IBT CBO 2005-1

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

Rating Details

Profile

Issuer: Land Bank of Taiwan (Land Bank) as trustee on behalf of Industrial Bank of Taiwan Collateralized Bond Obligation (IBT CBO) 2005-1 (the Special Purpose Trust (SPT))

Closing Date: December 1, 2005

Final Legal Maturity Date: June 3rd, 2012

Originator: IBT (twA-/positive/twA-2)

Trustee/Custodian/Account Bank: Land Bank (twAA+/stable/twA-1)

Swap counterparty: JP Morgan Chase Bank (rated AA-/stable/A-1+ by Standard & Poor’s Ratings Services)

Arranger: Industrial Bank of Taiwan (IBT) 　

Rationale

The four tranches of certificates issued by the issuer are backed by a portfolio of 20 New Taiwan dollar (NT dollar) denominated corporate bonds and bank debentures, as well as two United States dollar (US dollar) denominated Synthetic Collateralized Debt Obligations (SCDOs).

The ratings address the full and timely payment of interest and full repayment of principal on or before the final legal maturity date on June 3, 2012. The final ratings were assigned on the closing date after a satisfactory review of all documents, as well as legal and tax opinions.

The credit ratings are based on the following factors:

• The credit enhancement provided through the subordination of cash flows to the respective class;
• The transaction’s cash flow structure, which has been subjected to various stresses requested by Taiwan Ratings;
• The transaction’s cross currency swap and interest rate swaps;
• The ratings of the supporting parties such as the swap counterparty and the bank account provider; and
• The legal structure of the transaction, including the bankruptcy remoteness of the SPT.

Strengths, Concerns and Mitigating Factors:

Strengths:

• Of the total portfolio, more than 97%, in terms of NT dollar and par value, is rated twA+ or above, or is guaranteed by banks rated twA+ or above, or is rated investment grade by Standard & Poor’s; and
• Interest rate risk and foreign currency risk is adequately hedged through interest rate swaps and cross currency swap.

Concerns:

• Industry concentration. In terms of asset par value, SCDO and banking industry (bonds guaranteed by banks are also classified as banking industry) account for 50% and 34%, respectively, of the portfolio; and
• Some of the corporate names appear in both SCDOs. Therefore, the default of one name could affect two SCDO tranches.

Mitigating Factors:

• Although 84% of the portfolio is concentrated in SCDO and banking industry, such concentration has been taken into account by Standard & Poor’s CDO Evaluator when determining the loss threshold that this transaction has to withstand at various rating levels.
• Taiwan Ratings has adopted Standard & Poor’s drill-down approach to capture the overlap and other risks should a credit event occur on an underlying corporate name referenced in both SCDO tranches. 　

Transaction Overview

At closing, the Originator transferred US dollar denominated SCDOs and NT dollar denominated corporate bonds and bank debentures to the trust. The trustee on behalf of the trust issued NT dollar denominated class A [twAAA], class B [twAA], class C [twA], and class D [twBBB] trust certificates (collectively “Senior Trust Certificates”) and unrated subordinated trust certificates. The senior trust certificates were sold to investors. Part of the proceeds raised from investors were converted into US dollars with the swap counterparty. The US dollar proceeds, together with the remaining NT dollar proceeds and the subordinated trust certificates were paid to the Originator in consideration of the transferred SCDOs and NT dollar bonds.

The deal has a static pool from closing and no substitution of trust asset is allowed.

During the life of the transaction, the SPT will collect US dollar proceeds and NT dollar proceeds based upon different reference rates from the underlying assets. The SPT entered cross currency swap and interest rate swaps to convert such cash flow into fixed-rate based cash flow at predetermined exchange rate (if applicable) to pay fixed-rate coupon rates to certificate holders.

The interest collections will be distributed in accordance with interest waterfall. The principal collection will be first used to cover interest shortfall, and then to pay down the trust certificates sequentially.

From closing, the remaining interest collection after being applied according to interest waterfall, if any, will be distributed to equity holders. Upon the occurrence of early amortization trigger, or the breach of overcollateralization, or interest coverage tests, such residual interest will be diverted to pay down Senior Trust Certificates.

In terms of SCDO in the underlying pool, should a credit event occur on an underlying corporate name, a fixed recovery rate would be used to calculate loss. The resulting loss would be incurred by each SCDO tranche referencing that corporate name. If total losses exceed the loss threshold for the SCDO tranche, the interest bearing/redemption amount of the SCDO would be reduced by the excess amount. In other words, a principal loss would be incurred in the trust assets at CBO level. However, the SCDO with reduced redemption amount would remain in the trust asset of CBO and continue to generate yield based upon initial coupon rate to the SPT of the CBO.

Terms and Conditions of the Notes

Interest payment

The Senior Trust Certificates will pay fixed-rate coupon rates in arrears in March, June, September, and December starting from March 2006. Should the SCDOs experience any potential credit event in the last collection period, the trust distribution date will be reset to match the relevant terms of the SCDOs.

Principal payment

The transaction is structured as a pass-through with principal repayments being used to repay the trust certificates as they are received. When the Senior Trust Certificates outstanding represent less than 10% of the initial Senior Trust Certificates outstanding at closing, the trustor, subject to other terms in the transaction documents, may have a clean up call to redeem Senior Trust Certificates then outstanding in full.

Liability Hedging

Interest Rate Swaps

This transaction is exposed to interest rate risk because the SPT will receive structured coupon rates such as inverse floater (a constant rate minus a floating reference rate) and range accrual (coupon rate depends on which range the reference rate falls in) from the underlying NT dollar assets but will pay fixed-rate coupon rates on Senior Trust Certificates. The relevant interest rate risk will be eliminated through asset specific interest rate swap on each NT dollar denominated bond.

In the event of any NT dollar asset default and the immediate termination of the relevant swap, the potential swap breakage cost payable to the swap counterparty, if any, could negatively affect the cash available for distribution to the certificate holders. To mitigate such risk, the transaction is structured so that the trustee has the option to terminate the relevant swap, subject to Rating Agency Confirmation or the resolution of the certificateholder meeting. Moreover, Interest Rate Swap breakage cost for each rating level was taken into account when credit sizing.

Cross Currency Swap

The US dollar denominated SCDOs will pay floating-rate coupon rates in US dollars to the SPT, while the SPT will pay fixed-rate coupon rates in NT dollars to certificate holders. The SPT entered into cross currency swap to mitigate the relevant currency risk and interest rate risk.

If the total losses exceed the attachment point of the SCDO tranche, and in turn the swap notional amount needs to be adjusted accordingly, no swap breakage cost would incur due to the partial unwinding of the cross currency swap.

Collateral Characteristics

The collateral with the par value of NT$11,500,730,000 equivalent as of closing date consists of a portfolio of 20 NT dollar denominated bonds and debentures and 2 US dollar denominated SCDOs. The weighted average life of the NT dollar portfolio and SCDO is around 2.5 years and 5 years, respectively. The breakdown of the collateral portfolio by asset type and industry is as follows:

Credit and Cashflow Analysis

Standard & Poor's CDO Evaluator was utilized to determine the expected default rate for the portfolio at each rating level. Through a Monte-Carlo simulation, the CDO Evaluator factors the probability of individual bond issuer default, obligor concentration (guarantee banks were considered for bank guaranteed bonds in estimating credit risk of each underlying asset), industry correlations, and maturity of each asset, and computes the expected level of default that each CDO tranche would be able to withstand at a given rating level.

In addition, to verify that full and timely payment of interest and ultimate repayment of principal on the certificates can be met, Taiwan Ratings performed a cash flow analysis and subjected the transaction to a variety of stress scenarios.

The following elements were taken into account in the modeling to capture the specifics of the transaction:

• Various default patterns were modeled, including front-end losses, evenly-spread losses, and back-end losses;
• For NT dollar denominated assets, moderate recovery rates were assumed. Recovery rates were reviewed and adjusted by Taiwan Ratings case by case mainly based upon the seniority of the debt and industry. Recoveries were modeled with adequate time for workout after default.
• For SCDOs, a fixed recovery rate will be applied should a credit event occur on an underlying corporate name. The resulting loss is incurred by each SCDO tranche referencing that corporate name. If the total losses exceed the loss threshold of the SCDO tranche, a loss is incurred at the CBO level. This feature was taken into account when running the CDO Evaluator, and therefore removes the need for SCDO recovery assumption.
• Overcollateralization and Interest Coverage tests were also modeled to trap excess yield should the test be breached as per the transaction documents.
• Business tax on the collections from US dollar denominated SCDOs in accordance with the deal-specific tax ruling and withholding tax on the collections from NT dollar assets were deducted from cash available for distribution in cash flow modeling.

Structural Analysis

Commingling Risk

There is no commingling risk in this transaction since the payments from the underlying assets will be remitted directly to the SPT's account.

Set-off Risk

In theory, set-off risk is possible in this transaction. This is because the originator is a deposit taking institution and takes deposits from the underlying bond issuer. Moreover, bonds in bearer form have to be converted into registration form before entrustment in accordance with applicable laws and rulings. Therefore, should the originator be insolvent, the obligors may exercise set-off rights against trust assets, and the SPT may incur losses.

Potential set-off risk was crystallized at closing and mitigated by cash reserves set aside by the originator within 5 business days from closing.

The required cash reserves will be calculated on each Trust Distribution Date. Such required amount may reduce if deposits from the obligors reduce after closing. On each Trust Distribution Date, the amount exceeding required amount, after covering interest shortfall, will be returned to the originator.

Legal and Tax Analysis

Prior to assigning the final ratings and the closing of the transaction, Taiwan Ratings received satisfactory legal and tax opinions.