GENERIC EXAMPLE:

– 5 Aaa credits of EUR 4 mn each – 5 Aa1 credits of EUR 4 mn each – 5 A1 credits of EUR 4 mn each – 5 Baa1 credits of EUR 4 mn each

The WARF amounts to:

(5*1*4) + (5*10*4) + (5*70*4) + (5*260*4)/80 = 85.25 This corresponds with a A1/A2 WA rating

Portfolio's probability of default is 85.25x higher than the one of a portfolio with an average rating of Aaa Î 85.25*0.01%= 0.85%

(see table next page)

Rating agencies' approach to rating ABS – Selected methodologies

MOODY'S BINOMINAL EXPANSION TECHNIQUE FOR RATING CDOs

„ 1. Step: The above mentioned rating factors are derived from Moody's "Idealized Default Table"

(one can also use the Idealized Expected Loss Table Î Expected Loss=Probability of Default * Loss Severity (with Loss Severity= 1- Recovery Rate) ÎProbability of Default = Expected Loss/(1- Recovery Rate); Expected recovery rate = 55%), e.g. 4.2% = 2.31%/(100%-55%)*

EXAMPLE:

Rating factor is calculated by divding the 10Y expected default probability of a defined rating level by the 10Y expected default probability of a Aaa rated credit: 13.5%/0.01%= 1,350 (please refer to the table on page 94)

ÎRating factors do not increase linearÎlower rated assets have a stronger influence on the WARF as higher rated assets

Source: Moody's

MOODY'S IDEALIZED EXPECTED LOSS TABLE MOODY'S IDEALIZED DEFAULT PROBABILITY TABLE

*This only works in case of a fixed recovery rate!

MOODY'S BINOMINAL EXPANSION TECHNIQUE FOR RATING CDOs

„ 2. Step: Determination of the portfolio's diversity score

„ Moody's Diversity Score is a correlation measure for a CDO's underlying pool of assets (notwithstanding that Moody's does not apply its diversity score for all CDO types); it converts all assets N of a given underlying portfolio that are correlated to some extent regarding their default probability, into an equvivalent number D of asssets that

– have a 0% correlation amongst themselves

– are identical in all respects (yield, maturity, margin etc.)

„ The calculation is based on two main assumptions, namely a) intra-industrial correlation is the same for all industries and b) inter-industry correlation is zero

„ Basically, all assets are classified according to their industry. The diversity score "D" is computed by summing up the diversity scores of all industries represented in the same portfolio (Moody's differentiates between 33 industry groups, with some of them again being global or regional industry group, hence the regional distribution also play a role, e.g.

– "grocery" is a regional industry group Î an UK and a Japanese grocery store are expected to have a 0% default correlation, although they belong to the same industry)

– "automobiles" is a global industry group Îan UK and a Japanese automobile company are expected to have a default correlation of >0%

Rating agencies' approach to rating ABS – Selected methodologies

MOODY'S BINOMINAL EXPANSION TECHNIQUE FOR RATING CDOs

„ 2. Step: Determination of the portfolio's diversity score

Î The calculation requires seven steps (please refer to next page for a numerical example):

1. Aggregation of the par amount of the various borrowings of each obligor 2. Calculation of the assets' average par amount

3. The calculation of the equivalent unit score that is the lesser of – 1 and the

– obligor par amount/average par amount

Îprevents the overweight of a single obligor (as the value is always below 1), hence this is a protective measure to limit "N")

4. Separation of the equivalent unit scores into the different industry groups 5. Aggregation of the equivalent unit scores for each industry

6. Calculation of the industry diversity scores

7. Final aggregation of such industry diversity scores for the total portfolio

MOODY'S BINOMINAL EXPANSION TECHNIQUE FOR RATING CDOs

„ 2. Step: Determination of the portfolio's diversity score – Generic Example

Industry Group Industry equivalent unit score (STEP 4+5)

Rating agencies' approach to rating ABS – Selected methodologies

MOODY'S BINOMINAL EXPANSION TECHNIQUE FOR RATING CDOs

„ 3. Step: The calculation of default scenarios based on the WARF and the diversity score

„ Based on the portfolio's WARF and diversity score, Moody's applies ist Binominal Expansion Technique (BET")

„ Example: Portfolio consists of 100 credits that have a diversity score of 41 Î hypothetical portfolio of 41 independent/uncorrelated credits that all have the same rating, term etc.

„ Moody's calculates 42 scenarios (0 defaults, 1 default, 2 defaults, …, 41 defaults), for all of which a respective probability is determined

„ As all credits are the same in this hypothetical portfolio, it is irrelevant, which credit defaults; the pure number of defaults is crucial

„ This results in a default distribution of the underlying assets

MOODY'S BINOMINAL EXPANSION TECHNIQUE FOR RATING CDOs

„ 4. Step: The determintation of an expected loss for the tranches

„ Thereafter, the impact of these defaults (that are weighted with their probabilities) on the respective notes is assessed.

Hence, a cashflow model is required for cashflow deals taking into account the waterfall of payments, credit enhancement, assumptions regarding the timing of defaults etc. Îthis leads to an expected loss for the respective tranches.

„ The expected loss for a given tranche again determines the tranche's ratingbased on Moody's Idealized Expected Loss Table

MOODY'S IDEALIZED EXPECTED LOSS TABLE

Rules of thumb:

the higher the portfolio's diversity (e.g. by way of an increased number of assets), the higher ceteris paribus the expected loss for an equity piece, as the

probability for extreme scenarios including zero losses decreases (please note that the overall risk remains the same and only the shape of the loss distribution is changed

Îall other tranches' expected loss decreases in such a case

Rating agencies' approach to rating ABS – Selected methodologies

MOODY'S BINOMINAL EXPANSION TECHNIQUE FOR RATING CDOs

„ Quick and dirty tranching for a generic example (has to be adjusted according to the specifics of a given portfolio), whereas – the portfolio's WA rating amounts to "Baa3"

– the portfolio's diversity score amounts to 37.5

– Desired ratings for the four tranches: Aaa, Aa2, A2 and NR (equity piece to be purchased by originator)

„ Required credit enhancement for the Aaa rated tranche: 26%

Source: Moody's

MOODY'S BINOMINAL EXPANSION TECHNIQUE FOR RATING CDOs

„ Required credit enhancement for the Aa2 rated tranche: 17%

„ Required credit enhancement for the A2 rated tranche: 13%

Aaa = 74%

Aa2 = 9%

A2 = 4%

Equity Piece=13%

26%

17%

13%

Rating agencies' approach to rating ABS – Selected methodologies

MOODY'S APPROACH TO RATING EUROPEAN CMBS is mainly divided into two parts – the analysis of the asset side

– the modelling of effects on the liability side taking into account step 1's results and the transaction structure

„ Step 1: Analysis of the asset side: as asset pools of CMBS deals are generally less homogeneous and lesss granular than the ones of RMBS transactions, and as less historical data regarding delinquencies, defaults and losses are available, the analysis of the asset side is very much based on an in-depth fundamental assessment of the underlying assets. Hence, the following aspects are examined in detail:

– property characteristics to calculate the amount of sustainable cashflows the property generates (EBITDA) based on:

– sustainable occupancy rates and other revenue sources

– sustainable expenses/capital investments, including a fixed versus variable cost ratio for the property

– quality grade of property (construction quality, neighborhood, local market, competition, tenancy profile and quality of income

– property type (Moody's major property types, ranked in order from lowest to highest volatility regarding the cashflows to be generated: multi-family buildings, anchored* retail, industrial buildings, unanchored* retail, office buildings, and hotels) – tenants(if tenants are of very high quality, the property's quality grade may be improved etc.)

– cashflow volatility

– diversity in terms of cross-collateralization (if a certain commercial real estate loan of the pool defaults, the collateral of another real estate may be used to cover potential losses as well)

* Anchored refers to a retailer that has an above average ability to draw customers into a retail area, typically associated with national ultiples. Hence, unanchored refers to a retailer of a less well-known, more secondary nature