STS Criterion 18. Allocation of losses and amortisation of tranches

Description

Allocation of losses and amortisation of tranches

Content

Allocation of losses: The allocation of losses to holders of a securitisation position in a synthetic STS securitisation should always proceed in order of seniority of tranches, from the most junior tranche to the most senior tranche in the transaction.

Amortisation of size of tranches: Pro-rata amortisation may only be applied to determine the outstanding amount of all tranches where clearly specified triggers relating to the performance of the underlying exposures ensure the switch of the amortisation scheme to sequential amortisation. Such performance-related triggers should include at least the deterioration in the credit quality of the underlying exposures below a predetermined threshold.

Where this is not the case, sequential amortisation should apply to all tranches in order to determine the outstanding amount of the tranches at the respective payment dates i.e. as the underlying exposures amortise, such amortisation should be applied first to reduce the most senior tranches and only once these most senior tranches have fully amortised to reduce more junior tranches in accordance with the order of seniority as agreed in the transaction documentation.

As tranches amortise, where investors have provided collateral for tranches as part of the credit protection agreement establishing the synthetic securitisation, a collateral equal to the amount of amortisation on such tranches should be returned to investors. In case of underlying exposures in relation to which a credit event has occurred and the workout process has not been completed, the sequential amortisation scheme should ensure the total outstanding amount of all tranches at any payment date is at least equivalent to the notional outstanding amount of such underlying exposures after consideration of the amount of any interim payment that have already been effected on such underlying exposure in relation to the respective credit event.

All amortisation agreements, applicable before and after the occurrence of an enforcement or acceleration notice, should be clearly documented.

Rationale

See overarching rationale for consistency with traditional qualifying framework.

From a prudential perspective, pro-rata amortisation schemes in the presence of back-loaded losses, i.e. losses that crystallise towards the end of the underlying exposures’ tenor, may undermine the simplicity and standardisation of the transaction. Other things being equal, in the presence of pro-rata amortisation the originator is only able to rely on a level of credit protection that, towards the end of the tenor of the transaction, is materially lower than the one it could rely on when a sequential amortisation scheme is adopted. Therefore, pro-rata amortisation should be allowed only under limited circumstances i.e. subject to specific contractual triggers, which require a switch to sequential amortisation.

In order to ensure that all parties involved in the synthetic securitisation have at all times a thorough understanding of applicable amortisation schemes under a securitisation, such amortisation schemes should be clearly specified in the transaction documentation.