Page 84 - Annual Report 2010

3.3 Portfolio Guarantees & Securitisation (“G&S”)

EIF extends portfolio guarantees to financial intermediar-ies involved in SME financing, and by covering part of the risk faced by those institutions, it helps facilitate funding access, and in turn helps to finance SMEs.

For its G&S business, EIF has developed a set of tools to analyse portfolio guarantee and structured finance trans-actions in line with common market practices. Before EIF legally enters into a guarantee transaction, the G&S divi-sion, within the Transaction and Relationship Manage-ment (TRM) department, proposes an internal rating to each new own risk guarantee tranche in accordance with the EIF’s internal rules and procedures. When analysing a new transaction, and in order to estimate the expected losses and consequently assign an internal rating to a tranche, the most appropriate rating model is used in com-pliance with the internal rules. The rating is based on inter-nal models, which analyse and summarise the tranche’s credit quality based on an expected loss concept. The EIF rating is based on quantitative parameters and qualitative aspects. The following quantitative factors are examples of variables having an impact on the determination of an EIF internal rating: weighted average rating of the underly-ing portfolio and its volatility, base default rate, weighted average life of transaction, possible loan portfolio perfor-mance triggers, available credit enhancement, timing of defaults, expected recovery rates and its volatility, level of diversification in the underlying pool of assets. The credit risk estimation also takes into account various qualitative factors, such as: reliability and completeness of the avail-able data, size, quality and time horizon of the statistical samples, discontinuity in the origination criteria and servic-ing procedures, macro-economic effects.

Majority of EIF own risk guarantee tranches are also rat-ed by at least one external rating agency. In case there are differences in the rating levels among external rating agencies and EIF’s internal rating, EIF applies a retained rating rule for the calculation of capital. The rule is derived from and aligned to Basel II regulatory capital require-ments rating treatment, which is as follows:

if there is only one assessment by an external rating agency, that assessment should be used to determine the risk weight of the tranche (i.e. capital allocation),

if there are assessments by two external rating agen-cies, which map into different risk weights, the higher risk weight is applied,

if there are three or more assessments with different risk weights, the assessments corresponding to the two lowest risk weights should be referred to and the higher of those two risk weights is applied.

To allocate capital for an own risk guarantee tranche, an EIF internal rating is disregarded from the retained rating rule only when the tranche is rated at least by one of the external rating agencies.

Capital allocation and pricing are functions of the ex-pected loss, i.e. they are risk-adjusted and consequently vary according to the assigned rating. EIF’s conservative capital allocation rules have already incorporated Ba-sel II principles for several years. EIF, having a status of a Multilateral Development Bank, does not report to the national supervisor, “Commission de Surveillance du Sec-teur Financier” (CSSF) but has adopted rules which are in line with the Basel II framework.

The implementation of the Ratings Based Approach (RBA) for EIF’s G&S exposures has been carried out with the technical assistance of the CSSF and in close coopera-tion with the EIB.

As it is the responsibility of G&S within the TRM department to propose an EIF rating, which is based on an internal mod-el, RMM – in the course of the independent opinion process, at closing and in line with the Model Review Procedure – conducts a model review for each new rating, as well as sample checks of updated ratings. The purpose of this pro-cedure is to reduce the model risk and to establish guidelines applicable to the official EIF internal rating models.

A transaction is eligible if, at the time EIF enters into the transaction, the assigned internal rating is in the range of iAaa- iB1 (iAaa and iB1 are mapped to Moody’s Aaa and B1, respectively). The individual performance of tranches guaranteed by EIF is reviewed at least quarterly after closing. For the most relevant rating input variables a trigger value is defined and the internal rating model is typically re-run when the transaction performance breach-es those limits. The EIF’s rating model may also be re-run before a trigger breach when circumstances (such as a sudden deterioration of the performance) suggest that the EIF’s rating may already be affected.