What factors do the rating agencies consider in analyzing the structural risk in

a securitization?

What will be an ideal response?

The decision on the structure is up to the seller. Once selected, the rating agencies examine the extent to which the cash flow from the collateral can satisfy all of the obligations of the bond classes in the securitization. The cash flow of the underlying collateral is interest and principal repayment. The cash flow payments that must be made are interest and principal to investors, servicing fees, and any other expenses for which the issuer is liable. This is described by the structure's cash flow waterfall. The rating agencies analyze the structure to test whether the collateral's cash flows match the payments that must be made to satisfy the issuer's obligations. This requires that the rating agency make assumptions about losses and delinquencies and consider various interest rate scenarios after taking into consideration credit enhancements.

In considering the structure, the rating agencies will consider (1) the loss allocation (how losses will be allocated among the bond classes in the structure), (2) the cash flow allocation (i.e., the cash flow waterfall), (3) the interest rate spread between the interest earned on the collateral and the interest paid to the bond classes plus the servicing fee, (4) the potential for a trigger event to occur that will cause the early amortization of a deal (discussed later), and (5) how credit enhancement may change over time.

We can note that in the past four nationally recognized statistical rating organizations rate
asset-backed securities. These rating agencies evaluate many factors related to risk for
asset-backed securities (ASB). For example, in analyzing credit risk, the rating companies focus on the following factors: credit quality of the collateral, the quality of the seller/servicer, cash flow stress and payment structure, and legal structure. In regards to the servicer, Duff & Phelps reviews the following factors when evaluating servicers: servicing history, experience, originations, servicing capabilities, human resources, financial condition, and growth/competition/business environment. Based on its analysis, Duff & Phelps determines whether the servicer is acceptable or unacceptable. More details are supplied below.