160.The Central Bank will review how banks internally measure, monitor, and manage risks associated with securitisations of revolving credit facilities, including an assessment of the risk and likelihood of early amortisation of such transactions. At a minimum, the Central Bank will ensure that banks have implemented reasonable methods for allocating economic capital against the economic substance of the credit risk arising from revolving securitisations and must expect banks to have adequate capital and liquidity contingency plans that evaluate the probability of an early amortisation occurring and address the implications of both scheduled and early amortisation. In addition, the capital contingency plan must address the possibility that the bank will face higher levels of required capital under the early amortisation Pillar 1 capital requirement.

161.Because most early amortisation triggers are tied to excess spread levels, the factors affecting these levels must be well understood, monitored, and managed, to the extent possible by the originating bank. For example, the following factors affecting excess spread must generally be considered:

1. i.Interest payments made by borrowers on the underlying receivable balances;
2. ii.Other fees and charges to be paid by the underlying obligors (e.g. late-payment fees, cash advance fees, over-limit fees);
3. iii.Gross charge-offs;
4. iv.Principal payments;
5. v.Recoveries on charged-off loans;
6. vi.Interchange income;
7. vii.Interest paid on investors’ certificates;
8. viii.Macroeconomic factors such as bankruptcy rates, interest rate movements, unemployment rates; etc.

162.Banks must consider the effects that changes in portfolio management or business strategies may have on the levels of excess spread and on the likelihood of an early amortisation event. For example, marketing strategies or underwriting changes that result in lower finance charges or higher charge-offs, might also lower excess spread levels and increase the likelihood of an early amortisation event.

163.Banks must use techniques such as static pool cash collections analyses and stress tests to better understand pool performance. These techniques can highlight adverse trends or potential adverse impacts. Banks must have policies in place to respond promptly to adverse or unanticipated changes. The Central Bank will take appropriate action where they do not consider these policies adequate. Such action may include, but is not limited to, directing a bank to obtain a dedicated liquidity line or raising the early amortisation credit conversion factor, thus, increasing the bank’s capital requirements.

164.While the early amortisation capital charge described in Pillar 1 is meant to address potential supervisory concerns associated with an early amortisation event, such as the inability of excess spread to cover potential losses, the policies and monitoring described in this section recognise that a given level of excess spread is not, by itself, a perfect proxy for credit performance of the underlying pool of exposures. In some circumstances, for example, excess spread levels may decline so rapidly as to not provide a timely indicator of underlying credit deterioration. Further, excess spread levels may reside far above trigger levels, but still exhibit a high degree of volatility, which could warrant supervisory attention. In addition, excess spread levels can fluctuate for reasons unrelated to underlying credit risk, such as a mismatch in the rate at which finance charges reprice relative to investor certificate rates. Routine fluctuations of excess spread might not generate supervisory concerns, even when they result in different capital requirements. This is particularly the case as a bank moves in or out of the first step of the early amortisation credit conversion factors. On the other hand, existing excess spread levels may be maintained by adding (or designating) an increasing number of new accounts to the master trust, an action that would tend to mask potential deterioration in a portfolio. For all of these reasons, supervisors will place particular emphasis on internal management, controls, and risk monitoring activities with respect to securitisations with early amortisation features.

165.The Central Bank expects that the sophistication of a bank’s system in monitoring the likelihood and risks of an early amortisation event will be commensurate with the size and complexity of the bank’s securitisation activities that involve early amortisation provisions.

166.For controlled amortisations specifically, the Central Bank will also review the process by which a bank determines the minimum amortisation period required to pay down 90% of the outstanding balance at the point of early amortisation. Where the Central Bank does not consider this adequate, it will take appropriate action, such as increasing the conversion factor associated with a particular transaction or class of transactions.