Asset Securitization - Comptroller's Handbook - Borrower is Party to Securitization PG 8

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Comptroller of the Currency

Administratoro National Banks

sset

Securitization

Sec

Comptroller s Handbook

November 99

L

Ligui ity and Funds Management

BORROWER IS PARTY TO SECURITIZATION - PAGE 8





















redit

nhancer

Exhibit 1:

Parties

Involved In Structuring

Asset-Backed Securities

orrower

rlclnator ervlcer

I

peci l

-

urpose

ntitylTrultlle

I

Underwriter

I

nvestors

Borrower

The borrower is

responsible

for

payment

on the underlying loans

and therefore the ultimate

performance

of the asset-backed security. Because

borrowers

often

do not realize that their loans

have

been

sold

the originating

bank is

often able

to maintain the

customer

relationship.

From a credit risk

perspective

securitization has made popular the

practice

of

grouping borrowers by letter or

categories.

At the top of the

rating

scale A

quality borrowers have relatively pristine credit histories. At the bottom D

quality borrowers usually have

severely

blemished credit

histories.

The

categories are by no means rigid; in fact credit evaluation problems exist

because one originator s A borrower may be another s A- or B borrower.

Nevertheless the terms A paper and BIC paper are becoming more and

more popular.

Exhibit 2 is an example of generic borrower descriptions

used

by Duff

and

Phelps

Credit

Rating

Corporation in rating

mortgage

borrowers.

The

borrowers

characteristics

in the exhibit

are

generalizations of each

category s

standards

and fluctuate over time; however the table

does

provide an

illustration of general standards in use today. For example an A quality

Asset

Securitization


























Exhl•• 3: c.edk .isk

div

ific.lio.

• Talces catastrophiccredit

risk

• U,ually somemultipl. 01 expected 10

• Cantake several forms(letter ofcredit,CIA, ere.)

I

-Takes market

risk

but

only

minimal

creditrisk

redit

E hncer

nvestor

reI

latinS leney

O·ia; ·lo

•

Takes first-loss

ri lk

(built[ntosecurity

strucbJ

• Set standards for level of

risk

based on a

de ired

rating

•

Negotiates with

originator for

level

of

enhancement

based on desired creditrating

undertaken by the investors that buy the asset-backed securities themselves.

Although investors are exposed to other types of

risk,

such

as

prepayment or

interest

rate risk, senior-level

classes

of

asset-backed securities

typically

have

little

exposure

to credit

loss.

Aside

from the coupon rate

paid

to

investors,

the

largest

expense in

structuring

an asset-backed

security is the

cost

of credit

enhancement. Issuers

are

constantly attempting to minimize the costs associated with providing

credit protection to the ultimate

investors.

Credit enhancement

comes

in

several different

forms,

although it can generally be divided into two

main

types: external

third-party or seller s guarantee or internal

structural

or

cash

flow-driven). Common

types

of credit enhancements in use today include:

Credit

Enhancement

Provided by External

Parties

• Third party letter credit

For issuers with credit ratings below the

level sought

for the security issued, a third

party

may provide a letter of

credit to cover a certain amount of

loss

or percentage of losses. Draws

on the letter of credit protection

are

often

repaid

if

possible

from

excess

cash

flows from the securitized portfolio.

Asset Securitization

20
















Exhibit

4: The

Two Stag

of a Revolving Receivable A

et Backed Security

Revolving p lod - • • tD p r l n ~ 1 p.yments

.r e

reinvested in new receivables;

s.II. s

~ t e s t absorbs luclua lDns trust

ba nces

Amortlu.lIon

period k vsstors are paid thslr

share

of

princip.1callectiDns

\

mon 4

m_th

28 \ month 32

\

\

\

\

Revolving period ands and

amortization period begins

month

t

••

2•

j

~ ~

••

J _ . . I

on

Pl

Truat

a II

lnv lor

Certlflcatea

lellsr lervi

.ddltlon.1

receivabl.s

Early Amortization Protection

In addition to the previously discussed credit enhancement types revolving

asset-backed

securities

typically

use early

amortization triggers to protect

Investors

from credit risk.

These triggers

or

payout

events accelerate the

repayment

of investor principal If

cash

flow from the pool declines or the

condition of the pooled

assets

deteriorates.

This accelerated

repayment

method requires

that the

investors

share of all principal collections be

returned

Immediately as it is

received

by the trust.

The payout

events are

defined In the pooling

and

servicing agreement and series supplement of

each securitization and are

Intended

to protect investors from prolonged

exposure

to deteriorating

performance

of the underlying

assets

or the default

of a

servlcer.

To monitor the asset-backed security s

performance

the

trustee

the

rating

agencies and Investors focus on several indicators of pool

performance:

portfolio yield the

loss

rate

the monthly payment

rate and

the

purchase

rate.

• ortfolio yiel generally consists of

three

types of payments: finance

charges

fees and

interchange. Finance

charges

are the periodic


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Asset Securitization - Comptroller's Handbook - Borrower is Party to Securitization PG 8