Last updated: June 2, 2014

Consumer Loans
1.

Overview of Target Assets
Consumer loans (loan receivables of consumer finance companies) are typically small-scale anddiversified receivables, making it most desirable for securitization. In most cases, it takes the form of arevolving credit that allows borrowing and repayment within a credit line at any time, and thesecuritization scheme is built according to such characteristics.
The concept of rating consumer loan securitization is also applicable to the rating of securitized
products of cash advance on credit cards held by bank-affiliated and distributor-affiliated credit cardcompanies and credit sales companies.

2.

General Scheme
From the perspective of legal risk, consumer loans held for customers is generally entrusted to a trustbank and are classified into senior, subordinated or seller beneficial interest. In some cases, the senior
beneficial interest is in turn transferred to a special purpose company (SPC), which subsequently issues
bonds backed by the senior beneficial interest.
The subordinated beneficial interest and seller beneficial interest are held by the originator. Theseller beneficial interest aims to absorb fluctuations in the balance of consumer loans transferred to thetrust bank and does not function as a credit enhancement.
The originator provides collection services for the underlying assets as a servicer and delivers thecollected funds to the trust bank. The trust bank or SPC uses the funds provided by the servicer to pay theprincipal and interest on the senior beneficial interest or bonds.
The pool of transferred receivables is reduced by the ordinary repayment of principal. During therevolving period, the originator is required to add new consumer loans and maintain the balance of theloan receivables at a certain level.
If an early redemption event occurs, the aforementioned additional transfer of the loan receivables isceased and any new transfer from the originator is suspended. The collected interest from the underlying
obligor is used for the redemption of principal for the senior beneficial interest, accelerating theredemption of the securitization products.

3.

Key Analytical Points
Analysis of securitization of consumer loans focuses on credit risk assessment, which relates to thelevel of credit enhancement, and legal risk assessment, which examines how its structure coordinates withthe regulations of the Money Lending Business Act.

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(1) Risk of deteriorated creditworthiness of underlying debtors
Subordinated beneficial interest absorbs the amount of losses resulting from bad debts of theunderlying obligor. Total loan losses assumed during the securitization period is calculated on the basisof law of large numbers approach using historical data.
Changes in indicators derived from historical data such as the default rate, additional borrowingrate and principal repayment rate are examined to arrive at a base to be adopted in an analysis. Usually,each parameter is adjusted to the level closer to the performance of the receivables to be transferred.
This is done by using the mean of the historical data as the basis as well as assessing the trends from thepast and anomalies and through an interview with the originator.
Certain stress scenarios are applied to indicators such as the default rate, additional borrowing rate
and principal repayment rate to determine the subordination level needed for the rating. Because loanlosses during the securitization period will be absorbed by the subordinated tranche and excess spread,the level of necessary credit enhancement (subordination ratio) will vary depending on the level of theinterest rate on the loan expected during the securitization period.
Standard Stress Multiplying Factors:
RatingStress Multiplying Factor

AAA

3.5 times

AA

3.0 timesA

2.5 times

BBB

2.0 times(2) Commingling risk
As a credit enhancement for commingling loss that occurs when funds become uncollectible uponan originator’s bankruptcy because funds are mixed with those of the originator, JCR sets an amountthat is minimally required for the seller beneficial interest to be kept according to the remittanceschedule of collected funds for the securitized product to be rated.
(3) Deterioration in quality of transferred receivables during the revolving period
Securitization of consumer loans involves the risk of an increase in obligors with a large number oflender exchanges (LE or borrowing from other finance companies) due to additional assignment during
the revolving period and the risk of an increase in LE of the same obligor as time passes (discovered
during the examination for additional lending by the originator). As measures against such risks,
dynamic reserves are arranged according to the number of LE and the delinquency rate. This has thesame effect as setting up a loan loss reserve that matches the credit risk level.
In addition, general practice is such that an additional assignment of loan receivables is suspended
and an early redemption of the senior beneficial interest or bonds is commenced if the default rate or2/5
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delinquency rate of the assigned claims exceeds a certain level, or if the principal repayment rate hasdeclined.
(4) Legal risk
Consumer loans are subject to various regulations to protect consumers as described below, which
require an adequate examination of securitized products.
A. Obligation of notice under the Money Lending Business Act
Article 24, Paragraph 2 of the Money Lending Business Act requires that, when loan receivables
have been assigned, an assignee notify the obligor of the fact of the assignment by delivering thedocument prescribed in Article 17 (“Article 24-2 notice”). However, the method of sending thenotification to the obligor may violate the privacy of the obligor. Accordingly, it is general that aslong as the originator, the assignor, provides collection services and keeps in contact with the obligor,
it withholds notification, but that when servicer replacement occurs, the trust bank delivers theArticle 24-2 notice as well as the assignment notice to the obligor.
B. Gray zone interest rate
In the case that, in the pool of the loan receivables to be securitized, there exist loans to theobligors who in the past have paid interest that exceeds the maximum interest rate in the Interest
Rate Restriction Act (18% per year for principal of 100,000 yen or more and less than a million yen),
the trust bank could incur a new obligation to repay the excess interest, which may jeopardize thescheduled cash flow.
In securitizing loans, therefore, it is desirable from the viewpoint of ensuring the certainty of thescheme to extract from the loans held by the originator only those held for the customers who haveno history of borrowings at an interest rate above the aforementioned statutory rate. Furthermore, inthe case of term loans without a principal loan contract, even when a past loan contract has given riseto the right to demand reimbursement for overpayments, its impact on securitization can beconsidered extremely low so far as the loans are based on new borrowings after a lapse of 10 years
since previous ones were paid off.
Reference: “Items prescribed in Article 17 of the Money Lending Business Act”
Revolving Credit Loan(a) Name and address of money lender, (b) contract date, (c) maximum amount, (d)interest rate, (e) repayment method, etc.
Other than Revolving Credit Loan(a) Name and address of money lender, (b) contract date, (c) amount of loan, (d) interest
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rate, (e) repayment method, (f) repayment period and number of repayment installments,
etc.
4.

Monitoring
In principle, JCR monitors the performance of underlying assets and reviews the rating as long as arated debt is outstanding. JCR conducts monitoring on a constant basis to check the performance ofunderlying assets, including the monthly default rate; changes in the subordination ratio; and capabilitiesof parties to the structure to carry out their duties. When conducting the review of credit ratings, JCR
reexamines, as necessary, the base rate and other rating assumptions in light of the performance ofunderlying assets and economic conditions and analyses cash flows based on these assumptions with due
consideration given to the remaining term of securitization products. Rating review is held on a regularbasis, as well as on an ad hoc basis as necessary in case of a sudden change or event.

5.

Documents Required(1) Documents concerning the originator(2) Qualitative information on consumer loans
A. Product overview
B.

Credit criteria / flowC.

Bad debt disposal, recovery flow

D. Claim for payment, accounting system and related information
E.

Loan agreement template, credit card agreement

F.

System and requirements for extracting claims to be assigned(3) Quantitative data on consumer loans
A. Historical data of the matrix claims
B.

Attribute data of the matrix claims and assigned claimsi.

By age (in units of 10 years)

ii. By annual income (in units of 1 million yen)iii. By occupation, by type of job
iv. By region (prefectures)
v. By the number of LE
6.

Related General Criteria“Commingling Risk Pertaining to Securitization Products”“Backup Servicer in Securitization”

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Because of the possibility of human or mechanical error as well as other factors in the information herein, JCR makes no representation orwarranty, express or implied, as to accuracy, results, adequacy, timeliness, completeness or merchantability, or fitness for any particular purpose,with respect to any such information, and is not responsible for any errors or omissions, or for results obtained from the use of such information.
Under no circumstances will JCR be liable for any special, indirect, incidental or consequential damages of any kind caused by the use of any suchinformation, including but not limited to, lost opportunity or lost money, whether in contract, tort, strict liability or otherwise, and whether suchdamages are foreseeable or unforeseeable. Information herein is statements of opinion, and not statements of fact as to credit risk decisions orrecommendations regarding decisions to purchase, sell or hold any securities such as individual bonds or commercial paper. JCR retains all rights
pertaining to this document. Any reproduction, adaptation, alteration, etc. of this document, is prohibited, whether or not wholly or partly, without
prior consent of JCR.

Japan Credit Rating Agency, Ltd.
Jiji Press Building, 5-15-8 Ginza,Chuo-ku, Tokyo 104-0061, Japan
Tel. +81 3 3544 7013, Fax. +81 3 3544 7026

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