Another Perspective on Risk Transference and Securitization

Abstract

Although issuers often receive a wide variety of benefits from securitization, many commonly used securitization structures fail to transfer meaningful amounts of credit risk. Some structures, however, transfer more risk than others. This Rating Methodology presents an analytical approach that Moody's finds usefulwhen evaluating the credit risk transferred from issuers to securitization investors.

If a lender securitizes a portion of its loan portfolio and uses the proceeds to pay down debt, under what circumstances might the transaction lead to a decrease in risk from the perspective of the lender's unsecured creditors? Assuming that other aspects of the lender's business strategy are unchanged, the degree to which credit risk has been transferred away from the lender's unsecured creditors can be evaluated by remembering the following guideline:

Guideline on Securitization and Credit Risk Transfer A securitization may transfer credit risk away from a lender's balance-sheet creditors to other investors if (in the absence of implicit recourse to the lender or explicit third-party credit support)the securitization bonds are riskier - implying higher expected investor losses - than the lender's unsecured debt prior to the transaction. In contrast, if the securitization bonds are less risky than the lender's debt obligations, risk has generally not been shifted. In fact, the securitization has likely intensified the credit risk exposure of the issuer's unsecured creditors.

Keywords: credit risk, credit rating, securitization, risk transfer