DBRS Maintains Superior Trust Series B Floating-Rate Notes Under Review with Negative Implications

DBRS has today maintained the Series B Floating-Rate Notes (the Series B Notes) issued by Superior Trust (the Trust) at AAA and Under Review with Negative Implications, where they were placed on November 28, 2008.

Merrill Lynch International (the Swap Counterparty) has advised DBRS that it has agreed to a standstill agreement (the Standstill Agreement) with Superior Trust in which the Swap Counterparty has agreed not to make any calls for additional collateral from the Trust for a period of two weeks (until December 19, 2008). DBRS has been informed by Superior Trust that the spread-loss trigger to which the Trust has been exposed has been breached. As a result, the Trust is now subject to a mark-to-market (MTM) trigger. Due to the significant probability that the MTM trigger could soon be breached, the Swap Counterparty has proposed a restructuring that would give Series B Noteholders the option of exchanging their Series B Notes for new Series D Notes or Series E Notes. The proposal by the Swap Counterparty is to remove all funding risk for the Series D Notes and Series E Notes by removing any possibility for collateral calls. As such, Series D Notes and Series E Notes would only be exposed to the credit risk on a portfolio of corporate reference entities.

As part of the Standstill Agreement, Series B Noteholders have a one-week election period starting December 5, 2008 (until December 12, 2008) to consider the option of exchanging their Series B Notes. However, in the event that the MTM trigger is breached during that one-week period, the investor election period and the Standstill Agreement will shorten to 48 hours from the time of the breach. If a Series B Noteholder makes no election and chooses to remain in Series B, the Series B Notes will face considerable market risk and potential rating action if the MTM trigger is breached, once the Standstill Agreement expires.

Due to the presence of the Standstill Agreement, DBRS has maintained the Series B Notes rating of AAA Under Review with Negative Implications. If the Standstill Agreement were not in place, the Series B Notes would be downgraded to a non-investment grade rating, based on the significant probability that the MTM trigger will soon be breached and the Swap Counterparty would have a right to make a call on the Trust for further collateral.

In the absence of a Standstill Agreement, if the MTM trigger is breached and the required amount of additional Series B Notes were purchased to permit the Trust to meet its collateral call obligations to the Swap Counterparty, then the collateralized debt obligation (CDO) Note that currently backs the Series B Notes (as defined below) would be fully funded and the Trust would no longer be subject to funding risk (i.e., the Swap Counterparty would no longer have a right to make further collateral calls on the Trust). If such an event occurs prior to any rating action taken based on information provided to DBRS, then DBRS may confirm the rating of the Series B Notes at AAA. If the MTM trigger is breached and the required amount of additional Series B Notes are not purchased by the Series B Noteholders, the Swap Counterparty has the ability to partially unwind the credit default swap (CDS) which could result in the Series B Notes being downgraded (potentially to D).

DBRS will continue to closely monitor the status of the Standstill Agreement and restructuring discussions with the Series B Noteholders and will provide rating updates as required.

In July 2008, DBRS assigned a rating of AAA to the Series B Notes following the completion of a restructuring of the Trust. Under the terms of the restructuring, Series A Noteholders of the Trust had the option to exchange their Series A Notes for the Series B Notes or Series C Notes being issued by the Trust. DBRS ratings on the Series A Notes were discontinued after all of the Series A Noteholders exchanged their Series A Notes for Series B Notes or Series C Notes. Series C Notes are not rated by DBRS.

One of the assets of the Trust is a synthetic CDO note (the CDO Note), backed by a CDS, with exposure to a portfolio of corporate reference entities. Other assets of the Trust include commercial mortgage-backed securities (CMBS) and traditional asset-backed securities. The terms of the July 2008 restructuring included the cross-collateralization of CMBS and CDO assets, which reduced the amount of leverage on the CDO transaction.

Leveraged CDOs are subject to credit risk and market risk. The credit risk in a CDO transaction is quantified using the DBRS CDO Toolbox, which determines a level of portfolio loss that can be equated with a certain credit rating, based on factors such as the underlying credit ratings, correlation among the underlying entities and the time to maturity. From a credit perspective, the CDO Note remains rated AAA with a sufficient level of stability cushion. Market risk (or funding risk) is determined by calculating the probability of a collateralization trigger being breached and equating the likelihood with a certain credit rating. In rating a leveraged CDO transaction, the final rating assigned by DBRS is the lower of the implied rating from credit risk and the implied rating from market risk.

Although the amount of leverage has been reduced on the CDO transaction, the collateral currently held by the Swap Counterparty is smaller than the potential maximum exposure under the CDS. As a result, certain collateralization triggers are in place. As part of the July 2008 restructuring, the CDS was amended to change the MTM triggers in place to triggers based on a combination of spread and loss values, which made the possibility of a collateral call more remote. However, the CDS will be subject to margin calls if the collateralization triggers are breached.

The weighted average spread on the CDO portfolio has risen considerably and has now exceeded the trigger value. As a result, the CDS reverts to MTM triggers. Based on the current MTM value (as of December 3, 2008), the MTM trigger would not be breached; however, the current MTM is very close to its triggering value. If both the spread-loss trigger and the MTM trigger are breached, then the Series B Noteholders may be expected to purchase additional Series B Notes to fund a margin call by the Swap Counterparty. In the event that a Series B Noteholder does not purchase additional Series B Notes, the Swap Counterparty has the ability to partially unwind the CDS, which may result in significant negative rating action being taken on the remaining Series B Notes.

As a result of the ongoing risk of additional funding being required, DBRS has maintained the Series B Notes Under Review with Negative Implications. DBRS will continue to monitor the situation closely and will provide updates as required.

The applicable methodology is Rating Canadian Structured Credit Transactions, which can be found on our website under Methodologies.

This is a Structured Finance rating.