NIMS are securities that are collateralized by all or part of the residual cash flow of a securitized pool of mortgage loans. Typically associated with subprime loans, NIMS provide the issuers with liquidity to the residual cash flow, and they reduce the balance-sheet exposure created through securitization. Issuers may structure NIMS within the underlying transaction or as a separate bond at a later date. As of July 2000, there have been over $3 billion of "private" NIMS issued.

Issuers' interest in NIMS transactions has grown because NIMS reduce balance-sheet risk and provide the issuer with cash. FAS 125, the Financial Accounting Standards rule regarding booking future cash flows on current balance sheets, has proven volatile to issuers' earnings and has had an adverse impact on the valuation of equity securities. In addition, regulators, concerned about both the potential for predatory lending and financial soundness issues, are monitoring and regulating subprime activity.

Advanta National Bank, the bank subsidiary of Advanta Corp., signed an agreement with the Office of the Comptroller of the Currency regarding the carrying value of its retained interests in mortgage securitizations and allowance for loan losses. As a result of this agreement and the assumptions set forth in the agreement, the carry value of Advanta National Bank's residuals was reduced. The issuance of NIMS reduces the volatility associated with projecting future income. In addition, by selling the NIMS at the time of the securitization of the underlying mortgage loans, the issuer can compare the total proceeds from securitization to the whole loan execution in a more complete manner.

Many of the earlier NIMS transactions not rated by Standard & Poor's have performed poorly. This was due to several factors, including structure and insufficient assumptions with respect to expected losses, basis risk, and prepayments. In many of the underlying deals, overcollateralization targets have stepped up from the initially specified amount because of poor performance. As a result, cash flow to the NIMS was diminished or in some cases shut off.

More recently in Standard & Poor's rated NIMS, a variety of structural innovations have been incorporated to alleviate most of the problems experienced with earlier transactions. These features have been incorporated to stabilize the expected cash flow received by the NIMS holder. They include:

• Fully funded (upfront) overcollateralization;
• Capitalized interest reserve account;
• Pledge of prepayment penalties; and
• Pledge in some instances of nonamortizing, interest-only certificates.

Risks in NIMS rated by Standard & Poor's are adequately reflected in the size of the NIMS and the assigned rating. Standard & Poor's will rate NIMS transactions that incorporate some or a combination of the above structural features. If a transaction does not meet the above structural features, Standard & Poor's will factor the discrepancies into its analysis and the sizing of the NIMS at each rating level. A more detailed article discussing Standard & Poor's NIMS criteria will be released shortly. -- CreditWire

SOURCE: Standard & Poor's CreditWire

WEB SITE: http://www.standardandpoors.com/ratings/

CO: Standard & Poor's