A central role for providing investors with assurances about credit risk has devolved to the credit rating agencies. Prior to each issuance of securities, one or more credit ratings agencies examine the receivables, additional collateral, proposed securities, and the structure of the SPV, and assign a rating to the issue.
Rating agencies usually apply the “weak link” principle when assessing externally provided credit enhancements, meaning that the rating of a security can be no higher than the rating of an external provider of enhancements.
The rating agencies examine the historical performance of the receivables and perform “stress testing” on the underlying cash flows. For example, the historical rates of delinquency on receivables will be analysed and simulations undertaken to determine the impact on the portfolio of an extremely unfavorable event, such as the worst sustained period of poor performance in recent history. Based on this analysis, the ratings agencies will indicate the amount of credit enhancement that is required to achieve a desired rating.
The ratings agencies will also look at internal mechanisms for transforming cash flows, whether adequate information systems are in place to accurately track payments and to identify delinquencies, as well as processes for dealing with delinquent payments.
For citing this article, use:
- Venkatachalam, R. M. (2009). Evaluation of asset securitization mechanism in Indian financial market.