broadbenchmark.
Legal ConsiderationsIn legal analysis of trade receivables,
the
two key areas DCR focuses on are:
■ The sale or assignment of receivables to theSPV; and
■ The enforceability of such sale or assign-ment against the
obligors.
The SPV to which the receivables are as-signed should be
bankruptcy remote. The SPVbuys the receivables from the originator
andsells/pledges them to the trust, thereby dis-tancing receivables
from the risk of originator’sbankruptcy. DCR’s stress scenarios for
estab-lishing legal requirements assume that anynoninvestment-grade
seller experiences bank-ruptcy during the life of the transaction.
There-fore, in all trade receivables transactions, DCRneeds to be
assured that the trustee has a supe-rior interest in the
receivables compared to theinterest of other creditors. DCR also
evaluatesthe risk that such interest may be subject
tononinsolvency-related and timing delays, suchas those that may
arise due to sovereign or cor-porate reasons. DCR will also need to
reviewthe potential applicability of bankruptcy lawin any of the
related jurisdictions that providefor a debt moratorium, automatic
stay or othersimilar delays in the exercise of the creditors’rights
and the effect such laws may have onthe transfer of receivables
prior to bankruptcyor liquidation. Certain legal opinions
relatingto true sale/nonconsolidation and the perfec-tion of first
perfected security interest are re-quired to ensure legal
soundness.
The issue of notes to the seller from the SPCfor ineligible
receivables could affect the truesale characteristic of the
transaction in certainjurisdictions. The legal opinion should
pro-vide a comfort to DCR that such seller notesdo not hinder true
sale characterization or elsethe transaction should incorporate
requisite
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Duff & Phelps Credit Rating Co. DCR’s Approach to Rating
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covenants, such as capping the amount of theseller note, to
ensure the soundness of the le-gal structure of the
transaction.
The obligors in trade receivables transac-tions should be issued
a written notice inwhich the originator instructs the obligors
toeffect all payments to a collection account thatis under the
control of a trustee. The notices bythemselves may not be enough to
bind the ob-ligors to pay into the collection account andthe
acknowledgments from the obligors as areceipt by countersigning on
notice should beobtained. However, in many trade
receivablestransactions (particularly cross border), be-cause the
numbers of the obligors are verylarge, it is somewhat impracticable
for theoriginator to obtain acknowledgments fromall the
obligors.
In such a situation, DCR could rely on legalopinions from
various obligors’ jurisdictionsstating that notice by itself is
enough for per-fection of assignment against the obligors.However,
if such jurisdictional legal opinioncannot be obtained, then
acknowledgmentshave to be obtained from the obligors to
ensureenforceability of notice. Overall notices and
ac-knowledgments or jurisdictional legal opin-ions are necessary to
ensure that obligors payinto the specific collection account and to
miti-gate any payment diversion risks.
In addition to legal opinions on true sale,first perfected
security interest and noticeand acknowledgments, certain other
opin-ions from each applicable jurisdiction re-garding
enforceability of transaction docu-ments; enforceability of foreign
judgments;necessary government consents; and no im-munity from
legal process, etc., need to beobtained. The specific requirements
for aparticular transaction will determine the re-quirements of the
legal opinions.
Seller/Servicer IssuesThe evaluation of capabilities of the
servicer is a key component of rating a tradereceivables
transaction. Typically, in all tradereceivables transactions, the
seller is theservicer for the transaction also. DCR reviewsthe
servicer’s system capabilities, capacityand flexibility, controls
in place to mitigate er-rors and fraud, management/reporting
struc-ture and contingency plans. A sophisticatedaccounts
receivables system is essential totrade receivables transactions
because of therapid turnover of the receivables and very fre-quent
reporting requirements (perhaps on adaily or weekly basis). DCR
also evaluates theseller/servicer’s financial condition and therisk
of bankruptcy. A financially distressedseller/servicer may have a
negative impact onthe pool’s performance. An obligor’s willing-ness
to pay a financially troubled seller/
servicer may decrease if collection efforts areexpected to
slacken. Thus, the financial insta-bility of the seller/servicer
may result in higherdilutions, set-off risks and delinquencies.
Backup ServicerAs in the emerging markets, the transac-
tion rating is typically several notcheshigher than the
seller/servicer rating tomitigate the risk of seller’s bankruptcy
ordeterioration of seller’s financial condition.DCR will require in
most transactions thata “hot” or “warm” backup servicing mecha-nism
is in place to ensure continuous servic-ing during bankruptcy of
the seller/servicer. (A “hot” backup runs a paralleladministrative
system for receivables, whilea “warm” backup reviews the
periodicservicer reports, verifies the pool’s cashflows and
receives monthly computertapes.) The requirement of a backup
servic-ing mechanism is of particular importancein emerging markets
even though the sameis not rigidly applied in developed
markets.
For a rapidly revolving asset type liketrade receivables, the
timeliness of transfer tothe backup servicer’s system is critical.
Forthis reason, DCR prefers the backup servicerbe involved in the
servicing process at the be-ginning of the transaction. The
backupservicer should be provided with all the datafiles and the
same should be checked for op-erations in its system. The backup
servicershould receive all the data files on a fixedperiodic basis
and maintain an on-line link-up with the existing servicers’
systems sothat it has real time data and active over-sight of
servicing. The backup servicertransfer time plan should be clearly
set up.Also, the backup servicer servicing capabili-ties in terms
of its track record, experience,staffing levels, data handling,
processingcapabilities and set-up needs to reviewed.
The triggers incorporated in the transac-tion for the backup
servicer commencementneed to be carefully analyzed. In view of
theimportance of backup servicer and linkage ofreceivables
performance to the seller’s finan-cial condition, the triggers
should be proac-tive to warn any potential bankruptcy of
theoriginator. The triggers, therefore, should belinked directly to
the servicer’s financial con-dition such as its debt-to-capital
ratio, crossdefaults on other obligations, commence-ment of any
legal proceeding against theseller, etc.
Fraud RisksThe review of the seller/servicer’s structure
of management and controls/checks in place isalso necessary to
mitigate fraud risks. Fraudrisk is present in securitizations of
all assettypes. However, it is of critical importance in
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Duff & Phelps Credit Rating Co.DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
9 u
rapidly revolving asset type like trade receiv-ables. This risk
is further increased when a tradereceivables transaction is
structured in a subin-vestment-grade sovereign.
To mitigate fraud risks, the initial pool of re-ceivables, the
invoicing procedures, reportingsystems, etc., should be audited by
a certifiedpublic accounting firm (preferably “big-five”).Such an
audit, as well as a review of manage-ment controls and checks in
place, should becarried out throughout the term of the
transac-tion. The servicer report incorporating com-plete details
on receivables performance, re-serve requirements and compliance to
transac-tion covenants in a collection period should beprepared in
a predefined format throughoutthe life of the transaction. The same
needs to bevetted by a certified public accounting firm on aregular
basis. The servicer report is typicallyprepared by the
seller/servicer. However, DCRmay insist that a third-party servicer
take onthis responsibility in certain cases to furthermitigate the
fraud risks.
Major RisksLegal risks: The legal risks are mitigated bysuitable
legal opinions on the bankruptcy re-moteness of SPV, true sale of
receivables to theSPV and ensuring enforceability of notices
inapplicable jurisdictions either through obtain-ing
acknowledgments from customers orthrough jurisdictional legal
opinions.
Obligor default and dilution risks: The defaultrisk of the
obligors and dilution risks are miti-gated by culling out
ineligible receivables, set-ting up concentration limits and
determiningcredit enhancement levels based on historicalanalyses of
payments (in case of static creditenhancement) and ongoing analyses
of pay-ments (in case of dynamic reserve).
Sovereign risks: DCR perceives the element ofsovereign risks is
in both offshore and onshoretrade receivables transaction. In
offshore tradereceivables, the risk is considerably muted,
al-though the risk of sovereign interference in asevere stress
situation cannot be ruled out. Inonshore trade receivables, the
transaction issubject to a higher degree of legal and
macro-economic risks, as receivables are generatedonshore, and
therefore, the transaction ratingis typically capped near the LC
rating, de-pending on the transaction structure and thesovereign
involved.
The two other major elements of sovereignrisks are detailed
below:
◆ Redirection risks. There is no productredirection risks in the
transaction, as thefunding is against only the existing
receiv-ables. The payment redirection risks aremitigated by issuing
notice to all obligors(including negotiating banks in the case
ofindirect LOC payments by customers) andobtaining acknowledgments
or legal opin-ion in relevant jurisdictions to ensure
en-forceability of the notices.◆ Transfer and covertibility risks.
In thecase of an offshore trade receivables (off-shore funding
backed by offshore obli-gors), transaction automatically
mitigatesagainst transfer and convertibility risks,as the
receivable payments do not enter theoriginator’s country. In the
case of an on-shore trade receivables in which the fund-ing is
raised overseas (offshore fundingbacked by onshore receivables),
the trans-fer and convertibility risk is typically miti-gated by
incorporating a cross currencyswap.
Fraud risks. The risk of fraud is mitigated byan initial audit
of the receivables pool andinvoicing procedures and, thereafter, a
regu-lar audit of the same along with a review ofthe
seller/servicer’s structure of manage-ment and controls and checks
in place,throughout the term of the transaction. Theinstallation of
a hot third-party servicer thatprepares the servicer report also
mitigatesthe fraud risk to a certain extent. While fraudrisk is
apparent in all securitizations involv-ing the originator acting as
the servicer, DCRbelieves the risk is increased when structur-ing a
transaction in a subinvestment-gradesovereign.
Servicing risks. The servicing risks are miti-gated by
incorporating a “hot” or “warm”backup servicing mechanism. As the
origina-tor typically is the main servicer, the transac-tion
covenants should have suitable proac-tive backup servicer triggers
forewarning aoriginator’s deteriorating financial conditionand
impending bankruptcy. Review of thebackup servicer transfer plan
and thebackup servicer’s credentials is also neces-sary to ensure
smooth operation of the trans-action in the case of triggering the
backupservicer event. DCR
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u 10
Duff & Phelps Credit Rating Co. DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
Calculating the Dynamic ReserveDynamic Reserve = Loss Reserve +
Dilution Reserve (subject to a minimum required reserve floor)
Loss Reserve = (A x B x C x D) + E
A = Rating MultiplierB = Default RatioC = Default Horizon
StressD = Payment Terms FactorE = Default Volatility Factor
Rating Multiplier: This number is used to add a multiple of
stress commensurate with the transaction’s ratinglevel to the other
Loss Reserve components (see table below)
Default Ratio: Highest three-month rolling average (of the most
recent 12 months) of the default percentagethat is an approximation
of the losses, plus any identified write-offs less than 91 days
past due when written off,divided by the total sales in the month
in which these loss proxy accounts were generated. This sales
number isused to account for the time-lag effect when estimating
performance rates. Assuming 30-day payment terms andaccounts in a
delinquent bucket of 91-120 days used as a loss proxy, the Default
Ratio would equal the highestthree-month rolling average over a
12-month of all accounts 91-120 days past due plus any identified
non-pays,as a percentage of sales four months prior.
Default Horizon Stress: All sales that occurred during the
default horizon as a percentage of eligiblereceivables. The default
horizon is the lesser of (1) the actual time from origination for a
receivable to becomeineligible for the purposes of securitization,
or (2) the sum of the weighted-average payment terms and thenumber
of days delinquent used to approximate losses, in the example
above, the default horizon is approximatelyfour months (30 + 91 =
121 days). Given stable originations and a 30-day portfolio
turnover, the stress wouldequal approximately four. This stress, in
conjunction with the Default Ratio, quantifies the amount of
receivableslikely to default that are embedded in the current
portfolio.
Payment Terms Factor: Current weighted-average payment terms
divided by the original weighted-averagepayment terms. On the first
day of a transaction, this factor will always be one, but a
sampling of accountsthroughout the term of the transaction will
indicate changes in the weighted-average payment terms. This
factoris used to adjust the horizon stress if there is a
fluctuation in the payment terms, since the originator has the
abilityto control/change payment terms.
Default Volatility Factor: The 12-month sample standard
deviation of the monthly default percentage (anapproximation of the
losses, plus an identified write-offs less than 91 days past due
when written off, divided bythe total sales in the month during
which these loss proxy accounts were generated), multiplied by the
Z value.The Z value provides a confidence interval commensurate
with the rating of the transaction (see Table below).This
Volatility Factor protects investors from spikes occurring after a
period of relatively stable perfomance.
Dilution Reserve = [(A x B) + E] x C x DA = Rating MultiplierB =
Dilution RatioC = Dilution Horizon StressD = Payment Terms FactorE
= Dilution Volatility Factor
Rating Multiplier: This number is used to add a multiple of
stress commensurate with the transaction’s ratinglevel to the other
Dilution Reserve components (see table above).
Dilution Ratio: 12-month average of the percentage of current
dilutions over the sales in the month originatingthe dilutions.
Dilution Horizon Stress: Cumulative sales in the dilution
horizon divided by the ending balance of theeligible receivables.
The dilution horizon is the weighted-average time lag between the
sale and the recognitionof dilution, as estimated using a sampling
of invoices for dilutive items. This stress, in conjunction with
the DilutionRatio, quantifies the amount of receivables likely to
be subject to dilution that are embedded in the
currentportfolio.
Payment Terms Factor : See above.
Dilution Volatility Factor: Sample standard deviation over 12
months of the percentage of current dilutionsover the sales in the
month originating the dilutions, multiplied by the Z value. The
Zvalue provides a confidenceinterval commensurate with the rating
of the transaction (see table above). This volatility Factor
protects investorsfrom losses due to dilutions in a wind-down
scenario, even after a period of relatively stable dilutions.
Required RatingRating Multipliers “Z” Values
AAA 2.50 2.58AA 2.25 2.58A 2.00 1.96
BBB 1.50 1.96
Rating Multipliersand Appropriate Z Values
Annex
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Duff & Phelps Credit Rating Co.DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
11 u
The following illustrates the mechanics ofthe dynamic reserve in
an actual tradereceivables transaction (note that numbershave been
changed slightly to protect theidentity of the transaction). In
both theLoss Reserve and Dilution Reserve tables(page 13), it is
possible to see that everylevel of losses or dilutions is met by
morethan adequate credit enhancementcoverage.
Mechanics of the Loss Reserve: Thefollowing il lustration
emulates a ‘AAA’-rated security with constant 30-daypayment terms
so the Rating Multiplieralways equals 2.50 (see page 10) and the
Payment Terms Factor always equals 1 (30days/30 days). In month 10,
the number used as a loss proxy has increased from theprevious
month’s level to 1.25%. In this case, the loss proxy is a sum of
any accountsidentified as non-pays and accounts 91-120 days
delinquent. Because the loss proxyincreased, the three-month
rolling average of the loss proxy (column ii) also increases.Taking
the highest three-month rolling average gives a Default Ratio of
0.73%, meaningthat for every $1.00 of originations there is $0.0073
of embedded loss. To account for thelosses embedded in the portolio
that were generated since the period in which the lossproxy
accounts were generated, the Default Horizon Stress is calculated
by dividing thefour-month cumulative sales by the ending balance of
eligible receivables. Thus, it is expectedthat if a wind-down
commences in month 10, 2.24% (3.07 x 0.73%) of the total portfolio
isexpected to result in losses during the wind-down period. The
12-month sample standarddeviation of the loss proxy increases from
0.10% to 0.24% in month 10. The standarddeviation is then
multiplied by the ‘AAA’ Z value of 2.58% (see page 10) to calculate
theDefault Volatility Factor of 0.62%. The Default Volatility
Factor is added to the product of theRating Multiplier, Default
Ratio, Default Horizon Sress and Payment Terms Factor to realizethe
required Loss Reserve percentage [(2.50 x 0.73% x 3.07 x 1) - 0.62%
= 6.22%].
Wind-down protection: In a wind-down scenario, the reser ve
levels remain at thelevels required in the month preceding the
wind-down. The Loss Reserve table illustratesthat when the highest
losses occur (month 10), the reserve level required in the
previousmonth (4.24%) provides support equal to 3.4X the
single-month loss rate (1.25%). As thedefault horizon stress in
month nine is 3.23, the month nine reserve level is sufficient to
coverlosses during a wind down. Graph 2 presents a striking
representation of the sufficiency ofthe reserve, in dollar terms,
if a wind-down commences in month 10. The graph shows thatthe
reserve account, held at the month nine level (4.24%), covers even
the peak DefaultRatio for the balance of the horizon [1.25% - (3 x
0.73%) = 3.44%]. Notwithstanding awind-down, the Loss Reserve
immediately increases dramatically in response to a spike ofthe
loss proxy indicator, as illustrated in Graph 1.
Volatility Protection: The DilutionReserve table presents the
effect on thereser ve calculation of an increase indilutions in
month 12. While the DilutionReserve increases substantially at
theend of the month, the table indicatesthat the Dilution Volatili
ty Factor is astrong catalyst in the reserve requirementincrease.
Dilutions more than doublefrom month 11 to month 12, but
theDilution Ratio increases by only 7.9%because it is a 12-month
rolling averagecalculation. The standard deviationcalculation,
however, captures the spikeand causes the Dilution Volatility
Factorto increase 2.4%,-from 2.54% to 3.16%.
Mechanics of the Dilution Reserve: The calculation of the
Dilution Reserve is similarto that of the Loss Reserve. However,
because a 12-month rolling average of Dilutoins hasmore of a
tendency to dampen spikes than the three-month rolling average that
is used inthe Loss Reserve calculation, the volatility factor is
embedded in, rather than added to, theDilution Reserve. Taking
Month 12 as an example, dilutions as a percent of sales in themonth
that generated the dilutions increased to 5.76% from 2.33%. This
dramatic increasemet an increase in the Dilution Ratio from 3.16%
to only 3.41%. However, the 12-month
0
2,000
4,000
6,000
9 10 11 12
Loss Reserve in Previous PeriodLoss Proxy for Current Period
Loss Reserve $
Graph 2
Case Study: The Mechanics of the Dynamic Reserve
0
2,000
4,000
6,000
8,000
10,000
9 10 11 12
Loss Reserve in Previous PeriodLoss Proxy for Current Period
Loss Reserve $
Graph 1
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u 12
Duff & Phelps Credit Rating Co. DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
sample standard deviation simultaneously increased to 1.22%, in
turn causing the DilutionVolatility Factor to reach 3.16% (1.22%
times the ‘AAA’ Z value of 2.58).
In this example, the ‘AAA’ Rating Multiplier is used and the
Payment Terms Factor remainsunchanged at 1. To calculate the
required Dilution Reserve level, the product of the
RatingMultiplier and the Dilution Ratio is added to the Dilution
Volatility Factor (2.50 x 3.41%) +3.16), then this sum is
multiplied by both the Dilution Horizon and the Payment Terms
Factor(((2.50 x 3.41%) + 3.16) + 1.63 x 1).
Case Study (cont’d)
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Duff &
Phelp
s Cre
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13 u
A i ii B iii iv C D v E viRating Default Ending Default 12-Month
Default
Multiplier Loss/Proxy/ (3-Month Ratio 4-Month Balance Horizon
Payment Sample Standard Volatility Loss(for ‘AAA’ Sales Rolling
12-Month Cumulative Eligible Stress Terms Deviation Factor
Reserve
Month rating) 4-Month Prior Avg. of i) Peak of ii) Sales
Receivables (iii/iv) Factor (of i) (2.58xV) ((AxBxCxD)+E)1 2.50
0.32% 0.44% 0.56% $349,600 $110,700 3.16 1 0.13% 0.33% 4.71%2 2.50
0.60% 0.49% 0.56% $362,000 $120,750 3.00 1 0.14% 0.35% 4.51%3 2.50
0.42% 0.45% 0.56% $387.500 $121,700 3.18 1 0.14% 0.35% 4.77%4 2.50
0.33% 0.45% 0.56% $382,600 $112,800 3.39 1 0.10% 0.27% 4.98%5 2.50
0.52% 0.42% 0.49% $386,400 $116,000 3.33 1 0.11% 0.28% 4.37%6 2.50
0.50% 0.45% 0.49% $397,900 $123,900 3.21 1 0.11% 0.27% 4.21%7 2.50
0.47% 0.49% 0.49% $391,900 $120,900 3.24 1 0.11% 0.27% 4.28%8 2.50
0.40% 0.45% 0.49% $399,800 $109,750 3.64 1 0.11% 0.27% 4.78%9 2.50
0.54% 0.47% 0.49% $396,000 $122,750 3.23 1 0.10% 0.25% 4.24%10 2.50
1.25% 0.73% 0.73% $361,000 $117,500 3.07 1 0.24% 0.62% 6.22%11 2.50
0.76% 0.85% 0.85% $356,000 $126,750 2.81 1 0.25% 0.64% 6.62%12 2.50
0.27% 0.76% 0.85% $356,000 $118,200 3.01 1 0.26% 0.68% 7.09%
Loss Reserve
A i B ii iii C D iv E vRating Dilution Ending Dilution 12-Month
Dilution
Multiplier Dilutions/ Ratio 2-Month Balance Horizon Payment
Sample Standard Volatility Dilution(for ‘AAA’ Sales (12-Month
Cumulative Eligible Stress Terms Deviation Factor Reserve
Month rating) 2-Month Prior Avg. of i) Sales Receivables
(ii/iii) Factor (of i) (2.58 x iv) ((AxB)+E)xC+D)1 2.50 5.05% 3.26%
$191,000 $110,700 1.72 1 1.65% 4.26% 21.39%2 2.50 2.04% 2.95%
$186,500 $120,750 1.55 1 1.54% 3.98% 17.55%3 2.50 3.96% 3.09%
$196,500 $121,700 1.62 1 1.46% 3.76% 18.57%4 2.50 3.16% 3.10%
$196,100 $112,800 1.74 1 1.35% 3.48% 19.55%5 2.50 3.64% 3.16%
$189,900 $116,000 1.64 1 1.28% 3.29% 18.33%6 2.50 3.79% 3.22%
$201,800 $123,900 1.63 1 1.22% 3.15% 18.25%7 2.50 3.92% 3.29%
$202,000 $120,900 1.67 1 1.18% 3.03% 18.80%8 2.50 3.03% 3.27%
$198,000 $109,750 1.80 1 1.12% 2.90% 19.95%9 2.50 2.81% 3.45%
$194,000 $122,750 1.58 1 0.77% 1.98% 16.76%10 2.50 1.44% 3.26%
$163,000 $117,500 1.39 1 0.95% 2.45% 14.69%11 2.50 2.33% 3.16%
$162,000 $126,750 1.28 1 0.98% 2.54% 13.33%12 2.50 5.76% 3.41%
$193,000 $118,200 1.63 1 1.22% 3.16% 19.08%
Dilution Reserve
Annexure (contd)
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u 14
Duff & Phelps Credit Rating Co. DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
About the Authors
mit K. Agarwala is an assistant vicepresident in the
International Struc-tured Finance Group at DCR.
Based in Hong Kong, Mr. Agarwala is re-sponsible for credit
rating analysis of struc-tured finance transactions in the
Asia-Pacificregion. He works on various traditional exist-ing
asset-backed types, such as trade, creditcard and consumer
receivables, aside fromnontraditional future-flow transactions
in-cluding trade and financial future-flows.
Prior to joining DCR, Mr. Agarwala wasan assistant director at
Peregrine Fixed In-
come Limited. He was responsible fordebt structuring and
execution andworked on several deals in the region.Previously, he
worked for approximatelyfive years in the Proprietary CreditGroup
of Industrial Credit and Invest-ment Corporation of India Ltd.
(ICICI), apremier financial institution in India.
Mr. Agarwala holds a Bachelor of Com-merce (Hons.) and an
M.B.A., with special-ization in Finance, from University ofDelhi,
India. He can be reached at+(852) 2901 0505/[email protected].
regory J. Kabance is a vice president inthe International
Structured FinanceGroup at DCR.
Mr. Kabance plays a leading role in pro-viding credit ratings
for emerging marketstructured finance transactions. He is
cur-rently focusing on Asian securitization andis responsible for
analytical coverage of ex-isting asset transactions, including
con-sumer receivables and CBO/CLOs, and fu-ture-flow receivable
transactions, includingexport receivables and bank receivables.
Hehas recently moved to Hong Kong fromDCR’s Chicago office where he
was respon-sible for analytical coverage of Latin Ameri-can
securitization.
Prior to joining DCR, Mr. Kabanceserved as a commercial credit
analyst atthe Bank of Tokyo where he was respon-sible for analyzing
a variety of companies,including Japanese subsidiaries domiciledin
the United States. He was also respon-sible for certain
asset-backed transactions.Previously, he worked at Michigan
Na-tional Bank as a credit analyst responsiblefor various
transactions, including real es-tate and middle-market
corporations.
Mr. Kabance earned a B.A. in financefrom Michigan State
University and at-tended the University of Chicago’s Gradu-ate
School of Business. He can be reachedat +(852) 2901
0502/[email protected].
G
A
Information was obtained from sources believed to be accurate
and reliable. However, we do not guarantee the accuracy, adequacy
or completeness of any informationand are not responsible for any
errors or omissions or for the results obtained from the use of
such information. Issuers of securities rated by DCR have paid a
creditrating fee based on the amount and type of securities issued.
We do not perform an audit in connection with any information
received and may rely on unauditedinformation. Our ratings are
opinions on credit quality only and are not recommendations to buy,
sell or hold any financial obligation and may be subject to
revision,suspension or withdrawal at any time as necessary due to
changes in or unavailability of information or other
circumstances.
Copyright © 1999 Duff & Phelps Credit Rating Co. All rights
reserved. Contents may be used by news media with credit to Duff
& Phelps Credit Rating Co.
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Duff & Phelps Credit Rating Co.DCR’s Approach to Rating
Existing Trade Receivables Transactions in Emerging Markets
15 u
Short-Term DebtRating Scale
Rating Definition
High Grade
D-1+ Highest certainty of timely payment.Short-term liquidity,
including internaloperating factors and/or access toalternative
sources of funds, isoutstanding, and safety is just belowrisk-free
U.S. Treasury short-termobligations.
D-1 Very high certainty of timely payment.Liquidity factors are
excellent andsupported by good fundamentalprotection factors. Risk
factors are minor.
D-1- High certainty of timely payment.Liquidity factors are
strong andsupported by good fundamentalprotection factors. Risk
factors are verysmall.
Good Grade
D-2 Good certainty of timely payment.Liquidity factors and
companyfundamentals are sound. Althoughongoing funding needs may
enlarge totalfinancing requirements, access to capitalmarkets is
good. Risk factors are small.
Satisfactory Grade
D-3 Satisfactory liquidity and other protectionfactors qualify
issues as to investmentgrade. Risk factors are larger and subjectto
more variation. Nevertheless, timelypayment is expected.
Non-Investment Grade
D-4 Speculative investment characteristics.Liquidity is not
sufficient to insureagainst disruption in debt service.Operating
factors and market access maybe subject to a high degree of
variation.
Default
D-5 Issuer failed to meet scheduled principaland/or interest
payments.
Long-Term Debt& Preferred Stock
Rating Scale
Rating Definition
AAA Highest credit quality. The risk factors arenegligible,
being only slightly more thanfor risk-free U.S. Treasury debt.
AA+ High credit quality. Protection factorsAA are strong. Risk
is modest but may varyAA- slightly from time to time because of
economic conditions.
A+ Protection factors are average butA adequate. However, risk
factors areA- more variable and greater in periods of
economic stress.
BBB+ Below average protection factors butBBB still considered
sufficient for prudentBBB- investment. Considerable variability
in
risk during economic cycles.
BB+ Below investment grade but deemedBB likely to meet
obligations when due.BB- Present or prospective financial
protection
factors fluctuate according to industryconditions or company
fortunes. Overallquality may move up or down frequentlywithin this
category.
B+ Below investment grade and possessingB risk that obligations
will not be metB- when due. Financial protection factors will
fluctuate widely according to economiccycles, industry
conditions and/orcompany fortunes. Potential exists forfrequent
changes in the rating within thiscategory or into a higher or lower
ratinggrade.
CCC Well below investment grade securities.Considerable
uncertainty exists as totimely payment of principal, interest
orpreferred dividends. Protection factors arenarrow and risk can be
substantial withunfavorable economic/industryconditions, and/or
with unfavorablecompany developments.
DD Defaulted debt obligations. Issuer failed tomeet scheduled
principal and/or interestpayments.
DP Preferred stock with dividend arrearages.
Credit ratings are based on information obtained from sources
believed to be accurate and reliable and are not a recommendation
to buy, sell or hold a financial obligation. We do not perform an
audit inconnection with any information received and may rely on
unaudited information. Credit ratings may be subject to revision,
suspension or withdrawal at any time as necessary due to changes in
orunavailability of information or other circumstances.
-
Rating Hotline (312) [email protected]
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