Polaris Securities Co. Ltd. and Bank of Overseas Chinese Corporate Bond Securitization Special Purpose Trust 2006-1

This report does not constitute a recommendation to buy, hold, or sell securities. Subsequent information may result in rating changes.

Rating Details

Profile

Issuer: The Hong Kong and Shanghai Banking Corp. Ltd, Taipei Branch (HSBC Taipei) (rated AA-/Stable/A-1+ by Standard & Poor's Ratings Services) as Trustee for Polaris Securities Co. Ltd. (PSC) (twA-/Stable/twA-2) and Bank of Overseas Chinese (BOCC) (twBBB/Stable/twA-3) Corporate Bond Securitization Special Purpose Trust 2006-1 (the SPT).

Issue: NT$12.225 billion senior and subordinated trust beneficial certificates due in 2013 and NT$50 million seller certificates.

Closing date: April 18, 2006.

Trustee/Servicer: HSBC Taipei.

Trustor/Originator: PSC as New Taiwan dollar (NTD) asset originator; BOCC as U.S. dollar (USD) asset originator.

Rating Dependent: Account Bank, SWAP counterparties (including those of Cross Currency SWAP (CCS) and Credit Default SWAP (CDS) under Synthetic Collateralized Debt Obligation (SCDO)), collateral security under the SCDO.

Rationale

Taiwan Ratings Corp. assigned its 'twAAA', 'twAAA', 'twAA', 'twA', and 'twBBB' ratings to senior trust beneficial certificates of NT$7,150 million, NT$1,785 million, NT$1,080 million, NT$1,090 million, and NT$570 million, respectively, all due in 2013. The certificates were issued by HSBC Taipei in the capacity of Trustee for the SPT. The ratings address the timely payment of interest and full ultimate repayment of principal on or before the senior certificates' legal maturity date in 2013. The trust certificates are backed by a static pool of NTD corporate bonds (the NTD bond portfolio) and USD SCDO (together, the bond portfolio).

The ratings reflect:

• The credit quality of the portfolio;
• The level of credit support for each tranche of senior certificates provided by subordinated certificates and equity certificate;
• The establishment of a cash liquidity reserve at closing;
• Various cash flow runs for each tranche proving the structure's ability to achieve timely payment of interest and ultimate repayment of principal by the final legal maturity date;
• The existence of trigger events;
• Credit assessment result of the SCDO;
• The ratings of the supporting parties such as bank account providers, CCS and CDS provider, eligible investments, and SCDO collateral security;
• The CCS, which appropriately hedges the basis as well as foreign exchange risk;
• Satisfactory legal and tax opinions; and
• The bankruptcy remoteness of the SPT.
  
  

Strengths, Concerns and Mitigating Factors:

Strengths

• The transaction's sequential payment structure ensures that the most senior rated certificates will be repaid in full before any proceed may be used to redeem the junior classes of certificates;
• Over half of the bonds will mature within three years;
• A tail period between the last maturity date of the pool and the final legal maturity date of the certificates ensures sufficient time to work out defaulted bonds;
• Excess spread will either be trapped at liquidity reserve or at collection account. No payment will be made to equity holders before full redemption of senior Trust Certificates (TCs); and
• Non-amortizing credit support results in increasing amounts of credit support as more senior tranches are paid down.

Concerns

• Concentration of pool assets among several issuers and industries; and
• Low pool yield.

Mitigating Factors

• Standard & Poor's CDO EvaluatorTM takes the concentration issue into consideration when performing credit sizing;
• A cash liquidity reserve has been set aside at closing to compensate for insufficient yield. Taiwan Ratings has performed various cash flow tests to ensure the sufficiency of the reserve throughout the life of the transaction.
  
  

Transaction Overview

At closing, PSC and BOOC entrusted the bond portfolio consisting of 28 NTD denominated bonds and 1 USD denominated SCDO to the SPT. HSBC Taipei as the Trustee in turn issued three types of certificates, namely senior trust beneficial certificates, subordinated trust beneficial certificates, and seller certificates. The senior beneficial certificates were placed by public offering and the proceeds therefrom paid to the Originators. The subordinated beneficial certificates as well as the seller certificates were privately placed.

Terms of the Certificates

The senior trust beneficial certificate holders will receive fixed-rate coupon payments at the rate specified on the indenture. The subordinated trust beneficial certificates will not receive any payment until all senior beneficial certificates are fully redeemed. The seller certificate holders will only receive interest collection from certain NTD bonds specified on the indenture. Both the subordinated trust beneficial certificates and the seller certificates are non-rated. Except for the first interest payment, all payments with respect to trust certificates will be made on a semi-annual basis while payments to seller certificates will be made on a monthly basis. Except for those interest collections that will be directed to seller certificates, all principal and interest (P&I) collection will be pooled together and distributed to investors following the stipulated waterfall. When there is any shortage with respect to senior fees and senior beneficial certificate coupon payments, as P&I are pooled together, the principal collection will initially be used to cover the shortage on a temporary basis. If there is any remaining shortage, the cash liquidity reserve will be used, again on a temporary basis.

Article 41 of the Financial Asset Securitization Law stipulates that income from trust property, after deduction of costs and necessary expenses, belongs to the beneficiaries. The interest distribution, however, will be subject to withholding tax at the rate stipulated by the tax authority. Consequently, interest received by certificate holders will be net of tax withheld.

In addition to the tax abovementioned, the interest payment will also be net of remit expenses.

Before the acceleration event is triggered, trust certificates will be paid down following the principal amortization schedule. Principal collection in excess of the schedule payment will be trapped in a principal reserve account. Upon occurrence of the acceleration event, principal payment will be changed to pass-through basis and all proceeds sitting in the principal reserve account will be used to pay down trust certificates. Subordinated trust beneficial certificates will not receive any payment until all senior beneficial certificates have been fully redeemed. Principal payment, naturally, will not be subject to withholding tax. If the liquidity cash reserve and cumulative cash collection are sufficient to redeem Class D at its expected maturity day, all liquidity cash reserves will be pooled into the waterfall. Otherwise, the liquidity cash reserve will be saved to cover the SPT's obligation until the arrival of final legal maturity date.

The Bond Portfolio

The asset pool is static, i.e. the Originators cannot entrust new bonds to the SPT nor can any third party substitute any existing bonds after closing date. The reference pool of the SCDO is also static. On closing day, 29 bonds were included in the portfolio. About 21% of the pool balance is composed of NTD plain vanilla fixed rate corporate bonds, 39% is of NTD structured notes (inverse floaters and range accruals), and 40% is of USD SCDO.

The NTD bond portfolio is concentrated in Taiwan's financial services industry, given that a large portion of the non-bank corporate bonds are guaranteed by banks. Excluding the SCDO, about 20% of the total pool balance is concentrated on two obligors. The SCDO alone accounts for about 40% of the total pool size. The SCDO concentration is somewhat mitigated by its partial write down feature. The pool's weighted average yield and weighted average maturity is about 1.63% and 3.15 years, respectively. All the abovementioned features have been incorporated into Taiwan Ratings' analysis in deciding required credit support for each rating level.

Credit Assessment on the SCDO

As the SCDO is not rated by Taiwan Ratings or Standard & Poor's, Taiwan Ratings has performed credit assessment on it. Credit sizing on the CBO is based on the results of Taiwan Ratings' credit assessment. As with other bonds in the pool, continuous surveillance will also be performed on the SCDO by Taiwan Ratings to ensure the credit quality of the SCDO is commensurate with that of the trust certificates. The credit assessment may not be consistent with the ratings assigned by other rating agencies. The collateral security and CDS counterparty of the SCDO will be hard-linked to the CBO, i.e. if the collateral security is downgraded below a certain level and the SCDO administrator does not replace it with new collateral security that complies with the investment criteria, the CBO will be downgraded accordingly. Downgrade of the CDS counterparty might also trigger the downgrade of the CBO.

Investors should note that, upon the occurrence of a tax event, the counterparty will have the option to terminate the CDS and the SCDO will be early redeemed. Taiwan Ratings has received satisfactory legal opinions indicating no such tax event is occurring and continuing as of the closing day.

Credit and Cash Flow Analysis

The majority of the underlying issuers are rated by Taiwan Ratings and/or Standard and Poor's. Taiwan Ratings has performed credit assessment on those un-rated obligors. The ratings along with obligor and industry information, size, and maturities are then incorporated into Standard & Poor's CDO EvaluatorTM to determine the default risk of the bond portfolio. CDO EvaluatorTM applies the Monte-Carlo methodology to integrate all abovementioned factors in determining the maximum level of defaults that a CDO class must be able to withstand at a given rating level. To give credit to the partial write-down feature of the SCDO, drill down approach is used for the credit sizing. Instead of relying on the SCDO's rating, drill down approach takes the rating and industry distribution, as well as information such as maturity date, notional amount, and country and region information of the reference entities of the SCDO into consideration. The impact of the credit quality of the SCDO itself is reflected through the attachment and detachment points in the drill down approach.

Furthermore, Taiwan Ratings has performed cash flow analysis under various stress scenarios to verify the prompt interest payment and ultimate principal repayment of the senior beneficial certificates. Capped breakage cost of the CCS due to credit event(s) of reference entity(-ies) under the SCDO will rank junior to interest but senior to principal payments in the waterfall. Taiwan Ratings has sized in this cost into the cash flow runs.

Structural Analysis

Commingling risk.
Commingling risk is fairly remote with this transaction. The majority of the payments will be remitted directly to the trust accounts. Under rare occasions when proceeds are collected by the servicer, the servicer will be required to remit the collection to the Trust account within the same business day. The trustee will be responsible for defaulted bonds' workout and will deposit any recovery proceeds directly into the trust accounts.

Obligor set-off risk.
Set-off risk is very remote with this transaction. As PSC is a securities house, it is highly unlikely that debt relationships exist between PSC and the obligors and will grant set-off rights to the obligors. In addition, although the USD asset originator BOOC is a deposit taking bank, as the SCDO is issued by an offshore issuer, it is highly unlikely that any debt obligation exists between BOOC and the SCDO issuer. As such, set-off risk is very remote and is somewhat mitigated by the originator's representation and warranty.

Interest and Exchange rate risk.
There exist interest reference rate as well as payment currency mismatches between the SCDO and the trust certificates. Nevertheless, the trustee entered into a CCS on closing day to hedge these risks. All CCS settlements will take place before each trust certificate payment date. The SWAP counterparty complies with Taiwan Ratings' requirements. Investors need to be aware that when the trustee signing the CCS ceases to be trustee of the SPT and a successor trustee cannot be found, the CCS counterparty will have the option to terminate the CCS, which will expose investors to exchange rate and basis risks.

Prepayment risk.
All bonds are non-prepayable. Any prepayment will be regarded as default and all proceeds will be passed through to certificate holders. Nevertheless, upon the occurrence of tax event, the SCDO might be wound down and prepaid. Overall, prepayment risk is fairly limited with this transaction.

Negative Carry Risk.
Before the occurrence of the acceleration event, TCs will be redeemed on a control amortization basis. Some negative carry might arise due to this mechanism. The effect, nevertheless, has been sized into credit support and cash reserve when running cash flow runs.

Liquidity risk.
Interest for each collection period will be collected before each payment date. Nevertheless, the pool's yield is relatively tight. When underlying bonds is in arrear or default, it is likely that interest collection will not be sufficient to fulfill the SPT's obligations for all periods. As a result, a cash reserve was set aside at closing to cover the potential shortage at each payment day.

Legal Analysis

The transaction is structured in accordance with the Financial Asset Securitization Law of Taiwan, which provides for the establishment of the SPT, the perfected transfer of assets from the originator to the SPT, and protection from other creditors' and third parties' claims. Taiwan Ratings has received satisfactory legal and tax opinions, including those for the SCDO.