Banking (prudential standard) determination No. 6 of 2006 - Prudential Standard APS 120 - Funds Management and Securitisation
Second loss facilitySecond loss facility
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Second loss facility
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A “second loss facility” is a credit enhancement that provides a second tier of protection to a SPV and/or its investors.
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A second loss facility should:
(a) be protected by a “substantial” first loss facility;[7]
(b) only be capable of being drawn after the first loss facility has been completely exhausted; and
(c) only cover losses beyond those covered by the first loss facility.[8]
- APRA will review, in conjunction with an ADI which provides a second loss facility, the adequacy of any first loss protection. In reviewing first loss facilities with APRA, an ADI should provide details on:
(a) the class and quality of the assets held by the SPV;
(b) the history of default and loss rates on the assets;
(c) the output of any statistical or other models used by the ADI to assess expected losses on the assets;
(d) the types of activity permitted by the SPV and whether the risk underlying the credit enhancement extends beyond the assets held; and
(e) the quality of the parties providing the first loss facility, and the opinions provided by reputable third parties (e.g. ratings agencies) regarding the adequacy of the first loss protection.
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Where an ADI provides only a second loss facility, the facility should be treated as a direct credit substitute for the purpose of Prudential Standard APS 112 Capital Adequacy: Credit Risk, with a 100 per cent credit conversion factor and a 100 per cent risk weight covering the amount of the facility.
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Where a facility provided by an ADI substitutes for a first loss facility provided by another party upon that party’s default, the ADI’s facility should be treated as a first loss facility.
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An ADI providing both a first and a second loss facility may treat the facilities as separate facilities, where:
(a) the facilities are separately documented and clearly function separately;
(b) the second loss facility meets the conditions in paragraph 9(a)-(c)[9]; and
(c) the second loss facility is made up of subordinated securities (or some form of marketable credit enhancement) which could be readily transferred by the ADI at any time.[10]
Otherwise, the combined facilities shall be treated as a first loss facility.