There are two forms of CRT securitizations, also commonly referred to as significant risk transfers (SRTs). Traditional true-sale or cash securitizations, where the portfolio of assets the bank is seeking capital relief on is transferred to a special-purpose entity, and synthetic securitizations, where a bank enters into a credit protection agreement that transfers some of the credit risk associated with a defined reference portfolio of assets to third-party investors, while the reference portfolio remains on the bank's balance sheet. In synthetic transactions, the protected tranche notional can be either funded upfront by the protection seller or remain unfunded, in which case the protection buyer assumes their counterparty risk.

This report focuses on mapping the credit "DNA" of funded synthetic CRTs, as they are the most common. In the following sections, we discuss typical transaction features and the key considerations in our rating analysis, including how these may differ from the analysis for traditional cash securitizations. Chart 1 below shows the five key areas our rating analysis focuses on.

Chart 1

We have provided a glossary that summarizes some commonly used terminology for synthetic transactions in the Appendix.

Structural Elements

Credit protection agreement

There are several possible types of credit protection agreements that transfer credit risk to investors, including credit default swaps, guarantees, or insurance contracts. The credit protection agreement defines the key terms of the CRT, including the characteristics of the reference portfolio, any eligibility criteria and concentration limits, how credit events are determined, the protected tranche notional amount, and the loss attachment point at which protection payments are owed to the protection buyer.

The bank buying credit protection will typically retain the risk of the most senior tranche and purchase credit protection on one or more junior tranches, such that most of the unexpected losses on the reference portfolio are covered by third-party investors. Protection buyers may sell or retain the most junior (first loss) tranche, which typically covers expected credit losses on those assets. In return for assuming some of the credit risk of the reference portfolio, the protection seller is paid a periodic premium by the protection buyer. If cumulative credit events exceed the attachment point of the protected tranche, the protection buyer is owed payment from the protection seller (see chart 2).

Chart 2

CLN structures

In funded synthetic CRTs that feature CLNs, the notes may be issued either directly by the originating bank or indirectly through a special-purpose entity (SPE). In both structures the mechanics of the underlying credit protection agreements are the same (see chart 2). So, from a credit perspective, the key differentiating factor is the potential counterparty exposure to the protection buyer.

In a direct CLN structure, the protection buyer typically receives the initial issuance proceeds and has the financial obligation to make principal and interest payments on the notes, net of any protection payments they are owed under the credit protection agreement. In these structures, our ratings on the CLNs may be dependent on the rating on the protection buyer, to incorporate their associated counterparty risk. However, we've observed some direct CLNs with structural features that fully mitigate their counterparty risk. For example, where the CLN issuance proceeds are held in a collateral account established with a third party and sufficient liquidity is available to cover interest payments if the protection buyer defaults, our ratings on the CLNs may be delinked from the rating on the protection buyer (see chart 3).

Chart 3

In other synthetic CRTs, the sponsor establishes a bankruptcy-remote SPE to issue the CLNs (see chart 4). The ratings on SPE CLNs are typically not dependent on the rating on the protection buyer, given their counterparty exposure is limited to making premium payments under the credit protection agreement. Most transactions mitigate this exposure through liquidity reserves or letters of credit (LOCs), which can be drawn upon to pay CLN interest if the protection buyer defaults.

Chart 4

In either structure, where the counterparty risk of the protection buyer has been mitigated, the simplified flow of funds is as follows:

Issuance proceeds.  Proceeds from the CLNs are deposited in a segregated collateral account and may be held in cash or invested in highly rated securities. The issuance proceeds collateralize the protection seller's payment obligation to the protection buyer under the credit protection agreement, and the CLNs are secured by a secondary interest in any excess collateral amounts.

Credit protection payments.  If cumulative credit events exceed the attachment point of the protected tranche, credit protection payments will be paid to the protection buyer from amounts deposited in the collateral account. This will leave the notes undercollateralized and the CLN principal will be written down.

CLN repayment--normal course.   In SPE CLNs, periodic interest is paid using the protection premiums received from the protection buyer and any investment yield earned on the collateral account, after the payment of senior transaction fees. As the reference pool amortizes, principal on the CLNs is repaid from excess amounts released from the collateral account, and potentially any excess yield after the payment of CLN interest. In direct CLNs, the protection buyer is responsible for interest and principal payments on the notes.

CLN repayment--termination event.   The CRT transaction would unwind following a default of the protection buyer and any amounts on deposit in the collateral account, net of any senior termination payments, will be applied towards repayment of CLN principal. Interest on the CLNs is paid through drawing on a liquidity reserve or LOC.

The examples and simplified flow of funds assume only one class of CLN is issued to fund the entire protected tranche notional. However, some structures issue several classes of CLNs that further tranche credit risk. As credit events in the reference portfolio accumulate, the principal amount of the CLN classes would be written down in reverse priority, starting with the junior most class.

Credit Quality Of The Reference Portfolio

Protection buyers may include any assets from their balance sheets in reference portfolios. Historically, most transactions referenced loans to corporates and small and midsize enterprises, but more CRT exposures are shifting toward retail assets, such as residential mortgages and auto loans (see chart 5).

Chart 5

To assess the credit quality of the reference portfolio, we apply our sector-specific criteria. Specifically, our analysis of synthetic transactions considers the likelihood that the attachment point of the protected tranche will be breached; that is, cumulative credit events triggering a protection payment and write-down of CLN principal. We would generally classify this as a default under our rating definitions.

Differences in credit losses between synthetic and traditional cash securitizations

Common credit events in synthetic transactions include bankruptcy and failure to pay, but definitions are specific to each transaction and asset class. The definition of credit events is key to our rating analysis in synthetic CRTs, as CLN principal write-downs and their ultimate repayment depends on this accounting concept of default. By contrast, in a traditional securitization, it is the actual cash collections on the portfolio which determine the amounts available to repay noteholders.

In a traditional cash securitization, if a default is defined as occurring within a short period (for example, 30+ days delinquent), the structure could have favorable structural features that trap excess spread or make other changes to cash flows that may benefit noteholders. Even if payment of interest to some junior classes of notes is delayed to allow the amortization of principal on more senior classes, interest shortfalls typically accrue without triggering an event of default. If the asset default is ultimately cured, which may be more likely for receivables that are only 30 days delinquent, the transaction benefits from high recoveries.

In a synthetic CRT, by contrast, a short default definition may result in a high number of credit events that trigger a credit protection payment and write-down of CLN principal. Depending on how recoveries are defined and their timing, the write-down may eventually be reinstated, but investors are unlikely to be compensated for any foregone interest on the reduced CLN notional. Noteholders in synthetic CRTs are also exposed to the risk that the transaction is terminated before all recoveries can be realized. This risk is not present in traditional cash securitizations.

Credit events, recoveries, and eligibility criteria

To assess the credit quality of the reference portfolio, we may consider:

• If the reference portfolio is subject to eligibility criteria that may mitigate the effect of any credit deterioration or prevent weaker assets from being included during any revolving/replenishment period. Eligibility criteria may be based on obligor credit quality, contract term, and industry concentrations, for example. In our credit analysis, we typically contemplate migration to an adverse pool composition at the end of the revolving period, accounting for any eligibility criteria and conditions that would end the revolving period;
• How the eligibility criteria compare with the characteristics of the historical portfolio and performance data that we used to size the expected loss (base-case assumption);
• If the credit events are defined in a way that is consistent with the historical data used to size the expected loss. Historical data reflecting a longer default definition than the credit event definition may understate the likelihood of cumulative credit events exceeding the attachment point;
• Whether credit events are defined using gross loss or net loss--that is, whether they are determined before or after the enforcement of security and receipt of recoveries. This can impact what, if any, benefit we assign to recoveries in synthetic CRTs. The transaction may be exposed to timing mismatches or the risk of the protection buyers' default if it uses a gross loss definition with an adjustment for any future recoveries received;
• How the credit event definitions consider loan modifications or restructurings;
• If the protection buyer is restricted from removing or substituting assets in the reference portfolio; and
• Whether the protected amount of the reference obligations includes accrued and unpaid or capitalized interest.

Counterparty Risk

Funded synthetic CRTs fully collateralize the counterparty risk of the protection seller at inception, through the issuance proceeds of the CLNs. The remaining counterparty exposures that can influence our credit analysis include the protection buyer, the eligible investments, the account bank/custodian, and the providers of any third-party support, such as a LOC.

Protection buyer

Timely interest payments on the CLNs are made through periodic protection premiums paid by the protection buyer. In direct CLN structures, investors may also be exposed to the protection buyer if it holds the CLN issuance proceeds. Absent any structural mitigants to counterparty risk, our ratings on the CLNs may be dependent on the rating on the protection buyer.

Some of the most common mitigants we've observed to address the protection buyer's counterparty risk include:

• Collateralizing protection premiums (either at inception, or upon the breach of certain rating triggers);
• The provision of LOCs by third parties; and
• Establishing a segregated collateral account to secure the CLN principal.

Another key feature of synthetic CRTs is early redemption events that will terminate the transaction if the protection buyer defaults or is declared insolvent. These structures are referred to as terminating transactions, and they limit the exposure to potential interest shortfalls before the notes are redeemed. However, we do not consider the risk that an early termination may occur and shorten the weighted-average life of the transaction in our ratings.

In synthetic CRTs with fully mitigated counterparty risk, if the protection buyer defaults, we expect that the CLNs will be repaid in full solely through the collateral and other third-party support.

Eligible investments and account bank/custodian

In traditional securitizations, any cash accumulated between payment periods is only held temporarily before being remitted to investors. It therefore only ever constitutes a relatively small percentage of the note balance. However, in synthetic CRT structures, the entire CLN principal may be collateralized for the life of the transaction by cash or temporary investments that represent almost all of the assets available to repay principal to noteholders. As a result, the credit quality of the temporary investments and the counterparty risk of the institution in which they are held generally have a larger influence on the creditworthiness of the notes in a synthetic CRT.

As in traditional securitizations, we look to see whether structural features mitigate counterparty risks. That is, we consider whether effective and timely remedies are in place to address a deterioration in the creditworthiness of the account provider or temporary investments. We may also conclude that the exposure to an account provider is fully mitigated if we believe that the cash or securities deposited in a trust or custodial institution would be subject to laws and regulations that isolate these accounts from the counterparty's insolvency risk.

Our maximum potential ratings on the CLNs--and our assessment of whether counterparty risk is a constraining factor--may be affected by:

• Whether the collateral securing the CLNs has been effectively isolated from the insolvency of the protection buyer and account providers;
• The nature of the collateral (for example, whether it is held in cash or can be used in temporary investments);
• The minimum ratings on any temporary investments and account providers;
• The documented remedies if the minimum ratings are not met; and
• The maturity restrictions that apply to temporary investments.

Given that counterparty and temporary investment exposures in CLNs are elevated compared with traditional securitizations, we generally require higher minimum eligible ratings to support the same ratings on the liabilities. For example, to support a 'AAA' rating on a CLN under our current criteria, we would typically expect temporary investments to have long-term ratings of at least 'AA-', short-term ratings of at least 'A-1+', or be stable net asset value money-market funds with ratings of 'AAAm'.

For traditional securitizations, we would expect long-term ratings of 'A' and short-term ratings of 'A-1' (see "Global Investment Criteria For Temporary Investments In Transaction Accounts," published on May 31, 2012). Furthermore, in multi-class CLNs, we generally expect all temporary investments to have minimum eligible ratings that support the highest-rated CLN. This is because a shortfall caused by a default in the collateral associated with junior classes could require the use of collateral associated with more senior classes for credit protection payments.

In addition, the maturity of temporary investments may be limited to a much shorter period than the maximum tenor of the CLNs, allowing any credit deterioration to be remedied upon reinvestment and mitigating market-value risk. For example, if a CLN makes monthly payments, there would be no market-value risk if temporary investments mature before the payment date. Noteholders would be exposed to the credit quality of the temporary investments for a maximum of one month, and any credit deterioration would be quickly remedied upon reinvestment in new eligible securities with the minimum required ratings.

In structures where we do not consider that the period of exposure to temporary investments is for a limited period of time (for example, under our current criteria if remedies exceed 90 days), our ratings on the CLNs may be constrained by the ratings on the temporary investments (see "Counterparty Risk Framework: Methodology And Assumptions," published March 8, 2019, and "Global Investment Criteria For Temporary Investments In Transaction Accounts," published May 31, 2012).

Third-party support provider

In our experience, the most common form of third-party support in synthetic CRT securitizations is an LOC. To mitigate the counterparty risk of the protection buyer, the LOC is typically sized to cover the protection premiums needed to pay interest on CLNs if early termination is triggered. In some jurisdictions, the LOC may be sized to account for potential delays to the repayment of CLN principal, should regulators intervene (see "Legal And Regulatory Risk" section below).

As with other counterparty exposures, we consider any documented remedies that could mitigate a deterioration in the creditworthiness of the LOC provider (such as replacement or draw-to-cash provisions) when we determine the maximum supported rating on the CLNs. In general, under our current criteria, if exposure to the LOC provider is less than 5% of the initial collateral balance, LOC providers rated 'A' or higher can support CLNs rated up to 'AAA' (see "Counterparty Risk Framework: Methodology And Assumptions," published March 8, 2019, and "CDOs: Counterparty Risk In Terminating Transactions," published Aug. 15, 2014).

Payment Structure And Cash Flow Mechanics

In a traditional securitization, the primary source of funds from which payments are made to investors is the cash collected from the assets. For synthetic CRTs, cash collections on the reference portfolio are generally not used to make repayments on the CLNs. That said, the amount and timing of credit events (defaults), recoveries, prepayments, and synthetic excess spread may affect the payments made to investors.

Some synthetic CRTs aim to mirror the payments in traditional securitizations as closely as possible--in such cases, a cash flow model may inform our credit rating analysis, enabling us to stress the transaction's sensitivity to these variables. Other synthetic structures, such as those that make fully sequential repayments using a net loss-based definition of credit events and no synthetic excess spread, are generally less sensitive to the timing assumptions for these variables. Therefore, a cash flow model may provide us with limited insight in these cases.

Attachment and detachment point

The attachment point is effectively the amount of hard credit enhancement available for the CLN. It can be compared with subordination or overcollateralization concepts in traditional securitizations. In multi-class structures, if credit events fully erode one class's protected notional so that its CLN principal has been written down to zero, further losses are allocated to the class that is immediately senior to it. In other words, the detachment point of the junior tranche is the attachment point of the next most senior tranche.

Collateral yield

The yield earned on the collateral account may supplement the periodic protection premiums to pay timely interest on the CLNs.

CLNs may pay interest at a fixed or floating rate, and this can create basis risk due to the difference between the yield earned on the collateral account and the interest that accrues on the CLNs. We typically consider the nature of temporary investments and the reference rates used to calculate the interest payable on floating-rate CLNs when sizing the potential basis risk.

We also consider whether any liquidity reserves, such as LOCs or collateralized premiums, are likely to be sufficient to pay CLN interest under different interest rate stresses (see "Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities," published Dec. 22, 2020, and "Methodology To Derive Stressed Interest Rates In Structured Finance," published Oct. 18, 2019).

Amortization profile

Many synthetic CRTs amortize pro rata in line with the reference portfolio to maintain the economics of the transaction for the protection buyer. As in traditional securitizations, senior classes in pro rata amortizing structures are more exposed to the timing of losses and prepayments than they are in sequentially amortizing structures.

We typically test the resilience of pro rata structures by applying various default timing curves to evaluate the effectiveness of any performance-based triggers or remaining notional balance thresholds that would revert CLN principal repayments to fully sequential (see "Credit FAQ: Understanding Pro Rata Amortization Profiles In EMEA ABS Transactions," published Nov. 24, 2022, and "Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities," published Dec. 22, 2020).

Synthetic excess spread

There is no true sale of assets in a synthetic securitization, and so the protection seller does not directly benefit from any revenue collections on the reference portfolio. In a traditional securitization, any revenue collected that exceeds the amount required to pay timely interest on the notes is typically available to cure any principal deficiencies caused by asset defaults. This helps to maintain parity between the securitized pool balance and the outstanding note balance. The excess spread therefore provides a first line of defense against asset defaults before reliance on hard forms of credit enhancement, such as subordination or overcollateralization, to prevent losses for noteholders.

Although credit protection agreements can include a type of synthetic excess spread that may reduce credit events, the concept does not operate in the same way as excess spread in a traditional securitization. Traditional cash securitizations retain the benefit of any ongoing excess spread over the remaining life of a transaction. Therefore, asset defaults incurred in earlier periods can be cured over time using any excess spread in future periods.

By contrast, in CRTs, we understand that some regulators require synthetic excess spread to be applied only to defaults in a given period. Unlike traditional securitizations, if synthetic excess spread is not required to cure defaults in that period, it cannot be used to cure previous defaults, nor retained to cure potential future defaults. Therefore, we expect CRT transactions containing synthetic excess spread to be more sensitive to the timing of defaults than traditional securitizations.

Fees

In analyzing transaction cash flows, we consider what expenses rank senior to the interest and principal repayments on the CLNs. Incurring senior expenses (for example, certain fees) would erode the availability of cash flows from the collateral or other liquidity reserves available to repay the CLNs.

Early termination events

Most synthetic CRTs are structured as terminating transactions. If the protection buyer defaults or is declared insolvent, the transaction unwinds. There may also be jurisdiction-specific termination events, such as the protection buyer being subject to Federal Deposit Insurance Corp. (FDIC) receivership or conservatorship in the U.S. We consider early termination events when sizing the amount of liquidity available to mitigate the default risk of the protection buyer until the CLNs are repaid (see "Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities," published Dec. 22, 2020, and "Counterparty Risk In Terminating Transactions," published Aug. 15, 2014).

Depending on the jurisdiction and the potential for delays in accessing the collateral for the redemption of the CLN principal, unwinding the transaction typically takes from one to six months. The transaction typically includes a liquidity source (that is, a funded reserve or LOC) large enough to cover the protection premiums that the protection buyer would have paid during this period.

In addition, some structures contain senior termination payments that may be owed to the protection buyer in the event of early termination. If we consider that such payments have not been effectively mitigated, or that they cannot be sized through credit enhancement, our ratings on the CLNs may depend on our rating on the protection buyer (see "Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities," published Dec. 22, 2020, and "Counterparty Risk In Terminating Transactions," published Aug. 15, 2014).

Operational And Administrative Risks

Operational risk may not influence the creditworthiness of synthetic transactions as much as it does in traditional securitizations because the cash flows available to pay CLN investors may not be affected by a disruption to collections on the reference portfolio.

Servicer

Traditional securitizations remain exposed to ongoing collections on the assets until their maturity, and so must transfer servicing to a replacement if the original servicer defaults. However, in synthetic CRT transactions, the collateral account securing the notes is the primary source of repayment, and so actual cash collections on the reference portfolio may not be credit relevant.

Our operational risk analysis considers the performance of the reference portfolio following a disruption of the servicer (severity risk); the likelihood of finding a replacement servicer (portability risk); and the likelihood of a material disruption in servicing (disruption risk). (See "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published Oct. 9, 2014.)

In many synthetic CRTs, the protection buyer is also the servicer for the reference portfolio. In this case, if they default, the transaction is generally unwound and the CLNs are redeemed early. In this instance, we do not generally view servicer portability risk as a material concern, and the limited time for CLN principal redemption mitigates severity risk.

Nevertheless, the servicer can materially influence the number of credit events while the CLNs are outstanding. Therefore, we would not issue or maintain credit ratings on CLNs if we do not consider that the servicer has sufficient experience.

Where servicing of the reference portfolio is performed by a third party and a servicer default would not trigger an early termination event, we consider the transaction's exposure to operational risks to be higher and more closely aligned with those seen in traditional securitizations.

Verification agent

In synthetic CRTs, a conflict of interest may arise if the protection buyer benefits from collections on the reference portfolio and is also responsible for determining whether a credit event has occurred. There may be elevated risk for reference portfolios that include loans such as consumer receivables, where no publicly available information is available to enable stakeholders to verify the occurrence of a credit event.

To mitigate this risk, an unaffiliated third-party verification agent may be appointed. Depending on the transaction documentation, the agent may be responsible for reviewing whether a declared credit event is consistent with the definition in the credit protection agreement. Agents may also be tasked with initiating a review after certain cumulative credit event triggers are breached. We understand that some protection buyers also implement ethical walls so that officers responsible for servicing the reference portfolio are unaware which assets benefit from a credit protection agreement.

Administrative parties

Although the analysis is unlikely to constrain our ratings, we do assess the ability of administrative parties such as trustees or paying agents to perform their roles, and consider how easy it is to replace them. We do not assign credit ratings if, in our view, the transaction parties' roles, responsibilities, and rights are not sufficiently clear.

Legal And Regulatory Risks

A key feature separating synthetic CRT transactions from traditional securitizations is that there is no legal transfer of the ownership of the reference portfolio.

The regulatory treatment of synthetic CRTs (for example, whether protection buyers obtain regulatory capital relief) is generally not material to our credit analysis. Our credit ratings do not address the risk of early termination, although we understand that, in some jurisdictions, regulatory treatment may be linked to early termination.

Some of the legal risks that apply to traditional securitizations may not apply to synthetic transactions because they do not influence credit events. For instance, the definition of a credit event can affect whether or not commingling and setoff risk apply to a specific synthetic CRT transaction. Depending on the type of credit protection agreement, there may also be specific tax or regulatory risks that could affect the cash flows available to pay interest and principal on the CLNs.

Asset isolation and insolvency remoteness

Where CLNs are issued directly by the protection buyer, investors are exposed to their credit risk. If we do not believe that legal or structural factors effectively mitigate the counterparty risk, our ratings on the CLNs may depend on the rating on the protection buyer.

If an SPE issues the CLNs, we analyze legal and regulatory risks much like any traditional securitization. This includes reviewing whether the SPE is consistent with our insolvency remoteness criteria, and other legal risks that may affect the issuer's resources, cash flows, or ability to pay interest and principal on the rated debt (see "U.S. Structured Finance Asset Isolation And Special-Purpose Entity Criteria," published May 15, 2019, and "Asset Isolation And Special-Purpose Entity Methodology," published March 29, 2017).

Regulatory risk

For some structures, in certain jurisdictions, there may be a delay in CLN principal redemption following a termination event. For example, in the U.S., this could occur if the FDIC puts the protection buyer into receivership or conservatorship. Our rating analysis considers the sufficiency of any liquidity support to cover CLN interest during any potential stay or grace period (see "Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities," published Dec. 22, 2020).

What's On The Horizon

It can be difficult to make general predictions about the synthetic CRT market, given that most transactions are tailored according to the specific characteristics of the protection buyer, protection sellers, and reference portfolio. The upcoming implementation of the final aspects of the Basel 3 reforms by regulators around the world could also further affect banks' use of CRTs given that many banks will face higher capital charges under the new rules (see "ABS Frontiers: Looming Basel 3.1 Rules Could Incentivize More Bank Securitization," published June 3, 2024).

As outlined herein, from a credit risk standpoint, we believe that material differences could arise between the creditworthiness of a synthetic CRT and traditional securitization that have the same underlying portfolio of assets and the same level of hard credit enhancement, because of the differing structural features in the transactions.

As the use of synthetic CRT transactions expands into new jurisdictions and underlying asset types, stakeholders will need to remain alert to these potential differences.

Appendix: Glossary Of Synthetic Terminology

• Attachment point: The level of losses beyond which the protection seller makes credit protection payments to the protection buyer. For example, in a 5%-10% tranche, the attachment point is 5%. If cumulative credit events remain below 5%, there is no loss to the protection seller because the protection buyer remains exposed to losses from 0%-5%.
• Collateral posting triggers: To mitigate counterparty risk, the protection buyer or other third-party support providers may be required to post collateral if their credit rating falls below defined thresholds. Furthermore, in unfunded or partially funded synthetics, triggers may be used that require the protection seller to post additional collateral based on the market value of the credit protection agreement or their credit rating. Such triggers can introduce additional risks to the structure.
• Credit event: An event that contributes to contingent payments from the protection seller to the protection buyer (for example, a default of receivables in the underlying reference portfolio). Credit event definitions are specific to each transaction, and the cumulative amount determines the protection seller's obligation to the protection buyer. The timing and amount of credit events can be determined on a gross loss or net loss basis.
• Credit-linked note (CLN): A security that has an embedded credit default swap/guarantee/insurance contract that allows the protection buyer to shift specific credit risk to the investors (protection sellers). The CLN can either be issued directly by the protection buyer (direct CLN) or through a special-purpose entity (SPE) structured to be insolvency-remote.
• Credit risk transfer (CRT): A type of securitization where the primary motivation is to transfer a portion of the credit risk of an underlying portfolio, rather than to raise secured funding, for example. This type of securitization may also be referred to as a significant risk transfer (SRT) transaction.
• Detachment point: The point at which cumulative credit events have exhausted all of the credit protection, implying a total loss for the protection seller. For example, in a 5%-10% tranche, it would have a detachment point of 10%. If cumulative credit events exceed 10%, there is a complete loss to the protection seller and the protection buyer would be exposed to senior losses from 10%-100%.
• Initial collateral: Proceeds from the issuance of the CLN are used to collateralize the protection seller's contingent exposure to make payments to the protection buyer. In CLNs issued by SPEs, the collateral is the primary source of repayment for CLN principal, and may be invested to provide a return that can be used to pay interest on the CLNs.
• Protected tranche notional (tranche thickness): The difference between the tranche attachment and detachment points. In fully funded structures, the protected tranche notional is fully collateralized from day one by the protection seller.
• Protection buyer (short credit risk): The originator (typically a bank) seeking credit protection on the reference portfolio. The protection buyer pays protection premiums to the protection seller.
• Protection premium: A regular payment made by the protection buyer to the protection seller in exchange for the protection seller making contingent payments to the protection buyer. The premium reflects the credit risk of the underlying reference portfolio terms of the credit protection agreement. In funded transactions, the protection premium is combined with the yield on the initial collateral to pay interest on the CLNs.
• Protection seller (long credit risk): Makes payment to the protection buyer if cumulative credit events on the reference portfolio exceed the defined attachment point. By purchasing the CLNs, the investor becomes the protection seller, although where an SPE is the CLN issuer, this role is indirect.
• Reference portfolio: A static or revolving pool of assets that remains on the balance sheet of the protection buyer. The credit protection agreement transfers a portion of the credit risk of the reference portfolio to the protection seller. Some transactions use "blind" pools and disclose only limited information about the reference portfolio to the protection seller, which can introduce additional risks.

Related Criteria

• Criteria | Structured Finance | General: Criteria For Transactions Referencing Credit Derivative Definitions And Documentation, Feb. 10, 2020
• Criteria | Structured Finance | General: Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Criteria | Structured Finance | General: Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions, Jan. 30, 2019
• Legal Criteria: Structured Finance: Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017
• Criteria | Structured Finance | General: Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• Criteria | Structured Finance | CDOs: Counterparty Risk In Terminating Transactions, Aug. 15, 2014
• Criteria | Structured Finance | General: Global Derivative Agreement Criteria, June 24, 2013
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
• Criteria | Structured Finance | General: Methodology For Servicer Risk Assessment, May 28, 2009

Related Research

• ABS Frontiers: Looming Basel 3.1 Rules Could Incentivize More Bank Securitization, June 3, 2024
• Banks Ramp Up Credit Risk Transfers To Optimize Regulatory Capital, Feb. 22, 2024
• Credit FAQ: How We Analyze Credit-Linked Notes Referencing Credit Derivative Definitions And Documentation, Oct. 26, 2023
• S&P Global Ratings Definitions, June 9, 2023
• Credit FAQ: Understanding Pro Rata Amortization Profiles In EMEA ABS Transactions, Nov. 24, 2022
• CDO Spotlight: What Are Termination-With-No-Loss Structures?, Jan. 12, 2011
• CDO Spotlight: What Is A Synthetic CDO?, April 30, 2010