Moody's completes review of EMEA shipping loan ABS methodology

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The update of the shipping loan ABS methodology includes a suite of individual models. These use Monte Carlo techniques to simulate the specific characteristics of a shipping portfolio. For these types of transactions, the model focus is on two main components, obligor default and recovery following default.

Break-even analysis -- The event of default is driven by the break-even rate determined by comparing the revenue earned by a vessel with the stressed operating and debt service expenses associated with each loan.

Revenues are simulated via a mean reverting stochastic (Vasicek) process to predict charter rates for each vessel. The charter rate processes are calibrated to cover historical data to a sufficient confidence level. For example, 95th percentile annual charter rate declines for "Dry Bulk" ship types are above 90%, reflecting the high historical volatility of this particular ship type. More stable ship types, such as "Chemical Tankers,"

have 95th percentile annual charter rate declines in the 25% - 40% range. There are 29 Vasicek-style processes defined for eight broad ship classes. The debt-servicing component is driven by the loan amortisation profiles and an interest rate simulation. The operating expenses are determined on a loan-by-loan basis.

Post an event of default, the loss severity is determined by comparing the value of the vessel collateral upon sale/valuation of the vessel to the outstanding loan balance at the time of default plus accrued interest and foreclosure costs. The model splits the assets into 8 broad ship categories, for which mean reverting processes (Vasicek) are calibrated.

Each stochastic process follows a mean-reverting random walk about base depreciation curve thus decreasing the vessel value through time. Moody's base assumption is that ships depreciate fully over 20 years, (versus a general market assumption of 25 years). Moody's recognizes the ultimate scrap value of ships by flooring the ship value using a rate of $90/ton (compared with a minimum observed level around $100/LDT over the past 30 years). Time-to-foreclosure (i.e. the lag time between default and default resolution) and the associated foreclosure costs are simulated from a triangular distribution that has been conservatively calibrated to historical data. The maximum time to sale of a vessel is assumed to be 7.5 years. The maximum cost of the foreclosure process is assumed to be USD 4,000,000.

Additionally, the various stochastic process (charterer default, break-even analysis, and ship depreciation) are correlated using a multi-factor Gaussian copula. Correlation levels range between 36% (on average in the case of the correlation between charterer defaults and ship values) and 80% (on average in the case of the correlation between charter rates). In some cases these levels were determined via historical data over stressed periods and in others by benchmarking assumptions with Moody's CDO and Corporate Finance rating teams.

Moody's emphasises that both quantitative and qualitative factors will form part of the rating committee decision process. Such factors include the transaction type (cash or synthetic), the deal's structural protections, the legal environment, asset-specific protections such as insurance coverage, specific documentation issues and additional information about advance rates.

All information available to rating committees, including macro-economic forecasts, input from other Moody's analytical groups, market factors, and judgements regarding the nature and severity of credit risk inherent to a transaction, may influence the final rating decision. Due to the relatively high volatility of various aspects of the shipping market, such as charter rates and shipping vessel values, as well as the low credit quality of many ship charterers, the maximum rating that Moody's would assign to a typical shipping-loan-backed transaction would be in the low investment grade territory (Baa).

Currently, Moody's is not actively rating any ABS shipping securitisations in the EMEA region. However, this updated methodology will be used to assess the credit quality of cover pools backed by shipping loans and thus may impact future and existing covered bond transactions.

Moody's will publish a detailed methodology report in the next few months.

Frankfurt
Thorsten Klotz
Managing Director
Structured Finance Group
Moody's Deutschland GmbH
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
Stefan Augustin
Vice President - Senior Analyst
Structured Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

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