When using the Supervisory Formula Method, how do you calculate parameters T and L for a securitisation whose underlying assets are made of drawn and undrawn Revolving Credit Facilities?

Before the amendment introduced to Article 262 CRR by Regulation (EU) 2017/2401, in the Supervisory Formula Method, parameters T (thickness of the tranche) and L (credit enhancement level) are computed using the nominal amount of the exposures securitised.

On the other hand, K_IRBR is computed using the sum of the exposure values (EAD, or exposure at default) of the underlying assets of exposures that have been securitised.

Usually, nominal amount and EAD are quite similar, except in the case of assets such as Revolving Credit Facilities, where a conversion factor is applied to the nominal amount of the undrawn part of the assets in order to obtain EAD. As parameters T, L and K_IRBR are computed using two different asset base values, there may be some inconsistencies in the result.   

To illustrate this point, let’s consider a portfolio of undrawn RCFs whose nominal outstanding is 100 and whose EAD is 50 (i.e. after applying a credit conversion factor of 50%). Let’s assume that K_IRB amounts to 5 and that the junior tranche of the securitisation, which has been sold to a third party, amounts to 7  (Junior Tranche> KIRB).

In these conditions, K_IRBR = 10% (5/50) and T = 7% (7/100). Even though in absolute terms the amount of the tranche sold to third party is above the IRB charge in capital risk, in relative terms, T < K_IRBR.

In the Supervisory Formula Method – as defined in Article 242(6) of Regulation (EU) No 575/2013 (CRR) before the amendment introduced by Regulation (EU) 2017/2401, the T (thickness) is calculated as the ratio of

the nominal amount of the tranche to

the sum of the nominal amounts of the exposures that have been securitised.

L (credit enhancement) is measured as the ratio of:

the nominal amount of all tranches subordinate to the tranche in which the position is held to

the sum of the nominal amounts of the exposures that have been securitised.

K_IRBR is the ratio of

K_IRB  (that is the regulatory capital requirements in relation to the underlying exposures as if these had not been securitised) to

the sum of the exposure values of the exposures that have been securitised, and is expressed in decimal form.

In SFA both T and L parameters are calculated before the application of the relevant credit conversion factor. 

Update 26.03.2021: This Q&A has been archived as it relates to the use of the supervisory formula which is no longer applicable in the CRR framework.