Securitization Process

8/8/2019 Securitization Process

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Copyright 2001 Ian H. Giddy The Securitization Process3globalsecuritization.com

Asset-Backed Securities

qThe basic idea

qWhats needed?

qThe techniqueqApplications

qTypical sequence


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What is the Technique for CreatingAsset-Backed Securities?

q A lender originates loans, such as to ahomeowner or corporation.

q The securitization structure is added. The bank orfirm sells or assigns certain assets, such asconsumer receivables, to a special purposevehicle.

q The structure is legally insulated from

managementq Credit enhancement and rating agency reviews

q The SPV issues debt, dividing up the benefits(and risks) among investors on a pro-rata basis


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SPONSORINGCOMPANY

SPECIALPURPOSEVEHICLE

ACCOUNTSRECEIVABLE

ACCOUNTSRECEIVABLE

ISSUESASSET-BACKEDCERTIFICATES

SALE ORASSIGNMENT

Securitization: The Basic Structure


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The Process

Is the company

ready?

Is the company

ready?

Are the assetssuitable?

Are the assetssuitable?

What pool?

What pool?

What legal

structure?

What legal

structure?

What credit

enhancement?

What credit

enhancement?


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q Does the originator currently face a high cost offunding assets that would be recognized as sound,cash-generating assets if taken in isolation?

q Does it have a regulatory or capital constraint that

makes freeing up the balance sheet important?q Does it have data about the assets (required by rating

agencies and financial guarantors)?

q Does it have the servicing process and systems thatcan meet the more demanding standards of the asset-

backed market?q Is the originator willing to undertake a complex, time-

consuming transaction to obtain a broader, potentiallycheaper, ongoing source of funding?

Is the Company Ready for ABS?


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In short, the assets themselves must be sufficiently strong to support

a high credit rating without the backing of the originating lender.

The Pool of Assets Should Have:

Are the Assets Suitable?

n Volume which is sufficiently large and homogenous to facilitatestatistical analysis

n

A stable history of rates, defaults, delinquencies, prepayments and soforth

n Sufficient diversification--for example, geographic and socio- economic--to reduce vulnerability to economic stresses

n Basic lenders credit quality standards that are capable of being evaluatedand approved by rating agencies and specialized financial guaranty

companies

n Assets must be transferable and unencumbered


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What is the Technique for CreatingAsset-Backed Securities?

q A lender originates loans, such as to ahomeowner or corporation.

q The securitization structure is added. The bank orfirm sells or assigns certain assets, such asconsumer receivables, to a special purposevehicle.

q The structure is legally insulated frommanagement

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

IMP

LEMENT

ATION


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Finance Company LimitedFinance Company Limited


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Case Study: The Company(Finance Company Limited)

qFinance company whose growth is

constrained

qHas pool of automobile receivables

qHas track record

qPlans to use this as an ongoing source offinancing


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Securitize the assets

Form of transfer

of asset

Form of credit

enhancement

Form of

transformation of

cash flows

Form of cash flow

allocation

Decisions

Form of special

purpose vehicle

Key Decisions


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Finance Co. Ltd(Seller)

Finance Co.s

Customers

Hire-Purchase

Agreement

Case Study: Initial Exchanges


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FCL 1997-A(Special Purpose Co.)

InvestorsProceeds Proceeds

Finance Co.s

Customers

Hire-Purchase

Agreement



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Investors

Servicing Agreement

Proceeds

Sale of Assets

Proceeds

Asset-Backed

Securities

TrusteeTrust

Agreement

Finance Co.s

Customers

Hire-Purchase

Agreement



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Investors

Servicing Agreement

Proceeds

Sale of Assets

Proceeds

Asset-Backed

Securities

Rating Agency

Top Rating

TrusteeTrust

Agreement

Finance Co.s

Customers

Hire-Purchase

Agreement



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Investors

Financial Guarantee

Provider

Monthly HP

Payments

Guarantee

Responsibilities

TrusteeTrustee

Responsibilities

Monthly ABS

Payments

Servicing Fees

Finance Co.s

Customers

Hire-Purchase

Payments

Case Study: Ongoing Payments


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Getting a Rating: The Risks

q Credit risks

q Liquidity risk

q Servicer performance risk

q Swap counterparty riskq Guarantor risk

q Legal risks

q Sovereign risk

q Interest rate and currency risks

q Prepayment risks


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SPONSORINGCOMPANY

SPECIAL

PURPOSEVEHICLE

ACCOUNTSRECEIVABLE

ACCOUNTSRECEIVABLE


SALE ORASSIGNMENT

CREDIT

ENHANCEMENT

CREDIT

ENHANCEMENT

SOVEREIGN

PROTECTIONS

SOVEREIGN

PROTECTIONS

INTEREST RATE/

CURRENCY

HEDGES

INTEREST RATE/

CURRENCY

HEDGES

CASH FLOW

REALLOCATION

CASH FLOW

REALLOCATION

Risk-Management Techniques in ABS


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Investors

Financial Guarantee

Provider

(if required)

Servicing Agreement

Proceeds

Sale of Assets

Proceeds

Asset-Backed

Securities

Guarantee

Agreement

Rating Agency

Top Rating

TrusteeTrust

Agreement

Finance Co.s

Customers

Hire-Purchase

Agreement

Credit Enhancement: Guarantee Method


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Senior

Proceeds

Sale of Assets

Rating Agency

Top Rating

Credit Enhancement:An Alternative Approach

Subordinated

More Subordinated

Lower Rating

No Rating

Financial Guarantee

Provider

(if required)GuaranteeAgreement


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The Rating Processand Credit Enhancement

Prof. Ian Giddy

Stern School of BusinessNew York University



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Rating Agencies

Why bother with a rating?

q Compare equivalent credit risks acrossdifferent kinds of debt: corporate, sovereign,

ABSq Compare alternatives across different ratings

levels

q Obtain a relative as well as an absolutemeasure of credit risk

q Be reasonably sure of a market to sell thesecurity.

n Moodys

n Standard & Poors

n Fitch

n Moodys

n Standard & Poors

n

Fitch


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Default Matrix

Source: Fitch, Bank CLOs


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Rating Reports: Who Pays for Them?

q General reports on a sector, like CLOs

q Pre-sale report on an individual CLO, oncerisks have been evaluated but final terms and

credit enhancement have not yet beenfinanized

q Final deal report

q Periodic updates


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ABS: Factors Agencies Examine

qAsset portfolio analysis

q Legal structure of the transaction

qQuality of the originator/servicerqThe trustee

qThe cash flow structure

qThe counterparties


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Rating Agencies: Business Analysis

q Organization and management structure

q Financial performance

q Business strategy and planning processes

q Controls and procedures

q Asset origination and credit assessmentprocedures

q Quality of its loan documentationq Credit administation and debt recovery

procedures


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Credit Enhancement

qSenior/Sub or overcollateralization

qReserve and liquidity accounts and lines

qExcess cash flowqThird-party guarantees


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The Result: Bond Credit Ratings

MoodysStandard &Poors Interpretation

AaaAa

AAAAA

High-quality debt instruments

ABaa

ABBB

Strong to adequate ability topay principal and interest

BaBCaaCaC

BBBCCCCCC

Ability to pay interest andprincipal speculative

D In default


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Credit enhancement

Third party

credit enhancement

Legal structure based

credit risk reduction

Legal insulation from originator default

Legal insulation from servicer default

Pre-securitization

risk reduction

Internal

credit enhancement

Originators credit underwriting standards

Screening of assets to be included in the portfolio

Diversification of the portfolio

Credit quality of

deal participants

Originator/Seller/Servicer

Trustee, swap counterparties

Guarantors

Direct recourse

Senior/subordination or overcollateralization

Reserve or spread accounts

Cash collateralized accounts

Financial guarantees

Integrity of

cash flow structure

Cash flow sufficiency and mismatches

Safeguards and agreements such as swaps or caps

Rating

Typical Rating Analysis


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Credit Enhancement

qOvercollateralization

qSenior/Sub or

qReserve and liquidity accounts and linesqExcess cash flow

qThird-party guarantees


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COLLATERAL POOL

SENIOR

ASSET-BACKED

SECURITIES

OVER-COLLATERALEQUITY ABS

(owned by seller)

SPECIAL-PURPOSE VEHICLE

Over-Collateralization Method


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Example of Senior/Sub Structure

Class Rating Subordination

A1,A2,A-x AAA 28%

B AA 22%

C A 16.5%

D BBB 12%

E BB 8.5%

F B 5.5%

Issuer balance NR 0%


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Det er mi nat ion of st ruct ur e

Inform at ion Mem orandum

Com m en cem en t of d ocum ent at ion

Det ai led cash fl ow anal ysi s

Pr ep ar at ion for rat ing pr ocess

Res ul t of cash f low anal ysi s

Det er m in at io n of el igi bl e rec ei vab les

Ap p r oa ch r at i n g a ge nc i es a nd i n t ro d uc t i on o f t he st r u ct u r e e nv is ag ed

Found i ng of t he SPV

I n it i at i o n o f st o ck e xc h an ge ap p r ov al p r oc es s (i n c as e o f a B on d i s su a nc e)

D ra ft o f Of f er i n g Ci r cu l ar ( in ca se of a B on d is su an ce )

Co m m en t s o f th e Ra ti n g a gen ci es (Ra ti ng c on fi r m at i on )

Det er m in at ion of f un di ng s tr at egy

P ub l i ca t i on of Of f er i n g Ci r c ul a r ( i n c as e o f a B on d i ss ua nc e)

M ar ket i ng ( in cas e of a B on d i ss uan ce)

Com pl et ion of docum ent at ion

P ur c ha se of r ec ei va bl es an d i ss ua nc e o f se cu ri t i es

1

2

3

months

4

5

6

7

This schedule serves as an indication only and may

vary from transaction to transaction.

Possible Time Frame


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One Banks Assessment

qThe implementation of a transactionusually takes between two and six

months, provided all necessary data

and information is readily available.

qThis time frame does not take intoaccount the rating process.


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Select securi t izat ion counsel and accountants

Consid er t ax, accounting and securi t izat ion object ives

Discuss dat a f ields required for l oan data f i le

Define data to be audited by accountants

Begin dr af t ing Pr ivate Placement M emor andum (PPM)

Begin draft ing legal documents

Assem ble prel iminary pool and create ini t ial data tape

Consider prel iminary bond struct ure

Select r at in g agencies

Perform int egri ty check on data tape (cracking the tape)

If new c lient , thiswo uld followscreening ofcorpo ration and loanpool for suitability

If its a publicoffering, need apub lic Prospec tus orProspectusSupp lement.

A d iscussion w ith rat ingag enc y be nec essary forselec tion o f lega l structureand poo l selec tion if its anew typ e o f ABS.

Data from c omp anies c ome in

many different forms.

The Securitization Process - 1One Banks List

Any info used in the PPMor in the poo l ana lysis mustbe audited.

A private placement for a client who has doneprevious securitizations


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Model cash f low and bond structure

Prepare rat ing agency presentat ion

Select t rustee/ backup servicer

Recon ci le discrepancies wit h accountants

Distr ib ute rat ing agency p resentat ions

M eet with rat ing agenci es

Determine pending loan closings

Select r at in g agencies and sign engagement lett ers

Optim ize loan pool and revise bond str uctur e

Rating agency borr ower visi t s ( i f necessary)

Ratin g agency due di l igence ( i f necessary)

Com plete loan closings and f inal ize loan pool

Obtain pr el iminary subordination levels from rat i ng agencies

Most investment banksac tive in ABS havede velop ed mod ellingsoftware

Invariab ly, with the am ount o finforma tion be supp lied bythe issuer via the ta pe, the rewill be mistakes/discrepanciesto resolve, mostly with regardto loan d ata thats beenprovided.

During this process, theissue r is still origina tingcollateral going into thedea l. The ba nk has tode c ide wha t else itwa nt to include, andhas to esta blish a cut-off date .

Which asset shouldnot go into the po ol?Its not necessarilyba d c ollate ral, but itmay still hurt theove ra ll p rofile o f thepool



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Market tr ansaction t o sub-bond b uyers ( i f necessary)

Tie out col lateral cash f low with accountants

Final subordinati on levels from rat ing agencies

Final ize bond str uctur e based on f in al loan pool and sub-levels

Tie out bond cash f lows wit h accountants

Final ize PPM and legal documents

Arrange distr ib ut ion by other banks

Final ize internal m arketing mat erial

Issuer pr esentat ion t o salesforce

Print r ed herri ng PPM and distr ibut e to investors

Market tr ansaction t o investor s

Price bonds and execute Bond Purchase Agreement

Print final PPM

CLOSE TRANSACTION

Alternative would befor originator to keepsub tranc he

The c olla tera l ca shflows in ag grega te a restruc tured to p aybond s. The bond s arethen sold b ased on thelikelihood that thebond s will rec eive

those p aym ents at ac ertain period in time.Therefore, the cashflows tha t pa y thebo nds are what theinvesto r is purchasing.The b ond cash flowc harac teristics arepresented in thep rospec tus to investorsand if they arent tiedout , there is a hugelega l liab ility for theunderwriter and issuerif they aren t correc t.

This is the agreeme nt to purc hase the b ond s from

the SPV b y the investor or investment banks



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Asset-Backed Securities:Legal and Regulatory Issues

Prof. Ian Giddy

Stern School of BusinessNew York University



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Asset-Backed Securities:Legal and Regulatory Aspects

q Legal

uThe Transfer

uThe Special-Purpose Vehicle

qTaxation

qAccounting Treatment

qBank Regulatory Treatment


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Legal Aspects

qGoal: Credit quality must be solelybased on the quality of the assets and

the credit enhancement backing the

obligation, without any regard to theoriginator's own creditworthiness

qOtherwise, quality of the ABS issue

would be dependent on the originator'scredit, and the whole rationale of theasset-backed security would be

undermined.

LEGAL


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Three conditions enable the separationof the assets and the originator

q The transfer must be a true sale, or its legalequivalent. If originator is only pledging theassets to secure a debt, this would beregarded as collaterized financing in which

the originator would stay directly indebted tothe investor.

q The assets must be owned by a special-purpose corporation, whose ownership of the

sold assets is likely to survive bankruptcy ofthe seller.

q The special-purpose vehicle that owns theassets must be independent

LEGAL


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Form of transfer

of asset

True Sale

Assignment

The Form of Transfer: True Sale?

Collateral

LEGAL

Alternative:

Credit swap

(Synthetic ABS)


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What Makes it a Sale?

q The form and treatment of the transaction

q The nature and extent of the benefitstransferred

q

The irrevocability of the transferq The level and timing of the purchase price,

q Who possesses the documents

q Notification when the assets are sold

LEGAL


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Asset Securitization

CHASE (SPONSOR)


CREDIT CARDRECEIVABLES


SALE ORASSIGNMENT

CREDIT CARDRECEIVABLES


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The Alternative: Synthetic ABSLE

GAL

HVB (Originator)


REFERENCE

POOL OF LOANS

(Stay on

balance sheet)


CREDIT SWAPAGREEMENT

TOP QUALITYINVESTMENTS


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Accounting Treatment

qSale versus financing

qConsolidation

q

Accounting for loan servicing

ACCOUN

TING


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FASB Sale Treatment

qThe transferor relinquishes control ofthe future economic benefits embodied

in the assets being transferred

qThe SPV cannot require the transferor

to repurchase the assets except

pusuant to certain recourse provisions

qThe transferor's obligation under anyrecourse provision are confined and can

be reasonably estimated

ACCOUN

TING


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Bank Regulationand Capital Requirements

q Goal: Ensure that the substance and not theform of the asset transfer is what governscapital requirements.

The regulatory authorities may assess capital orreserve requirements as if the financing wasa secured borrowing:uWhere the transfer leaves the bank open to

recourse deemed risky by the authorities,

uOr where there is potential for a "moral hazard"whereby a bank may shore up potential or actuallosses in the sold assets to protect its name evenwhen not legally required to do so.


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Basel 2 and ABS

qOriginating banks (clean break)

q Investing banks (use of ratings)

q

Sponsor banks (for ABS conduits)qSynthetic securitization (degree of risk

transference)


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Basel 2 for Investing Banks

AAA to AA- 20%

A+ to A- 50%

BBB+ to BBB- 100%BB+ to BB- 150%

B+ and below Deducted from capital

Source: Basel Committee on BankingSupervision, January 2001


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Example:Ford Credit Owner Trust 1999-A


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Ford Structure

Ford Ford Motor Credit

Ford Credit Auto

Rec. Two LP

Ford Credit Auto

Owner Trust

Receivables

Class A-1 to A6Class B

Class C

Class D

Class A-5 and A-6

Class D

Sale

Sale


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Ford Structure: Waterfall

Receivables Class A-1 to A6

Class B

Class C

Class D


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Ford Structure: Default or Loss?

Receivables

Class A-1 to A6

Class B

Class C

Class D


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Paydown: Soft Bullet Structure


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InvestorsSingaDBS Bank

Seller/Servicer

Example: DBS Singa Deal

Loan portfolio US$ FRN


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General Re

Investors

Hong Kong

SARRes Mort. Ltd

Dah Sing

Seller/Servicer

Dah Sing/Hong Kong SAR

ASIA Ltd

CapMac

Mortgageportfolio US$ FRN

CurrencySwaps

FinancialGuarantees


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Atherton Capital(Seller)

Atherton FLF 1998-A(Special Purpose Co.)

Investors

Servicing Agreement

Proceeds

Sale of Assets

Proceeds

Asset-Backed

Securities

Mellon Mortgage

(Servicer)

Franchisees

(Borrowers)

Loan

Agreement

Franchise Loan Securitization

Servicing Advisor

Loan

Payments

Class Rating Subordination

A1,A2,A-x AAA 28%

B AA 22%

C A 16.5%

D BBB 12%

E BB 8.5%

F B 5.5%

Issuer balance NR 0%


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Films (Finance for an ItalianLibrary of Movies)


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Highly rated

U.S. oil buyer

Noteholders

Oil Trading Co.

(Cayman Is. SPV)

YPF

(Argentinianoil producer)

Oil (under

sales agreement) Notes

Oil

(under purchase

agreement)

Trust

US$

US$

US$

Fixed

debt payments

Future-Flow Financing:Offshore Purchase Agreement


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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

[email protected]://giddy.org

Documents

Securitization Process