Tokyo, July 27, 2010 -- Moody's Investors Service has commented on the important topic of back-up
servicing for securitizations backed by loan receivables, and which
involve payments (both current and prior) of gray-zone interest,
and where back-up servicing is delegated to regulated servicers.
Moody's sees uncertainty in back-up servicing operations,
such as recalculation risk, in gray-zone interest asset ABS,
when such servicing is delegated to regulated servicers.
This is because i) the operational guidelines for the inspection and supervision
of servicer firms were revised on July 1, 2010; ii) the nature
of regulated servicers' policies on back-up servicing operations;
and iii) recent events surrounding regulated servicers, etc.
Moody's believes the rating levels for the associated securitizations
may differ, depending on the availability of back-up servicers
in each instance, and the current servicers' credit quality.
1. Revisions to operational guidelines for servicer firms
On January 25, 2010, the Ministry of Justice ("MOJ")
called for comments on its proposed revision of operational guidelines
for the inspection and supervision of servicer firms.
By "servicer firms," the MOJ is referring to all companies
regulated under the Act on Special Measures Concerning the Business of
Management and Collection of Claims -- the Servicer Law. (These
firms are defined as "regulated servicers" in this report.)
On June 17, the MOJ published a summary of the public comments on
its proposed revisions to the operational guidelines. These guidelines
were then revised on July 1 ("the revised guidelines").
The revised guidelines include clauses on receivables with "gray-zone
interest," and which are:
(i) Re-calculation of the principal amount -- based
on the maximum interest rate under the IRRL -- should be
carried out by returning to the loan agreement date, that is when
the receivables were first generated.
(ii) The principal amount of the receivables will be re-calculated
based on the above, even when the regulated servicers provide only
notices on repayments -- but not demand for repayments --
to the obligors about repayment amounts.
(In Japan, interest rate caps are regulated by two statutes:
the Interest Rate Restriction Law (IRRL) and the Capital Subscription
Law, each of which stipulates a different cap. The difference
in the interest rate charged between the two caps is called "gray-zone
Regarding these clauses, the MOJ's answers --
in summary -- to the public comments include the following:
- MOJ advises that it is better to dissolve, or decrease
agreements on delegated payment notice operations, and this is the
case with gray-zone interest receivables.
- The revisions are a clarification of MOJ's original view.
- The revised guidelines are applied to notifications to obligors
of repayment amounts under the relevant agreements entered into after
the revised guidelines become effective.
2. Moody's view on back-up servicing
Moody's considers that the main issues for assessing the back-up
servicing of transactions are their actual policies for back-up
servicing, based on the revised guidelines.
Moody's interviewed the regulated servicers, who are back-up
servicers in existing securitizations, on their policies on back-up
servicing operations and the recalculation of the underlying receivables.
The answers differed according to each regulated servicer, but we
could not get definite answers -- such as those which said
that they would not recalculate receivables -- on back-up
servicing agreements entered into before the revised guidelines.
Regarding securitizations -- where back-up servicing
agreements were entered into before the enforcement of the revised guidelines
-- Moody's considers the possibility of the recalculation
of the underlying receivables when this back-up servicing takes
This is a result of -- in addition to the regulated servicers'
policies -- two factors: i) recently, some regulated
servicers received administrative punishments because they deviated from
the scope of payment notice operations, and ii) the difficulties
in handling gray-zone interest assets in the scope of payment notice
3. Risks and impact to ratings
Moody's has concerns about the uncertainty over back-up servicing
for gray-zone interest asset ABS, and wherein the back-up
servicer is the regulated servicer.
"Uncertainty over back-up servicing" means-- in our
i) The regulated servicers may recalculate the principal amounts of the
underlying receivables when back-up servicing occurs (recalculation
ii) The delegation of back-up servicing to a third party --
other than the regulated servicers -- may be difficult.
Recalculation risk will occur only when the following events materialize,
although not for all transactions;
- A servicer replacement events occur and back-up servicing
takes place, and,
- The back-up servicer determines that it needs to recalculate
the underlying receivables principal amount, and,
- Back-up servicing cannot be delegated to those servicers
which do not recalculate receivables.
However, should recalculation risk materialize, it is generally
assumed that over half of the underlying receivables may be diluted.
Moreover, if the diluted amount cannot be sufficiently covered by
the credit enhancement available, then the rated securities may
Moody's believes that the credit quality of current servicers and
the availability of back-up servicers are key factors for making
any risk assumptions.
If the relevant servicer's credit quality is low, or the availability
of a back-up servicer seems low, then Moody's believes
it may be difficult for the transaction to pass the stressed scenario
under a high rating level.
This is because the scenario -- wherein servicer replacement
occurs and back-up servicing takes place should --
be considered as one of the stressed scenarios when determining the ratings.
The availability of a back-up servicer should be considered on
a deal-by-deal basis.
Generally, Moody's currently considers that -- in cases
of securitizations of major consumer credit (shinpan) and credit card
companies -- the availability of back-up servicers
is higher than in other instances.
This was concluded after interviewing each company and after considering
the existence of transactions where back-up servicing is delegated
to firms other than the regulated servicers. If the availability
of back-up servicers seems high, then such a situation would
mitigate the uncertainty over back-up servicing.
However, even when the availability of back-up servicers
is high, any uncertainty over the issue would still not be resolved
unless an agreement is entered into with another back-up servicer.
Therefore, if there remains uncertainty over back-up servicing,
then the ratings on the relevant securitizations may be negatively affected,
especially for deals where the servicer's credit quality is low.
On the other hand, if the availability of back-up servicers
is assumed as low, then the possibility of actual recalculation
risk is higher. Therefore, the ratings on such a securitization
may be lower than when the availability of back-up servicers is
The guidelines for the rating ceilings for gray-zone interest asset
ABS -- which meets certain conditions, including where
the back-up servicer is a regulated servicer -- are
Each rating ceiling has a range because rating levels differ according
to factors such as the level of back-up servicer availability,
the level of servicer credit quality, etc.
Note that the availability of a back-up servicer is relative,
and may change according to regulatory, or legal conditions,
the policies of back-up servicer candidates, their capacity,
etc. The guidelines below are just a guide, given current
<Rating ceiling guidelines for gray-zone interest asset ABS
which meets the conditions (**) including BUS is the regulated
- Availability of back-up servicer is assumed to be high
Servicer's rating is investment grade equivalent: Aaa
Servicer's rating is Ba1- B1 equivalent: Aaa-
Servicer's rating is B2- B3 equivalent: Aa-
Servicer's rating is Caa1 or lower equivalent: A- Baa
- Availability of back-up servicer is assumed to be low
Servicer's rating is investment grade equivalent: Aa-
Servicer's rating is Ba1- B1 equivalent: Baa-
Servicer's rating is B2- B3 equivalent: Ba
Servicer's rating is Caa1 or lower equivalent: Ba-
1. The back-up servicer is a regulated servicer under the
2. The back-up servicing agreement was entered into before
the enforcement of the revised guidelines.
3. It is considered that dilution -- due to recalculation
under the IRRL -- will not be sufficiently covered by the
4. The liquidity reserve is sufficient to actually start back-up
5. There are no governance concerns for the servicer.
(*1) In this case, it is assumed that some candidates for back-up
servicing exist in the market, and delegation to other back-up
servicers may be possible.
(*2) In this case, candidates for back-up servicing are
extremely limited, and delegation to other back-up servicer
These are just guidelines and therefore actual ratings may be higher than
the rating ceiling if the transactions include any positive factors.
(see the following for example).
Positive factors to be considered (examples):
- Diluted amount -- due to recalculation --
is fully covered by the increased level of credit enhancement.
- The asset trustee has definitive and feasible policies,
regarding delegation of back-up servicing, to prevent recalculation
- The deal's remaining period is short, for example less
than 6 months.
As for the servicer's credit quality, if the servicer or its
parent has no ratings assigned by Moody's, then there will
be reference to credit estimates. (See the Moody's rating
methodology "Updated Approach to the Usage of Credit Estimates in
Rated Transactions" October 2009)
4. Points of concern
- Even if the transaction is considered to have a high level of
access to a back-up servicer, its ratings may be affected
if any events -- which affect the availability of a back-up
servicer -- occur.
- When delegating the back-up servicing operations to another
back-up servicer, there may exist some issues, such
as the nature of the asset trustee's decision; selecting the
back-up servicer; investor approval, if needed;
execution of back-up servicing agreement; amendment of the
trust agreement, if needed; payment of fees; construction
of a system for back-up servicing, etc. These issues
should be carefully monitored.
Moody's Investors Service is a publisher of rating opinions and research.
It is not involved in the offering or sale of any securities, nor
is it acting on behalf of the offering party. This release is not
a solicitation or a recommendation to buy, hold, or sell securities.
Asst Vice President - Analyst
Structured Finance Group
Moody's Japan K.K.
JOURNALISTS: (03) 5408-4110
SUBSCRIBERS: (03) 5408-4100
MD - Structured Finance
Structured Finance Group
Moody's Japan K.K.
JOURNALISTS: (03) 5408-4110
SUBSCRIBERS: (03) 5408-4100
Moody's comments on impact of back-up servicing for gray-zone ABS to ratings