Chinatrust Commercial Bank 2004 ¡V A Special Purpose Trust

2004/08/10

Analysts:

Diane Lam, CFA, Hong Kong Clementine Kiang, Taipei

This report does not constitute a recommendation to buy, hold, or sell securities

Rating Details

(1) The coupon rate is the lower of (a) the 90-day average commercial paper rate plus annualized spreads for each class of certificates for Classes A through D; or (b) the available funds cap rate. Please see ¡§Terms of Certificates¡¨ below for the definition of Available Funds Cap rate (AFC).
(2) Expressed as a percentage of the sum of the aggregate principal balance of the mortgage loans as of the Cut-Off Date and the deposits in the liquidity reserve on the Closing Date.

Profile

Issuer: Deutsche Bank AG, Taipei Branch as trustee for The Chinatrust Commercial Bank
¡@¡@¡@2004-A Special Purpose Trust
Closing date: August 10, 2004
Final legal maturity date: August 25, 2026
Originator/Servicer: Chinatrust Commercial Bank
Trustee/Back-up Servicer: Deutsche Bank AG, Taipei Branch
Arranger: Lehman Brothers

Rationale

Taiwan Rating Corp. today assigned its credit ratings to NT$4.855 billion mortgage-backed floating rate certificates issued by The Chinatrust Commercial Bank 2004 ¡V A Special Purpose Trust (the SPT). Deutsche Bank AG, Taipei Branch, is acting as the trustee for the SPT. The certificates are backed by a pool of first ranking lien residential mortgages originated by Chinatrust Commercial Bank (twAA-/Stable/twA-1).

The ratings reflect the issuer¡¦s ability to pay the contracted interest in full to certificate holders on each interest payment date, and to repay the principal in full on or prior to the final distribution date in respect of the certificates.

The ratings are based on information as of July 19, 2004 (cut-off date). Taiwan Ratings has not consented to, and will not consent to, being named an ¡§expert¡¨ under applicable securities law. A security rating is not a recommendation to buy, sell or hold a Certificate and may be changed or withdrawn at any time by the assigning rating agency. Moreover, the rating does not address the likelihood or timing of prepayment or payment of any available funds cap shortfall amount or shortfall catch-up amount (see Terms of Certificates section) and does not comment on market price or suitability for a particular investor.

The ratings are based on the following:

• The credit enhancement for each class of note is appropriately sized, and the credit support is provided by the subordination of the junior tranches and equity, and subordination of all excess interest cashflows in each monthly collection period;
• The sound payment structure and cashflow mechanics of the transaction;
• The establishment of a cash reserve to support the transaction and to mitigate servicer transition risk;
• Appropriately rated counterparties such as bank account providers;
• The ability of the servicer, Chinatrust Commercial Bank, to service this portfolio;
• The trustee acting as the back-up servicer in the event that another acceptable servicer cannot be retained; and
• The bankruptcy remoteness of the trust.

Originator

Chinatrust Commercial Bank was established in 1966. The bank reported total assets of NT$1,198 billion and equity of NT$84 billion as of the end of May 2004, ranking it as the seventh-largest bank in Taiwan. Taiwan Ratings affirmed its 'twAA-' long-term counterparty credit rating and 'twA-1' short-term credit rating in July 2003. The outlook on the long-term rating is stable.

Transaction Overview

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At the closing of the transaction, Chinatrust Commercial Bank transferred a static portfolio of eligible residential mortgage loans to the SPT. Deutsche Bank AG, Taipei Branch, is the trustee and, according to the trust agreement, is responsible for finding a back-up servicer, or acting as the back-up servicer, if required. The SPT issues four tranches of rated certificates ¡V Class A (twAAA), Class B (twAA), Class C (twA), and Class D (twBBB). The SPT also issues unrated Class E subordinated certificates. The Class A, Class B, Class C, and Class D certificates are sold to investors and the proceeds ultimately paid to Chinatrust Commercial Bank. The Class E certificates are issued to Chinatrust Commercial Bank to absorb the gross losses incurred in the portfolio of up to 3.5% in excess of the losses absorbed in any month by excess interest cashflows.

Terms of Certificates

The rated certificates will pay monthly interest at the lower of: (1) the 90-day average commercial paper rate plus annualized spreads for each class of certificates for Classes A through D; or (2) the available funds cap rate. The available fund cap rate is equal to the annualized interest due and payable on the mortgages, net of senior expenses, such as servicer fees, as a percent of the total certificates outstanding of Class A, Class B, Class C, and Class D. As a result, it is possible that in some or all periods, the interest earned on the certificates could be less than the 90-day average commercial paper rate plus spreads.

Class E certificates will not accrue interest at a fixed rate but will be entitled to distributions of residual interest amounts. Principal on the subordinated certificates will be paid only after the senior certificates have been redeemed in full.

On payment dates, if the 90-day average commercial paper rate plus various spreads is greater than the available funds cap rate, the difference is called the available funds cap shortfall amount. If the available funds cap shortfall is not paid in full, the unpaid portion is called shortfall catch-up amount. Both the available funds cap shortfall and the shortfall catch-up amount are tracked and accumulated, and on current and subsequent payment dates, investors will be entitled to excess funds in the form of waterfall payments as stipulated in the trust agreement. The rating will not address the timely and full payment of the available funds cap shortfall amounts and shortfall catch-up amounts.

Structural benefits to investors include:

• Principal collections may be used to fund any shortfalls on senior expenses and interest to certificate holders. This is a form of internal liquidity, which helps ensure timely of interest payment to investors.
• Excess interest may be used to accelerate principal reduction under certain situations.
• Chinatrust Commercial Bank, as Servicer, will make servicer advances to fund delinquencies and other liquidation costs. For analytical and cashflow analysis purposes, we have assumed that the servicer is unable to make such advances.
• Liquidity reserves are sized to ensure that temporary disruption associated with a servicer transition event can be overcome, and the reserve is sized to include the cost of notifying obligors.

Loan Portfolio

The loan pool for this securitization consists of 2,723 loans, representing a balance of about NT$5.008 billion. Features of the mortgage pool include the following:

• All of the mortgages are secured by a first lien over the relevant property;
• 76% of the loan pool balance are private loans (adjustable rate mortgages) originated by Chinatrust Commercial Bank and 24% are subsidized loans under the NT$800 billion government subsidy program;
• The mortgages are amortizing and 39% incur only interest for up to one-sixth the term of the loans;
• The largest concentration of mortgages by geographic area is in northern Taiwan, accounting for 64% of the total loan amount, while the other regions account for 36% of total loan amount;
• All loans were originated after January 2002 with a weighted average loan seasoning of 19 months;
• About 77% of the loan pool has a loan to value that does not exceed 80% at the date of the initial advance;
• The weighted average original loan to value of the mortgage pool is 73%;
• The average outstanding mortgage balance is NT$1.8 million;
• The average age of the property is 10 years;
• About 67% of borrowers are employed with regular salary; and
• About 73% of total loans are collateralized by condominiums.

Credit and Cashflow Analysis

The analysis includes a conservative assessment of the credit risk inherent in the transaction. The credit enhancement level of each rating category is determined after analyzing the impact of various stress scenarios. The cash flow analysis takes into account:

• The ability of the transaction to withstand losses through defaults under different stress scenarios;
• The ability of the transaction to realize the recovery value of defaulted mortgages under various stress scenarios;
• The ability of the transaction to withstand a significant prepayment stress;
• The ability of the deal to withstand a sharp rise in the interest rate and interest rate mismatching (basis risk); and
• The ability of the deal to withstand delay in payment as a result of delinquent loan payments and in the absence of servicer advances.

Structural Analysis

Interest rate risk.

Interest payments in the portfolio are calculated according to the adjustable rate mortgage (ARM) rate for private mortgages and the two-year postal savings rate for mortgages subsidized by the government. The ARM rate is based on the one-year time savings deposit of 10 banks in Taiwan, excluding the two banks with the highest interest rates and the two with the lowest, and averaging the interest rates of the six remaining banks. The rated certificates will pay monthly interest at the lower of: (1) the 90-day average commercial paper rate plus annualized spreads for each class; or (2) the available funds cap rate. Although the certificates are entitled to payments of available funds cap shortfall and shortfall catch-up amounts, as described previously, this feature is not included in the cashflow analysis.

Basis risk exists between the ARM rate and the 90-day average commercial paper rate. The risk is also presented between the postal savings rate and the 90-day average commercial paper rate. Since there is no basis swap in this transaction, Taiwan Ratings used interest rate assumptions based on the historical interest rate movements of the three index rates.

Prepayment risk

Prepayment may occur if a borrower transfers its loan to another bank or it has increased income and may desire to repay the debt. Government subsidized loans tend to have slower prepayment rate than normal loans. Prepayment risk is determined according to expected reduced amount of total interest received from the loan pool when prepayment occurs. The risks are mitigated by assuming the cash flow at different levels of prepayment.

Commingling risk

The servicer remits monies, such as loan principal and interest, to the collection account one business day after the funds are collected. Nevertheless, should the servicer become insolvent, there is a risk that collection of the mortgages may be lost. After analyzing the amount at risk, commingling risk is determined, and factored in a solvency reserve, which will be funded at closing. The solvency reserve is not used for general liquidity purposes.

Obligor set-off risk

Set-off risk exists because borrowers have the right to set off debt by using deposits placed in the lending bank to settle debts owed to the bank. The amount of the borrower can set off is equal to the borrower¡¦s total deposits in the lending bank at the time the transfer of the borrower¡¦s loan to the SPT is publicized. As the government-funded Central Deposit Insurance Co. offers deposit insurance of up to NT$1 million for every depositor in each bank, the set-off risk is partly mitigated by this deposit insurance. Set-off risk is mitigated by increasing the solvency reserve that will be funded at closing.

Servicer risk

Chinatrust Commercial Bank will act as the initial servicer for the loan portfolio. Upon the occurrence of a servicer termination event, Deutsche Bank AG, Taipei Branch, will either replace Chinatrust Commercial Bank as the servicer or find another suitable servicer for the pool. To provide additional liquidity support to cover possible interruptions in cashflow to the certificates that may occur during a servicer transition, a liquidity reserve will be funded when the transaction is closed to meet three months of senior expenses plus certificate interest payments for the transaction.

Earthquake risk

All mortgages in Taiwan must carry fire insurance policies. New loans originated after April 1, 2002 must be covered by earthquake insurance. Mortgages which were originated before April 2002 and later transferred to another institution are not required to have earthquake coverage. As a result, not all mortgages are covered by earthquake insurance. Earthquake insurance covers up to NT$1.2 million of the replacement cost of the mortgaged property. To mitigate earthquake risk, the mortgaged property is diversified by geographic distribution.

Legal and Tax Analysis

Legal

The transaction structure is in accordance with the Financial Asset Securitization Law of Taiwan (FASL), which provides for the establishment of the SPT, the transfer of assets from the originator to the SPT, and perfection third parties.

Tax

Article 41 of the FASL stipulates that income from trust property after deduction of costs and necessary expenses belongs to the beneficiaries. Such net income will be taxed as interest income for certificate holders at a rate of 6% and withheld by the SPT.

Taiwan Ratings received satisfactory legal and tax opinions prior to the closing of the transaction.