The Securitization Process: Prof. Ian Giddy

Asset-Backed Securities
The Securitization Process

Prof. Ian Giddy
Stern School of Business New York University
q The
basic idea q Whats needed? q The technique q Applications q Typical sequence
Copyright 2001 Ian H. Giddy
globalsecuritization.com
The Securitization Process3
Securitization of Assets
Securitization is the transformation of an illiquid asset into a security. q For example, a group of consumer loans can be transformed into a publically-issued debt security. q A security is tradable, and therefore more liquid than the underlying loan or receivables. Securitization of assets can lower risk, add liquidity, and improve economic efficiency. q Sometimes,assets are worth more off the balance sheet than on it.
q
Copyright 2001 Ian H. Giddy globalsecuritization.com
What is the Technique for Creating Asset-Backed Securities?

A lender originates loans, such as to a homeowner or corporation. q The securitization structure is added. The bank or firm sells or assigns certain assets, such as consumer receivables, to a special purpose vehicle. q The structure is legally insulated from management q Credit enhancement and rating agency reviews q The SPV issues debt, dividing up the benefits (and risks) among investors on a pro-rata basis
q
Securitization: The Basic Structure

SPONSORING COMPANY
ACCOUNTS RECEIVABLE
SALE OR ASSIGNMENT
SPECIAL PURPOSE VEHICLE ISSUES ASSET-BACKED CERTIFICATES
ACCOUNTS RECEIVABLE
The Process
Is Isthe thecompany company ready? ready? Are Arethe theassets assets suitable? suitable? What Whatpool? pool? What Whatlegal legal structure? structure? What Whatcredit credit enhancement? enhancement?
Is the Company Ready for ABS?

q
q q q
Does the originator currently face a high cost of funding assets that would be recognized as sound, cash-generating assets if taken in isolation? Does it have a regulatory or capital constraint that makes freeing up the balance sheet important? Does it have data about the assets (required by rating agencies and financial guarantors)? Does it have the servicing process and systems that can meet the more demanding standards of the assetbacked market? Is the originator willing to undertake a complex, timeconsuming transaction to obtain a broader, potentially cheaper, ongoing source of funding?
Are the Assets Suitable?

The Pool of Assets Should Have:
n
Volume which is sufficiently large and homogenous to facilitate statistical analysis A stable history of rates, defaults, delinquencies, prepayments and so forth Sufficient diversification--for example, geographic and socio- economic-to reduce vulnerability to economic stresses Basic lenders credit quality standards that are capable of being evaluated and approved by rating agencies and specialized financial guaranty companies Assets must be transferable and unencumbered In short, the assets themselves must be sufficiently strong to support a high credit rating without the backing of the originating lender.
What is the Technique for Creating Asset-Backed Securities?

A lender originates loans, such as to a homeowner or corporation. q The securitization structure is added. The bank or firm sells or assigns certain assets, such as consumer receivables, to a special purpose vehicle. q The structure is legally insulated from management q Credit enhancement and rating agency reviews q The SPV issues debt, dividing up the benefits (and risks) among investors on a pro-rata basis
q
IM
E PL
E M
T N
T A
N IO
Finance Finance Company Company Limited Limited
Case Study: The Company (Finance Company Limited)

q Finance
company whose growth is constrained q Has pool of automobile receivables q Has track record q Plans to use this as an ongoing source of financing
Key Decisions
Securitize the assets

Decisions
Form of transfer of asset
Form of special purpose vehicle
Form of credit enhancement
Form of Form of cash flow transformation of allocation cash flows
Case Study: Initial Exchanges

Finance Co.s Customers
Hire-Purchase Agreement
Finance Co. Ltd (Seller)

Hire-Purchase Agreement
Proceeds
FCL 1997-A (Special Purpose Co.)
Proceeds
Investors

Hire-Purchase Agreement Servicing Agreement
Proceeds
Proceeds
Investors
Sale of Assets
Trustee
Trust Agreement

Rating Agency
Top Rating
Proceeds
Proceeds
Investors
Sale of Assets
Trustee
Trust Agreement
Case Study: Ongoing Payments

Hire-Purchase Payments Servicing Fees Monthly HP Payments Monthly ABS Payments
Investors
Trustee
Trustee Responsibilities Guarantee Responsibilities
Financial Guarantee Provider
Getting a Rating: The Risks

Credit risks q Liquidity risk q Servicer performance risk q Swap counterparty risk q Guarantor risk q Legal risks q Sovereign risk q Interest rate and currency risks q Prepayment risks
q
Risk-Management Techniques in ABS

SPONSORING COMPANY
CREDIT CREDIT ENHANCEMENT ENHANCEMENT
ACCOUNTS RECEIVABLE
SOVEREIGN SOVEREIGN PROTECTIONS PROTECTIONS

SALE OR ASSIGNMENT
SPECIAL PURPOSE VEHICLE
ACCOUNTS RECEIVABLE
ISSUES ASSET-BACKED CERTIFICATES
INTEREST INTERESTRATE/ RATE/ CURRENCY CURRENCY HEDGES HEDGES
CASH CASHFLOW FLOW REALLOCATION REALLOCATION
Credit Enhancement: Guarantee Method

Rating Agency
Top Rating
Proceeds
Proceeds
Investors
Sale of Assets
Trustee
Trust Agreement Guarantee Agreement
Financial Guarantee Provider (if required)
Credit Enhancement: An Alternative Approach
Rating Agency Top Rating Senior Lower Rating
Proceeds
Subordinated No Rating More Subordinated
Sale of Assets
Guarantee Agreement
Financial Guarantee Provider (if required)
The Rating Process and Credit Enhancement

Prof. Ian Giddy
Rating Agencies
n n n n n n
Moodys Moodys Standard Standard& &Poors Poors Fitch Fitch
Why bother with a rating? q Compare equivalent credit risks across different kinds of debt: corporate, sovereign, ABS q Compare alternatives across different ratings levels q Obtain a relative as well as an absolute measure of credit risk q Be reasonably sure of a market to sell the security.
Default Matrix
Source: Fitch, Bank CLOs
Rating Reports: Who Pays for Them?

General reports on a sector, like CLOs q Pre-sale report on an individual CLO, once risks have been evaluated but final terms and credit enhancement have not yet been finanized q Final deal report q Periodic updates
q
ABS: Factors Agencies Examine

q Asset
portfolio analysis q Legal structure of the transaction q Quality of the originator/servicer q The trustee q The cash flow structure q The counterparties
Rating Agencies: Business Analysis

Organization and management structure q Financial performance q Business strategy and planning processes q Controls and procedures q Asset origination and credit assessment procedures q Quality of its loan documentation q Credit administation and debt recovery procedures
q
Credit Enhancement or overcollateralization q Reserve and liquidity accounts and lines q Excess cash flow q Third-party guarantees
q Senior/Sub
The Result: Bond Credit Ratings

Standard & Moodys Poors Aaa Aa A Baa Ba B Caa Ca C
Interpretation High-quality debt instruments Strong to adequate ability to pay principal and interest Ability to pay interest and principal speculative
AAA AA A BBB BB B CCC CC C D
In default
Typical Rating Analysis

Originators credit underwriting standards
Pre-securitization risk reduction
Screening of assets to be included in the portfolio Diversification of the portfolio
Legal structure based credit risk reduction Credit quality of deal participants
Legal insulation from originator default Legal insulation from servicer default
Originator/Seller/Servicer Trustee, swap counterparties Guarantors
Integrity of cash flow structure
Cash flow sufficiency and mismatches Safeguards and agreements such as swaps or caps
Direct recourse
Internal credit enhancement Credit enhancement Third party credit enhancement
Senior/subordination or overcollateralization Reserve or spread accounts
Cash collateralized accounts Financial guarantees
Rating
Credit Enhancement
q Overcollateralization q Senior/Sub
or q Reserve and liquidity accounts and lines q Excess cash flow q Third-party guarantees
Over-Collateralization Method
SPECIAL-PURPOSE VEHICLE
COLLATERAL POOL
SENIOR ASSET-BACKED SECURITIES EQUITY ABS (owned by seller)
OVER-COLLATERAL
Example of Senior/Sub Structure
Class A1,A2,A-x B C D E F Issuer balance

Rating AAA AA A BBB BB B NR

Subordination 28% 22% 16.5% 12% 8.5% 5.5% 0%

Possible Time Frame

1 2 3
R e s u lt of cash flow analysis Determination of eligible receivables Approach rating agencies and introduction of the structure envisaged Founding of the SPV Initiation of stock exchange approval process (in case of a Bond issuance) Draft of Offering Circular (in case of a Bond issuance) Comments of the Rating agencies (Rating confirmation) Determination of funding strategy Publication of Offering Circular (in case of a Bond issuance) Marketing (in case of a Bond issuance) Completion of documentation Purchase of receivables and issuance of securities Determination of structure Information Memorandum Commencement of documentation Detailed cash flow analysis Preparation for rating process
months 4
7
This schedule serves as an indication only and may vary from transaction to transaction.
One Banks Assessment

q The
implementation of a transaction usually takes between two and six months, provided all necessary data and information is readily available. time frame does not take into account the rating process.
q This
The Securitization Process - 1

One Banks List A private placement for a client who has done previous securitizations

Select securitization counsel and accountants C o n sider tax, accounting and securitization objectives Discuss data fields required for loan data file D e fine data to be audited by accountants Begin drafting Private Placement Memorandum (PPM) Begin drafting legal documents A s s e m ble preliminary pool and create initial data tape C o n sider preliminary bond structure Select rating agencies Perform integrity check on data tape (cracking the tape)
If new client, this would follow screening of corporation and loan pool for suitability Any info used in the PPM or in the pool analysis must be audited. If its a public offering, need a public Prospectus or Prospectus Supplement. A discussion with rating agency be necessary for selection of legal structure and pool selection if its a new type of ABS.
Data from companies come in many different forms. The Securitization Process39
investment banks The Securitization Process - 2 Most active in ABS have
One Banks List

Model cash flow and bond structure Prepare rating agency presentation Select truste e/backup servicer R e c o n cile discrepancies with accountants Distribute rating agency presentations M e et with rating agencies Determine pending loan closings Select rating agencies and sign engagement letters Optimize loan pool and revise bond structure R a ting agency borrower visits (if necessary) R a ting agency due diligence (if necessary) C o m plete loan closings and finalize loan pool
developed modelling software
Invariably, with the amount of information be supplied by the issuer via the tape, there will be mistakes/discrepancies to resolve, mostly with regard to loan data thats been provided. During this process, the issuer is still originating collateral going into the deal. The bank has to decide what else it want to include, and has to establish a cutoff date. Which asset should not go into the pool? Its not necessarily bad collateral, but it may still hurt the overall profile of the pool
Obtain preliminary subordination levels from rating agencies
The Securitization Process - 3

One Banks List

Market transaction to sub-bond buyers (if necessary) Tie out collateral cash flow with accountants
Alternative would be for originator to keep sub tranche
The collateral cash flows in aggregate are structured to pay Final subordination levels from rating agencies bonds. The bonds are Finalize bond structure based on final loan pool and sub-levels then sold based on the likelihood that the Tie out bond cash flows with accountants bonds will receive those payments at a Finalize PPM and legal documents certain period in time. Therefore, the cash Arrange distribution by other banks flows that pay the bonds are what the Finalize internal marketing material investor is purchasing. The bond cash flow Issuer presentation to salesforce characteristics are presented in the Print red herring PPM and distribute to investors prospectus to investors Market transaction to investors and if they arent tied out, there is a huge Price bonds and execute Bond Purchase Agreement legal liability for the underwriter and issuer Print final PPM if they arent correct.
CLOSE TRANSACTION
This is the agreement to purchase the bonds from the SPV by the investor or investment banks Process41 globalsecuritization.com The Securitization
Asset-Backed Securities: Legal and Regulatory Issues

Prof. Ian Giddy
Asset-Backed Securities: Legal and Regulatory Aspects

q Legal
u The
Transfer u The Special-Purpose Vehicle

q Taxation q Accounting
Treatment q Bank Regulatory Treatment
Legal Aspects
q Goal:
L A G E L
Credit quality must be solely based on the quality of the assets and the credit enhancement backing the obligation, without any regard to the originator's own creditworthiness q Otherwise, quality of the ABS issue would be dependent on the originator's credit, and the whole rationale of the asset-backed security would be undermined.
Three conditions enable the separation AL G E of the assets and the originator L
The transfer must be a true sale, or its legal equivalent. If originator is only pledging the assets to secure a debt, this would be regarded as collaterized financing in which the originator would stay directly indebted to the investor. q The assets must be owned by a specialpurpose corporation, whose ownership of the sold assets is likely to survive bankruptcy of the seller. q The special-purpose vehicle that owns the assets must be independent
q
The Form of Transfer: True Sale? Form of transfer of asset True Sale Assignment Collateral
L A G E L
Alternative: Credit swap (Synthetic ABS)
What Makes it a Sale?

The form and treatment of the transaction q The nature and extent of the benefits transferred q The irrevocability of the transfer q The level and timing of the purchase price, q Who possesses the documents q Notification when the assets are sold
q
L A G E L
Asset Securitization
CHASE (SPONSOR)
CREDIT CARD RECEIVABLES
SALE OR ASSIGNMENT
CREDIT CARD RECEIVABLES
The Alternative: Synthetic ABS

HVB (Originator)
REFERENCE POOL OF LOANS (Stay on balance sheet)
L A G E L
CREDIT SWAP AGREEMENT
TOP QUALITY INVESTMENTS
Accounting Treatment
q Sale
versus financing q Consolidation q Accounting for loan servicing
G N I T N U O C AC
FASB Sale Treatment

q The
transferor relinquishes control of the future economic benefits embodied in the assets being transferred q The SPV cannot require the transferor to repurchase the assets except pusuant to certain recourse provisions q The transferor's obligation under any recourse provision are confined and can be reasonably estimated
G N I T N U O C AC
Bank Regulation and Capital Requirements

Goal: Ensure that the substance and not the form of the asset transfer is what governs capital requirements. The regulatory authorities may assess capital or reserve requirements as if the financing was a secured borrowing:
q
u Where
the transfer leaves the bank open to recourse deemed risky by the authorities, u Or where there is potential for a "moral hazard" whereby a bank may shore up potential or actual losses in the sold assets to protect its name even when not legally required to do so.
Basel 2 and ABS

q Originating
banks (clean break) q Investing banks (use of ratings) q Sponsor banks (for ABS conduits) q Synthetic securitization (degree of risk transference)
Basel 2 for Investing Banks AAA to AAA+ to ABBB+ to BBBBB+ to BBB+ and below 20% 50% 100% 150% Deducted from capital
Source: Basel Committee on Banking Supervision, January 2001

Example: Ford Credit Owner Trust 1999-A
Ford Structure
Ford Ford Motor Credit
Sale
Ford Credit Auto Rec. Two LP
Class A-5 and A-6
Sale
Ford Credit Auto Owner Trust Class A-1 to A6 Class B Receivables Class C Class D
Class D
Ford Structure: Waterfall
Receivables
Class A-1 to A6 Class B Class C Class D
Ford Structure: Default or Loss?
Receivables Class A-1 to A6 Class B Class C Class D
Paydown: Soft Bullet Structure
Example: DBS Singa Deal
DBS Bank Loan portfolio Seller/Servicer
Singa
US$ FRN
Investors
Dah Sing/Hong Kong SAR
Dah Sing Seller/Servicer
Mortgage portfolio
Hong Kong SAR Res Mort. Ltd
US$ FRN
Investors
Currency Swaps
Financial Guarantees
ASIA Ltd General Re CapMac
Franchise Loan Securitization

Franchisees (Borrowers)
Loan Agreement Loan Payments
Atherton Capital (Seller)
Proceeds
Atherton FLF 1998-A (Special Purpose Co.)
Proceeds
Investors
Sale of Assets Servicing Advisor
Mellon Mortgage (Servicer)
Servicing Agreement
Class A1,A2,A-x B C D E F Issuer balance
Rating AAA AA A BBB BB B NR
Subordination 28% 22% 16.5% 12% 8.5% 5.5% 0%

Films (Finance for an Italian

Library of Movies)
Future-Flow Financing: Offshore Purchase Agreement
YPF (Argentinian oil producer)
Oil (under sales agreement) Oil Trading Co. (Cayman Is. SPV) US$ Oil (under purchase agreement) Highly rated U.S. oil buyer
Notes Noteholders US$ Fixed debt payments US$ Trust
Asiansecuritization.com
Ian H. Giddy Stern School of Business New York University 44 West 4th Street, New York, NY 10012, USA Tel 212-998-0426 ian.giddy@nyu.edu http://giddy.org

The Securitization Process: Prof. Ian Giddy

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

The Securitization Process: Prof. Ian Giddy

Uploaded by

Copyright:

Available Formats

Asset-Backed Securities

The Securitization Process

basic idea q Whats needed? q The technique q Applications q Typical sequence

Copyright 2001 Ian H. Giddy

The Securitization Process3

The Securitization Process4

What is the Technique for Creating Asset-Backed Securities?

The Securitization Process5

Securitization: The Basic Structure

SPECIAL PURPOSE VEHICLE ISSUES ASSET-BACKED CERTIFICATES

Copyright 2001 Ian H. Giddy

The Securitization Process6

Copyright 2001 Ian H. Giddy

The Securitization Process8

Is the Company Ready for ABS?

Copyright 2001 Ian H. Giddy

The Securitization Process9

Are the Assets Suitable?

Copyright 2001 Ian H. Giddy

The Securitization Process11

What is the Technique for Creating Asset-Backed Securities?

Copyright 2001 Ian H. Giddy

The Securitization Process12

Finance Finance Company Company Limited Limited

Case Study: The Company (Finance Company Limited)

Copyright 2001 Ian H. Giddy

The Securitization Process14

Securitize the assets

Form of transfer of asset

Form of special purpose vehicle

Form of credit enhancement

Form of Form of cash flow transformation of allocation cash flows

Copyright 2001 Ian H. Giddy

The Securitization Process15

Case Study: Initial Exchanges

Finance Co. Ltd (Seller)

Copyright 2001 Ian H. Giddy

The Securitization Process16

Case Study: Initial Exchanges

Finance Co. Ltd (Seller)

FCL 1997-A (Special Purpose Co.)

Copyright 2001 Ian H. Giddy

The Securitization Process17

Case Study: Initial Exchanges

Finance Co. Ltd (Seller)

FCL 1997-A (Special Purpose Co.)

Copyright 2001 Ian H. Giddy

The Securitization Process18

Case Study: Initial Exchanges

Finance Co. Ltd (Seller)

FCL 1997-A (Special Purpose Co.)

Copyright 2001 Ian H. Giddy

The Securitization Process19

Case Study: Ongoing Payments

Finance Co. Ltd (Seller)

FCL 1997-A (Special Purpose Co.)

Financial Guarantee Provider

Copyright 2001 Ian H. Giddy

The Securitization Process20

Getting a Rating: The Risks

The Securitization Process21

Risk-Management Techniques in ABS

CREDIT CREDIT ENHANCEMENT ENHANCEMENT