Our file: P2218-1

September 15, 1999

TO: Chief Executive Officers

Federally Regulated Life Insurance Companies and Fraternal Benefit Societies

Subject: MCCSR Guideline: Capital Requirements for Investments in Asset Securitization Transactions

It has come to OSFI's attention that some companies are not applying the correct capital requirements for investments involving asset securitization transactions. Companies are requested to closely review the documentation supporting these types of investments, paying particular attention to the investment’s financial structure. The review should determine whether the investment structure, including any credit support facilities provided to a securitization vehicle by the company would, in accordance with Guideline B-5 Asset Securitization, require a deduction of an amount from total capital for capital adequacy purposes.

Guideline B-5 distinguishes between three types of support facilities for capital purposes and outlines the different capital requirements for each. The facilities are first loss protection, enhancement, and liquidity support. In allowing for distinct capital treatment of these facilities, the Guideline establishes, across a variety of securitization structures, minimum requirements for the involvement and participation of independent third parties.

For example, where a facility constitutes the first level of financial support for a securitization transaction, it is referred to as a first loss protection facility. It should be noted that there may be instances where senior facilities such as credit enhancements and liquidity supports are treated as first loss facilities for purposes of capital requirements. Where there is no significant first loss facility provided by an independent party, the credit enhancement would be considered to be a first loss protection facility.

Where the investment consists of subordinated notes and there is no distinct significant first loss protection facility provided by an independent third party, the investment would be treated as a first loss protection facility. Based on Guideline B-5, the notes considered as a first loss facility would be deducted from total capital subject to a limit on the amount. That limit is the amount that would have been required under OSFI’s risk-based capital adequacy requirements for a direct credit substitute equal to the full amount of the assets transferred, including any senior note exposure in the particular securitization structure. The counterparty factor used in this calculation will be that for the underlying assets subject to a minimum of 4 percent. Therefore the minimum amount to be deducted from total capital would be 4 per cent.

Companies are also reminded that they should have in place adequate procedures to monitor the performance of their investments. These procedures should be consistent with the risk of loss to which the company is exposed. Where their facilities are directly exposed to loss from the underlying assets, institutions should have procedures in place to track the performance of the underlying assets. Impairment of an investment should be recognised in accordance with CICA Handbook Section 3025 Impaired Loans of the CICAHandbook. Investments identified as impaired require a C-1 capital component in addition to the basic requirement of 35 per cent less amounts of individual allowances and write-downs. For investments in asset securitizations, companies should ensure that there is an adequate reporting system for monitoring the creditworthiness of the borrower asrequired under Section 3025.

Should you have any questions, please contact the Relationship Manager assigned to your company.

Nicholas Le Pan
Deputy Superintendent
Supervision

cc. MCCSR Guideline holders