Presale: Capital Securities 2006-1 CBO Special Purpose Trust

This presale report is based on information as of Jan. 03, 2007. The ratings shown are preliminary. This report does not constitute a recommendation to buy, hold, or sell securities. Subsequent information may result in the assignment of final ratings that differ from the preliminary ratings.
Rating Details

Rating Details

*The rating on each class of certificate is preliminary and subject to change at any time.
**The rating on Class A2 certificates only addresses the ultimate principal repayment on or before the legal maturity date.
***Interest on Class B and Class C certificates is deferrable. The ratings on Class B and C certificates address the ultimate interest and ultimate principle payment on or before the final legal maturity date subject to the timely rebate of tax.

Profile

Issuer: Land Bank of Taiwan (Land Bank, twAA+/stable/twA-1) as trustee on behalf of Capital Securities 2006-1 CBO Special Purpose Trust (the SPT)

Expected Closing Date: January 2007

Final Legal Maturity Date: June 20, 2016

Seller: Capital Securities Co. Ltd. (Capital Securities, twA/stable/twA-2)

Trustee/Custodian/Account Bank: Land Bank

Swap counterparty: Taipei branch of Citibank N.A. (Citibank N.A., Standard & Poor's Ratings AA/Watch Pos/A-1+)

Arranger: Citibank N.A, Taipei Branch and Citigroup Global Market Asia Ltd.
Rationale

Rationale

The four tranches of rated certificates to be issued by the issuer will be backed by a static portfolio of 10 New Taiwan dollar (NT dollar) principal only bonds, two NT dollar bank debentures, as well as one United States dollar (US dollar) denominated principal protected note (PPN).

The Class A1 certificates do not bear interest. The preliminary rating on the Class A1 certificates addresses the repayment of principal at par (before deducting withholding tax) by the final legal maturity date. The rating on the Class A2 certificates addresses the ultimate payment of principal by the final legal maturity date. The ratings on the Class B and class C certificates address the full payment of interest (before deducting withholding tax) and principal on or before the final legal maturity date on June 20, 2016. The final ratings are expected to be assigned on the closing date subject to a satisfactory review of all documents, as well as a full legal and tax analysis.

The preliminary ratings are based on the following factors:

• The credit enhancement provided through the subordination of cash flows to the respective class;
• An adequate cash reserve to support senior fees and expenses throughout the life of the transaction;
• The transaction's foreign exchange swap to hedge currency risk associated with the principal portion of the US dollar denominated PPN;
• The ratings on 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:

• Most of the underlying bonds are publicly rated by TRC or S&P;
• A foreign exchange swap adequately hedges foreign currency risk associated with the principal portion of the US dollar denominated PPN;
• When certain events are triggered, excess interest will be trapped to repay principal on certificates first, which will speed up the repayment of certificates;
• A cash reserve will be set aside at closing and topped up over a period of time to cover fees and expenses during the life of the transaction;
• The final legal maturity date takes into account adequate time for recovery if any of the underlying bonds default.

Concerns:

• Underlying assets are concentrated in the banking industry;
• The principal portion of the US dollar denominated PPN will carry currency risk;
• Financial holding companies are required by law to defer their bond issue payment obligations in the event that their capital adequacy ratio drops below 100%;
• The full redemption of the certificates will be subject to the timely rebate of the 10% tax levied on the NT dollar principal only bonds.

Mitigating Factors:

• The industry concentration issue has been taken into account by S&P's CDO Evaluator when determining the loss threshold that this transaction has to withstand at various rating levels;
• Currency risk of the principal portion of the US dollar PPN is fully hedged by foreign exchange swaps;
• Payment deferral risk mitigated by an extension of the final legal maturity date; and
• Previously, securitization deals in Taiwan have not involved tax rebates. Our tax rebate time frame assumption is based on the rebate time frame associated with bond fund investments plus an additional cushion. In the event that payments on the underlying bonds are not deferred, the trustee will apply for the final tax rebate in 2012. Investors will be exposed to default risk if the tax rebate is not completed by the final legal maturity date in 2016.

Transaction Overview

At closing, the Seller will transfer the US dollar denominated principal protected note and NT dollar denominated bonds and bank debentures to the trust. The trustee on behalf of the trust will issue NT dollar denominated class A1 [twAAA], class A2 [twAAApNRi], class B [twA], and class C [twBBB-] trust certificates and unrated subordinated trust certificates. Part of the proceeds raised from investors will be converted into US dollars with the swap counterparty. The US dollar proceeds together with the remaining NT dollar proceeds will be paid to the Seller in consideration of the transferred US dollar denominated principal protected notes 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 NT dollar proceeds and US dollar proceeds from the underlying assets. The principal portion of the US dollar denominated PPN will be converted into NT dollar proceeds under a foreign exchange swap at the final exchange date.

A cash reserve will be set aside at closing to cover fees and expenses during the life of the transaction and will be topped up from excess interest (mainly from the two debentures) because all of the NT dollar principal only bonds in the portfolio will not pay interest during the life of the transaction and the interest payments on the US bond are not likely to be steady and scheduled because they are linked to the performance of another instrument.

Interest collection will be distributed according to interest waterfall to make senior fee and expense payments if the reserve is inadequate to cover such fees and expenses. Excess interest will then be used to top up the reserve before being used to make interest payments (up to expected internal rate of return) on class A2 certificates. Upon the occurrence of an early amortization event, excess interest will not be used to pay Class A2 interest in the interest waterfall but will be diverted to pay principal waterfall. Principal waterfall will cover senior fee and expense payments if the reserve is inadequate, and then pay the principal of the rated notes and the interest on the class B and class C certificates. Senior class notes will be redeemed before junior class notes. Payment on class A1 and Class A2 notes will be sequential prior to an early amortization trigger. Thereafter, payment basis will change to pari passu. Any residual from the principal waterfall will then go back to the interest waterfall to make payments down to the equity holder.

Terms and Conditions of the Notes

Interest Payment
Of the four tranches of certificate issued, class A1 certificates will carry no interest; class A2 certificates will carry interest up to an expected rate of return but TRC will not rate the interest part of the certificate. Hence, the class A2 certificates will be assigned a principal only rating. Class B certificates and class C certificates will carry interest according to an expected schedule and amount, but interest payments may be deferred until 2016 because of uncertainties prior to the legal maturity date regarding the cash flows to make the interest payments.

Principal Payment
The transaction is structured as a pass-through transaction with principal collected from underlying bonds being used to repay the principal on trust certificates (with a portion of principal collected to pay interest on class B and class C certificates). There are two sources of principal collection: 1) principal collected from NT dollar denominated bonds; and 2) NT dollar proceeds from the swap counterparty after the final exchange of US dollar proceeds when the US dollar denominated note matures. In the underlying assets, there are ten principal-only bonds, which will be purchased at discount at closing and redeemed at par upon maturity. A 10% tax will be levied on the principal only bonds according to a tax ruling. Taxes levied on the principal only bonds will be returned to the trust to distribute according to the principal waterfall.

Hedging

At closing, a portion of NT dollar proceeds from the issuance of the certificates will be exchanged for US dollars under a foreign exchange swap to purchase the US dollar denominated principal protected note. At the maturity of the US dollar principal protected note, the US dollar proceeds will be exchanged into NT dollars under the swap agreement to redeem the trust certificates. The interest on the US dollar principal protected note will not be hedged, as there is no scheduled payment of interest on the principal protected note and the repayment of rated certificates will not rely on such interest.

Collateral Characteristics

The portfolio will consist of 12 NT dollar bonds with a par value of NT$9.2 billion and one US dollar denominated principal protected note with a par value of US$249 million. Proceeds from the US dollar denominated bond will be converted into NT dollars at a predetermined exchange rate on the final swap payment date. Features of the portfolio include:

• The portfolio consists of 10 NT dollar denominated principal only bonds, two NT dollar bank debentures, and one US dollar denominated principal protected note;
• Fifty two percent of the total portfolio amount consists of principal only bonds with scheduled payment at maturity;
• The US dollar denominated principal protected note accounts for 40% of the total portfolio amount calculated at the exchange rate on the final swap payment date;
• Excluding the US dollar bond, there are five obligors in the portfolio. The top three issuers of the NT dollar bonds contribute 17%, 16%, and 13.5% of the total portfolio;
• The maturity dates of the NT dollar bonds range between June 2010 and February 2012 and the maturity date of the US bond is [January] 2014;
• Bonds issued by the two financial holding companies account for 27% of the total portfolio amount;
• All the bonds are issued by financial institutions;
• All except one of the issuers of the NT dollar denominated bonds are rated by TRC. The creditworthiness of the unrated issuer is estimated by TRC;
• The US bond is expected to be assigned a rating by S&P which will only address ultimate principal repayment;
• The two NT dollar bank debentures will pay interest annually; interest payments on the US dollar bond are linked to an equity instrument of a CDO. Interest from these bonds will be applied to make fee and expense payments if the reserve is insufficient.

Credit Analysis

S&P'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, industry correlations, and maturity of each asset, and computes the expected level of default that each CDO tranche must be able to withstand at a given rating level.

TRC assumes that the rated certificates will rely on principal collection only to redeem the certificates, even though excess interest (if available) will divert to redeem the notes when certain events are triggered. A scenario loss rate is derived by assuming an appropriate recovery on the defaulted bonds. The scenario loss rate is then compared to the capital structure of the transaction to ensure the credit enhancement (with ultimate interest payment on class B and C certificates factored into the required credit enhancement) for each rating level is adequate.

As interest generated from most of the bonds is uncertain, a reserve will be partially funded at closing to cover fees and expenses for the life of the transaction (factoring in the possibility of payment deferral on the bonds issued by the financial holding companies). TRC has given credit to the interest generated by the two NT dollar bank debentures to top up the reserve.

The following elements were taken into account in the credit analysis:

• For NT dollar denominated assets, moderate recovery rates were assumed. Recovery rates were reviewed and adjusted by Taiwan Ratings on a case by case basis, mainly based upon the seniority of the debt. Recoveries were modeled with adequate time for workout after default;
• For the US dollar denominated principal protected note, a recovery rate is assumed based on S&P's research on bond recovery;
• Payment deferral risk is mitigated by an extension of the final legal maturity date;

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
Set-off risk will arise if the seller has payment obligations with the underlying bond issuers and such payment obligations exist before the transfer of the bonds and such claims mature on or prior to the maturity of such bonds.

Potential set-off risk will be mitigated by a warranty from the seller declaring no payment obligations to the underlying bond issuers before the closing date.

Termination of the Trust
The trust will be terminated if requested by law or the final legal maturity date is reached. In addition, the termination of the trustee will trigger the trust to terminate if: 1) a successor trustee is not found and the certificate holders reach a resolution to terminate the trust; or 2) a certificate holder meeting fails to be called.

Legal Opinion

Prior to assigning the final ratings and the closing of the transaction, TRC will need to receive satisfactory legal opinions.

Tax Analysis

According to the tax ruling, 10% withholding tax will be levied on the interest portion of the underlying bonds (including the portion to be levied on the NT principal only bonds) when interest on the underlying bonds is paid or when the principal only bond matures. Total withholding tax will amount to NT$121 million if no underlying bonds default. The withholding tax will be fully returned after the trustee applies for a tax rebate. Our tax rebate time frame assumption is based on the rebate time frame associated with bond fund investments plus an additional cushion. Previously, securitization deals in Taiwan have not involved tax rebates. However, the likelihood that the tax rebate will fall after the final legal maturity date of the certificates is deemed remote.