Rating Action: Moody's assigns provisional ratings to credit risk transfer notes issued by Freddie Mac STACR REMIC 2020-HQA3
Global Credit Research - 16 Jul 2020
New York, July 16, 2020 -- Moody's Investors Service, ("Moody's") has assigned provisional ratings to 23 classes of credit risk transfer notes issued by Freddie Mac STACR REMIC 2020-HQA3. The ratings range from (P)A3 (sf) to (P)Ba1 (sf).
Freddie Mac STACR REMIC 2020-HQA3 (STACR 2020-HQA3) is the third transaction of 2020 in the HQA series issued by the Federal Home Loan Mortgage Corporation (Freddie Mac) to share the credit risk on a reference pool of mortgages with the capital markets. The transaction is structured as a real estate mortgage investment conduit (REMIC).
The notes in STACR 2020-HQA3 receive principal payments as the loans in the reference pool amortize or prepay. Principal payments to the notes are paid from assets in the trust account established from proceeds of the notes issuance. Interest payments to the notes are paid from a combination of investment income from trust assets, an asset of the trust known as the interest-only (IO) Q-REMIC interest, and Freddie Mac. Freddie Mac is responsible to cover (1) any interest owed on the notes not covered by the investment income from the trust assets and the yield on the IO Q-REMIC interest and (2) to reimburse the trust for any investment losses from sales of the trust assets.
Investors have no recourse to the underlying reference pool. The credit risk exposure of the notes depends on the actual realized losses and modification losses incurred by the reference pool. Freddie Mac is obligated to pay off the notes in July 2050 if any balances remain outstanding.
The complete rating actions are as follows:
Issuer: Freddie Mac STACR REMIC 2020-HQA3
Cl. M-1, Assigned (P)A3 (sf)
Cl. M-2, Assigned (P)Baa3 (sf)
Cl. M-2A, Assigned (P)Baa3 (sf)
Cl. M-2AI*, Assigned (P)Baa3 (sf)
Cl. M-2AR, Assigned (P)Baa3 (sf)
Cl. M-2AS, Assigned (P)Baa3 (sf)
Cl. M-2AT, Assigned (P)Baa3 (sf)
Cl. M-2AU, Assigned (P)Baa3 (sf)
Cl. M-2B, Assigned (P)Ba1 (sf)
Cl. M-2BI*, Assigned (P)Ba1 (sf)
Cl. M-2BR, Assigned (P)Ba1 (sf)
Cl. M-2BS, Assigned (P)Ba1 (sf)
Cl. M-2BT, Assigned (P)Ba1 (sf)
Cl. M-2BU, Assigned (P)Ba1 (sf)
Cl. M-2I*, Assigned (P)Baa3 (sf)
Cl. M-2R, Assigned (P)Baa3 (sf)
Cl. M-2RB, Assigned (P)Ba1 (sf)
Cl. M-2S, Assigned (P)Baa3 (sf)
Cl. M-2SB, Assigned (P)Ba1 (sf)
Cl. M-2T, Assigned (P)Baa3 (sf)
Cl. M-2TB, Assigned (P)Ba1 (sf)
Cl. M-2U, Assigned (P)Baa3 (sf)
Cl. M-2UB, Assigned (P)Ba1 (sf)
*Reflects Interest-Only Classes
Summary Credit Analysis and Rating Rationale
Moody's expected loss for this pool in a baseline scenario-mean is 1.02%, in a baseline scenario-median is 0.78%, and reaches 5.50% at a stress level consistent with our Aaa ratings. We calculated losses on the pool using our US Moody's Individual Loan Analysis (MILAN) GSE model based on the loan-level collateral information as of the cut-off date. Loan-level adjustments to the model results included, but were not limited to, qualitative adjustments for origination quality and third-party review (TPR) scope.
Our analysis has considered the effect of the COVID-19 outbreak on the US economy as well as the effects that the announced government measures, put in place to contain the virus, will have on the performance of mortgage loans. Specifically, for US RMBS, loan performance will weaken due to the unprecedented spike in the unemployment rate, which may limit borrowers' income and their ability to service debt. The softening of the housing market will reduce recoveries on defaulted loans, also a credit negative. Furthermore, borrower assistance programs, such as forbearance, may adversely impact scheduled cash flows to bondholders.
The rapid spread of the coronavirus outbreak, the government measures put in place to contain it and the deteriorating global economic outlook, have created a severe and extensive credit shock across sectors, regions and markets. Our analysis has considered the effect on the performance of US RMBS from the collapse in the US economic activity in the second quarter and a gradual recovery in the second half of the year. However, that outcome depends on whether governments can reopen their economies while also safeguarding public health and avoiding a further surge in infections.
The contraction in economic activity in the second quarter was severe and the overall recovery in the second half of the year will be gradual. However, there are significant downside risks to our forecasts in the event that the pandemic is not contained and lockdowns have to be reinstated. As a result, the degree of uncertainty around our forecasts is unusually high. We increased our model-derived median expected losses by 15% (12.34% for the mean) and our Aaa losses by 5% to reflect the likely performance deterioration resulting from of a slowdown in US economic activity in 2020 due to the COVID-19 outbreak.
We regard the COVID-19 outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety.
Servicing practices, including tracking COVID-19-related loss mitigation activities, may vary among servicers in the transaction. These inconsistencies could impact reported collateral performance and affect the timing of any breach of performance triggers and the amount of modification losses.
We may infer and extrapolate from the information provided based on this or other transactions or industry information, or make stressed assumptions.
The reference pool consists of over one-hundred eighteen thousand prime, fixed-rate, one- to four-unit, first-lien conforming mortgage loans acquired by Freddie Mac. The loans were originated on or after January 1, 2015 with a weighted average seasoning of eight months. Each of the loans in the reference pool had a loan-to-value (LTV) ratio at origination that was greater than 80% and less than or equal to 97%. 13.6% of the pool are loans underwritten through Freddie Mac's Home Possible program and 98.7% of loans in the pool are covered by mortgage insurance as of the cut-off date.
We consider Freddie Mac's overall seller management and aggregation practices to be adequate and we did not apply a separate loss-level adjustment for aggregation quality.
Freddie Mac uses a delegated underwriting process to purchase loans. Sellers are required to represent and warrant that loans are made in accordance with negotiated terms or Freddie Mac's guide. Numerous checks in the selling system ensures that loans with the correct characteristics are delivered to Freddie Mac. Sellers are required to cure, make an indemnification payment or repurchase the loans if a material underwriting defect is discovered subject to certain limits. In certain cases, Freddie Mac may elect to waive the enforcements of the repurchase if an alternative such as an indemnification payment is provided.
Freddie Mac monitors each seller's risk exposure both on an aggregated basis as well as by product lines. A surveillance team reviews sellers' financials at least on an annual basis, monitors exposure limits, risk ratings, lenders QC reports and internal audit results and may adjust credit limits, require additional loan/operational reviews or put the seller on a watch list, as needed.
Home Possible loans: Approximately 13.6% of the loans by Cut-off Date Balance were originated under the Home Possible program. The program is designed to make responsible homeownership accessible to low- to moderate-income homebuyers, by requiring low down payments, lower risk-adjusted pricing, flexibility in sources of income, and, in certain circumstances, lower than standard mortgage insurance coverage. Home Possible loans in STACR 2020-HQA3's reference pool have a WA FICO of 745 and WA LTV of 93.8%, versus a WA FICO of 753 and a WA LTV of 91.3% for the rest of the loans in the pool. While our MILAN model takes into account characteristics listed on the loan tape, such as lower FICOs and higher LTVs, there may be risks not captured by our model due to less stringent underwriting, including allowing more flexible sources of funds for down payment and lower risk-adjusted pricing. We applied an adjustment to the loss levels to address the additional risks that Home Possible loans may add to the reference pool.
Enhanced Relief Refinance (ERR)
The ERR program is designed to provide refinance opportunities to borrowers with existing Freddie Mac's mortgage loans who are current on their mortgage payments but whose LTV ratios exceed the maximum permitted for standard refinance products. The program is intended to offer refinance opportunities to borrowers so they can reduce their monthly payment. STACR 2020-HQA3's reference pool does not include ERR loans at closing, however, transaction documents allow for the replacement of loans in the reference pool with ERR loans in the future. The replacement will not constitute a prepayment on the replaced loan, credit event or a modification event.
At closing, we did not make any adjustment to our collateral losses due to the existence of the ERR program. We believe the programs are beneficial for loans in the pool, especially during an economic downturn when limited refinancing opportunities would be available to borrowers with low or negative equity in their properties. However, since such refinanced loans are likely to have later maturities and slower prepayment rates than the rest of the loans, the reference pool is at risk of having a high concentration of high LTV loans at the tail of the transaction's life. We will monitor ERR loans in the reference pool and may make an adjustment in the future if the percentage of them becomes significant after closing.
As master servicer, Freddie Mac has strong servicer oversight and monitoring processes. Generally, Freddie Mac does not itself conduct servicing activities. When a mortgage loan is sold to Freddie Mac, the seller enters into an agreement to service the mortgage loan for Freddie Mac in accordance with a comprehensive servicing guide for servicers to follow. Freddie Mac monitors primary servicer performance and compliance through its Servicer Success Program, scorecard and servicing quality assurance group. Freddie Mac also reviews individual loan files to identify servicing performance gaps and trends.
We consider the servicing arrangement to be adequate and we did not make any adjustments to our loss levels based on Freddie Mac's servicer management.
We consider the scope of the TPR based on Freddie Mac's acquisition and QC framework to be adequate. We assessed an adjustment to loss at a Aaa stress level due to lack of compliance review on TILA-RESPA Integrated Disclosure (TRID) violations.
The results and scope of the pre-securitization third-party, loan-level review (due diligence) suggest a heavier reliance on sellers' representations and warranties (R&Ws) compared with private label securitizations. The scope of the TPR, for example, is weaker because the sample size is small (only 0.39% of the loans in reference pool are included in the sample). To the extent that the TPR firm classifies certain credit or valuation discrepancies as 'findings', Freddie Mac will review and may provide rebuttals to those findings, which could result in the change of event grades by the review firm.
The third-party due diligence scope focuses on the following:
Compliance: The diligence firm reviewed 333 loans for compliance with federal, state and local high cost Home Ownership and Equity Protection Act (HOEPA) regulations (297 loans were reviewed for compliance plus 36 loans were reviewed for both credit/valuation and compliance). None were deemed to be noncompliant.
Appraisals: The third-party diligence provider also reviewed property valuation on 999 loans in the sample pool (963 loans were reviewed for credit/valuation plus 36 loans were reviewed for both credit/valuation and compliance). Seven loans received final valuation grades of "C". The third-party diligence provider was not able to obtain property appraisal risk reviews on 1 mortgage loan due to properties located in Guam. The remaining 6 loans had Appraisal Desktop with Inspections (ADI) which did not support the original appraised value within the 10% tolerance.
Credit: The third-party diligence provider reviewed credit on 999 loans in the sample pool. Five loans had final grades of "D" and six loans had final grades of "C" due to underwriting defects. These loans were removed from the reference pool. The results were consistent with prior STACR transactions we rated.
Data integrity: The third-party review firm analyzed the sample pool for data calculation and comparison to the imaged file documents. The review revealed 74 data discrepancies on 67 loans, with 26 discrepancies related to DTI and 13 discrepancies related to first time home buyers.
Unlike private label RMBS transactions, a review of TRID violation was not part of Freddie Mac's due diligence scope. A lack of transparency regarding how many loans in the transaction contain material violations of the TRID rule is a credit negative. However, since we expect overall losses on STACR transactions owing to TRID violations to be fairly minimal, we only made a slight qualitative adjustment to losses under a Aaa scenario. Furthermore, lender R&Ws and the GSEs' ability to remove defective loans from the transactions will likely mitigate some of aforementioned concerns.
Reps & Warranties Framework
Freddie Mac is not providing loan level (R&Ws for this transaction because the notes are a direct obligation of Freddie Mac. The reference obligations are subject to R&Ws made by the sellers. As such, Freddie Mac commands robust R&Ws from its seller/servicers pertaining to all facets of the loan, including but not limited to compliance with laws, compliance with all underwriting guidelines, enforceability, good property condition and appraisal procedures. Freddie Mac will be responsible for enforcing the R&Ws made by the sellers/lenders in the reference pool. To the extent that Freddie Mac discovers a confirmed underwriting defect or a major servicing defect, the respective loan will be removed from the reference pool. Since Freddie Mac retains a significant portion of the risk in the transaction, it will likely take necessary steps to address any breaches of R&Ws. For example, Freddie Mac undertakes quality control reviews and servicing quality assurance reviews of small samples of the mortgage loans that sellers deliver to Freddie Mac. These processes are intended to determine, among other things, the accuracy of the R&Ws made by the sellers in respect of the mortgage loans that are sold to Freddie Mac. We made no adjustments to the transaction regarding the R&W framework.
We refer to the M-1, M-2A, M-2B, B-1A, B-1B, B-2A and B-2B notes as the original notes, and the M-2, M-2R, M-2S, M-2T, M-2U, M-2I, M-2AR, M-2AS, M-2AT, M-2AU, M-2AI, M-2BR, M-2BS, M-2BT, M-2BU, M-2BI, M-2RB, M-2SB, M-2TB, M-2UB, B-1, B-2, B-1AR, B-1AI, B-2AR and B-2AI notes as the Modifiable and Combinable REMICs (MACR) notes; together we refer to them as the notes.
The M-2 notes can be exchanged for M-2A and M-2B notes, M-2R and M-2I notes, M-2S and M-2I, M-2T and M-2I, and M-2U and M-2I notes.
The M-2A notes can be exchanged for M-2AR and M-2AI notes, M-2AS and M-2AI notes, M-2AT and M-2AI, and M-2AU and M-2AI notes.
The M-2B notes can be exchanged for M-2BR and M-2BI notes, M-2BS and M-2BI notes, M-2BT and M-2BI notes, and M-2BU and M-2BI notes.
Classes M-2I , M-2AI, M-2BI, B-1AI and B-2AI are interest only tranches referencing to the notional balances of Classes M-2, M-2A, M-2B, B-1A and B-2A, respectively.
Classes M-2RB, M-2SB, M-2TB and M-2UB are each an exchangeable for two classes that are initially offered at closing. Our ratings of M-2RB, M-2SB, M-2TB and M-2UB reference the rating of Class M-2B only, disregarding the rating of M-2AI. This is the case because Class M-2AI's cash flow represents an insignificant portion of the overall promise. In the event Class M-2B gets written down through losses and Class M-2AI is still outstanding, we would continue to rate Classes M-2RB, M-2SB, M-2TB and M-2UB consistent with Class M-2B's last outstanding rating so long as Classes M-2RB, M-2SB, M-2TB and M-2UB are still outstanding.
Credit enhancement in this transaction is comprised of subordination provided by mezzanine and junior tranches. Realized losses are allocated in a reverse sequential order starting with the Class B-3H reference tranche.
Interest due on the notes is determined by the outstanding principal balance and the interest rate of the notes. The interest payment amount is the interest accrual amount of a class of notes minus any modification loss amount allocated to such class on each payment date, plus any modification gain amount. The modification loss and gain amounts are calculated by taking the respective positive and negative difference between the original accrual rate of the loans, multiplied by the unpaid balance of the loans, and the current accrual rate of the loans, multiplied by the interest bearing unpaid balance.
So long as the senior reference tranche is outstanding, and no performance trigger event occurs, the transaction structure allocates principal payments on a pro-rata basis between the senior and non-senior reference tranches. Principal is then allocated sequentially amongst the non-senior tranches.
The STACR 2020-HQA3 transaction allows for principal distribution to subordinate notes by the supplemental subordinate reduction amount even if performance triggers fail. The supplemental subordinate reduction amount equals the excess of the offered reference tranche percentage over 6.15%. The distribution of the supplemental subordinated reduction amount would reduce principal balances of the offered reference tranche and correspondingly limit the credit enhancement of class A note to be always below 6.15% plus the note balance of B-3H. This feature is beneficial to the offered certificates.
Credit Events and Modification Events
Reference tranche write-downs occur as a result of loan level credit events. A credit event with respect to any loan means any of the following events: (i) a short sale with respect to the related mortgaged property is settled, (ii) a related seriously delinquent mortgage note is sold prior to foreclosure, (iii) the mortgaged property that secured the related mortgage note is sold to a third party at a foreclosure sale, (iv) an REO disposition occurs, or (v) the related mortgage note is charged-off. As a result, the frequency of credit events will be the same as actual loan default frequency, and losses will impact the notes similar to that of a typical RMBS deal.
Loans that experience credit events that are subsequently found to have an underwriting defect, a major servicing defect or are deemed ineligible will be subject to a reverse credit event. Reference tranche balances will be written up for all reverse credit events in sequential order, beginning with the most senior tranche that has been subject to a previous write-down. In addition, the amount of the tranche write-up will be treated as an additional principal recovery, and will be paid to noteholders in accordance with the cash flow waterfall.
If a loan experiences a forbearance or mortgage rate modification, the difference between the original mortgage rate and the current mortgage rate will be allocated to the reference tranches as a modification loss. The Class B-3H reference tranche, which represents 0.25% of the pool, will absorb modification losses first. The final coupons on the notes will have an impact on the amount of interest available to absorb modification losses from the reference pool.
Similar to prior STACR transactions, the initial subordination level of 4% is lower than the deal's minimum credit enhancement trigger level of 4.50%. The transaction begins by failing the minimum credit enhancement test, leaving the subordinate tranches locked out of unscheduled principal payments until the deal builds an additional 0.50% subordination. STACR 2020-HQA3 does not have a subordination floor. This is mitigated by the sequential principal payment structure of the deal, which ensures that the credit enhancement of the subordinate tranches is not eroded early in the life of the transaction.
Factors that would lead to an upgrade or downgrade of the ratings:
Levels of credit protection that are insufficient to protect investors against current expectations of loss could drive the ratings down. Losses could rise above Moody's original expectations as a result of a higher number of obligor defaults or deterioration in the value of the mortgaged property securing an obligor's promise of payment. Transaction performance also depends greatly on the US macro economy and housing market. Other reasons for worse-than-expected performance include poor servicing, error on the part of transaction parties, inadequate transaction governance and fraud.
Levels of credit protection that are higher than necessary to protect investors against current expectations of loss could drive the ratings of the subordinate bonds up. Losses could decline from Moody's original expectations as a result of a lower number of obligor defaults or appreciation in the value of the mortgaged property securing an obligor's promise of payment. Transaction performance also depends greatly on the US macro economy and housing market.
The principal methodology used in rating all classes except interest-only classes was "Moody's Approach to Rating US RMBS Using the MILAN Framework" published in April 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_1201303. The methodologies used in rating interest-only classes were "Moody's Approach to Rating US RMBS Using the MILAN Framework" published in April 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_1201303 and "Moody's Approach to Rating Structured Finance Interest-Only (IO) Securities" published in February 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_1111179. Please see the list of ratings at the top of this announcement to identify which classes are interest-only (indicated by the *). Alternatively, Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
In addition, Moody's publishes a weekly summary of structured finance credit ratings and methodologies, available to all registered users of our website, www.moodys.com/SFQuickCheck.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
The analysis relies on an assessment of collateral characteristics to determine the collateral loss distribution, that is, the function that correlates to an assumption about the likelihood of occurrence to each level of possible losses in the collateral. As a second step, Moody's evaluates each possible collateral loss scenario using a model that replicates the relevant structural features to derive payments and therefore the ultimate potential losses for each rated instrument. The loss a rated instrument incurs in each collateral loss scenario, weighted by assumptions about the likelihood of events in that scenario occurring, results in the expected loss of the rated instrument.
Moody's quantitative analysis entails an evaluation of scenarios that stress factors contributing to sensitivity of ratings and take into account the likelihood of severe collateral losses or impaired cash flows. Moody's weights the impact on the rated instruments based on its assumptions of the likelihood of the events in such scenarios occurring.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
Ruomeng Cui Asst Vice President - Analyst Structured Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Sang Shin VP-Sr Credit Officer/Manager Structured Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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Additional terms for Japan only: Moody's Japan K.K. ("MJKK") is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody's Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody's SF Japan K.K. ("MSFJ") is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization ("NRSRO"). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.
MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any credit rating, agreed to pay to MJKK or MSFJ (as applicable) for credit ratings opinions and services rendered by it fees ranging from JPY125,000 to approximately JPY250,000,000.
MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.