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Types of retained amounts

First loss funds

‘RA� will in particular cover the establishment of ‘first loss funds� to meet repayments of principal where there are impairment losses on the securitised assets. Such funds will commonly be established from funds raised from subordinated lenders, and will support the ratings of more senior classes of debt. The required level of the first loss fund will be determined on the basis of rating agency criteria, and may vary from time to time depending on the performance of the securitised assets. It will normally be accepted that a first loss fund determined in accordance with rating agency criteria is ‘reasonably required� to maintain the company’s creditworthiness.

Where the required level of the fund rises, the priority of payments schedule (CFM72510) may require income to be deposited in the fund. In this case ‘R� is used to meet ‘RA� rather than ‘P�. If the required level of the fund falls, the priority of payments schedule may require such funds to be released and paid out. This is an example of ‘RA� being added back to ‘R� before being paid out as ‘P�, in accordance with sub-paragraph 3(b) of Regulation 11.

Impairment losses may leave the company short of receipts to repay the principal on the senior debt. The documentation may require the withdrawal of amounts from the first loss fund to repay the principal. Again, ‘RA� is added back to ‘R� and paid out as ‘P�.

Other types of retained funds

‘First loss� funds are only one particular example of ‘RA�. Other examples are

• deposits made to fund payments to an originator over the life of a credit derivative (this covers such deposits which serve as ‘collateralâ€� as described in CFM72090);
• reserves to meet incidental expenses of a revenue nature (such reserves are more likely to be built up entirely out of income or placed on deposit in accordance with the applicable priority of payments);
• reserves held by an SPV to meet liabilities of another SPV in the same structure, if the creditworthiness of the former SPV depends on payments flowing to it from the latter SPV;
• funds that cover a timing mismatch between amounts receivable by a securitisation company on its assets and amounts payable by it on its funding. For example, a note-issuing company may hold assets which consist of amortising loans but have issued bonds providing for bullet repayment at the end of the transaction. In that case, the company may begin to receive repayments of principal on its funding before it is liable to make the ultimate repayment of principal on its bonds. The documentation will provide that, when the company receives repayments of principal on its assets, it must place those amounts on deposit so as to create a reserve against its ultimate liability to repay its bonds. The reserve will be required to ensure that the company will have sufficient resources to meet all of its liabilities when due, that is, to keep the company solvent. The reserve will qualify as ‘RAâ€� since it will be reasonably required in order to maintain the company’s creditworthiness.