1. Securitization Process
The process by which a firm sells credit-sensitive assets to a third party that in turn issues securities whose cash flows are backed by the original assets as collateral
http://www.youtube.com/watch?v=Z8kCQkfblzY&feature=related
- financing & risk transfer impact on the original firm
- asset-backed security (ABS) or securitized product: A security whose value & income payments are derived from and collaterized by a specified pool of underlying assets. The pools of underlying assets can include common payments from credit cards, auto loans, & mortgage loans, to esoteric cash flows from aircraft leases, royalty payments & movie revenues.
- off-balance-sheet transaction
*removal of a loan from B/S completely by selling the loan without recourse (true sale)
Objectives
- reducing regulatory capital requirements
- obtaining an additional source of funding at a lower cost
- enhancing financial ratios
- managing portfolio risk (reducing large exposures or sectoral concentrations)
1-2. Participants in the Securitization Market
- Originator/Trnsferor: original asset owner who desires to convert credit-sensitive assets into cash and to transfer the credit risk
- Sponsor: institution that initiates the securitization process
- Asset purchaser/Transferee/Securitized product issuer: the counterparty to the bilateral asset sale; the asset purchaser buys the assets from the originator. SPE (special purpose entity) or SPV is a structure that is created solely for the purpose of buying the assets.
- Trustee: the trustee is charged with looking out for the investors in the securitized product issued by the SPE.
- Custodian and/or Servicer: servicer collect and disburse cash flow on the underlying assets.
- Structuring Agent: a sort of general contractor for the securitization process (de facto advisor); the agent will be responsible for the security design (maturity, desired credit rating, credit enhancement) and forecasting the P&I cash flows.
- Underwriter: the underwriter is responsible for marketing and distributing the securities.
- Rating Agencies: rating agencies offer both issue and issuer credit ratings. shadow ratings or nonpublished ratings can be provided.
- Law Firms: law firms provide legal advice on structuring the assets, jurisdictional issues, proper accounting and regulatory compliance, etc.
- Regulatory Agencies
- External risk transfer and Risk finance counterparties: securitization may itself create new risks. If exteernal risk transfer is required, additional counterparties may become involved in the securitization process
**Banks act as the originator of the assets, the servicing agent, sponsors or managers to securitization programs, a trustee, a swap counterparty, undrwriter or investor.
2. Issuing Securitized Products
For the securitization transaction, an entirely new legal entity (SPV or SPE) is constructed. The additional entity is created to further distance the originator from the issuer and the underlying assets. The SPE may be designated as a corporation or a trust. Under a trust arrangement, two distict SPEs are created. SPE1 is organized as a master trust or SPC and purchases the assets from originator. SPE1 deposits the assets it purchased into SPE2, a grantor trust.
2-1. SPV
- bankruptcy remote
- limited & predetermined activity
- orignator surrenders control
- SPV can pledge/resell/exchange assets
3. Securitization Guidelines
3-1. FAS 140 (Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities) lists four guidelines to determine if there was a true sale. If satisfied, the SPE does not have to be consolidated on the originator's balance sheet.
- the asset will not be affected in bankruptcy (SPE is bankruptcy remote)
- permissible activities of the SPE must be significantly limited, must be specified at deal inception/incorporation of the vehicle, and can be changed only with approval of a majority of interest holders other than the originator or its afiliates or agents
- the originator must surrender effective control over the assets
- the SPE must have the right to pledge/resel/exchange the assets acquired from the originator
3-2. QSPE (qualified SPE)
- the SPE must be demonstrably distinct from the originator and any affiliates of the originator
- the SPE may hold only passive financial assets and passive derivatives used for hedging
- sale or disposition of assets by the QSPE must be prescribed in deal documents and may never be discretionary
3-3. FIN46R - The Anti-Enron Rule
FIN46R defines certain types of SPEs as VIEs(variable interest entities) if the SPE is nonpassive and requires subordinated financial support for its activities above and beyond the equity issued by the entity. a VI(variable interest) in a VIE is defined as any contract that changes in value when the NAV of the VIE changes and may include equity, subordinate debt, subordinated interests and compensation, credit protection and credit support instruments, derivaties, etc. The holder of VI that is exposed to the largest expected loss or gain is the primary beneficiary (PB) of the VIE and must consolidate the VIE on its financials.
4. Credit Enhancements
4-1. Internal Credit Enhancement
4-1-1. Overcollateralization(O/C): the assets exceed the fixed liabilities or debt
Losses up to the difference will be absorbed by the O/C.
4-1-2. Direct Equity Issue
The SPE issue the equity to an investor for the C/E, but the appetite for the equity tranche is fairly limited
4-1-3. Holdback
The originator fund without creating consolidation, accounting, tax, and control problem. The SPE pay less than fair value for the assets
4-1-4. Cash Collateral A/C (CCA)
The CCA is reserves set aside by the originator to cover losses in the pool
4-1-5. Excess Spread
Difference between interest earned on the collateral assets and interest paid on the debt liabilities of the SPE. The excess spread is the cash flow equivalent of retained earnings for the structure.
- net excess spread: gross excess spread minus senior fees and expenses
4-2. External Credit Enhancement
- Insurance, wraps and guaranties
- Letters of credit (LOC)
- Credit Default Swaps
- Put Options on Assets
**wrap: Generally, the purpose of a wrap is to achieve a higher (AAA) rating for part or all of a transaction. The transaction issuer pays a premium/fee to the guarantor, and this increase in cost is usually more than offset by the reduction of interest on the securities issued. The presence of a wrap is an added structural protective feature for the investor. In the case of structured instruments, such as asset backed securities, they are used as one form of external credit enhancement. However, they are also used for other plain vanilla products
**first-loss exposure: the debt issued by the securitization trust is less than the value of the assets, and the difference between the two is called first-loss
e.g.) subordinated interests in trusts, cash reserves, and deposits due from trusts
5. Liquidity Support
Liquidity risk is a major risk endemic to many securitization structures. Liquidity risk is the risk that the underlying portfolio of assets acting as collateral for an ABS issue may not generate enough cash to service the P&I obligations fo the ABSs issued by the tranferee SPE
5-1. Two Common Internal Support Mechanisms
- Maturing structuring: managing credit risk via subordination.
5-2. Liquidity Reserves
Cash is set aside for the sole purpose of smothing liquidity problems that may arise
5-3. Letters of Credit with recourse
5-4. Asset Swaps
6. Interest Rate Risk and Currency Risk
Interest rate risk may arise when the assets and liabilities of the structure have a fixed-rate/floating-rate basis mismatch. Interest rate changes can erode the net spread in a structure.
7. MBS and ABCP
7-1. MBS
Securitized assets backed by a pool of residential mortgage
7-2. ABCP (Asset-Backed Commercial Paper)
Trade receivables from one or more companies are pooled together and short-term, typically between 90 and 180 days, commercial paper is issued to investors. ABCP does not trade in an active secondary market.
- short investment horizon
- ABCP continually purchases new assets and offers new issues
ABCP conduit: http://www.youtube.com/watch?v=KvG3X7KPb3M
Minimum Criteria for Removing Securitised Assets from the Calculation of its Risk-Based Capital Ratio
- the bank must transfer the assets legally or economically via a true sale (novation, assignment, declaration of trust or subparticipation)
- the transferred assets must be legally isolated from the transferor
- the transferee is a qualifying SPV and the holders of the beneficial interests in that entity have the right to pledge or exchange those interests
- the transferor does not maintain effective or indirect control over the transferred assets
The process by which a firm sells credit-sensitive assets to a third party that in turn issues securities whose cash flows are backed by the original assets as collateral
http://www.youtube.com/watch?v=Z8kCQkfblzY&feature=related
- financing & risk transfer impact on the original firm
- asset-backed security (ABS) or securitized product: A security whose value & income payments are derived from and collaterized by a specified pool of underlying assets. The pools of underlying assets can include common payments from credit cards, auto loans, & mortgage loans, to esoteric cash flows from aircraft leases, royalty payments & movie revenues.
- off-balance-sheet transaction
*removal of a loan from B/S completely by selling the loan without recourse (true sale)
Objectives
- reducing regulatory capital requirements
- obtaining an additional source of funding at a lower cost
- enhancing financial ratios
- managing portfolio risk (reducing large exposures or sectoral concentrations)
1-2. Participants in the Securitization Market
- Originator/Trnsferor: original asset owner who desires to convert credit-sensitive assets into cash and to transfer the credit risk
- Sponsor: institution that initiates the securitization process
- Asset purchaser/Transferee/Securitized product issuer: the counterparty to the bilateral asset sale; the asset purchaser buys the assets from the originator. SPE (special purpose entity) or SPV is a structure that is created solely for the purpose of buying the assets.
- Trustee: the trustee is charged with looking out for the investors in the securitized product issued by the SPE.
- Custodian and/or Servicer: servicer collect and disburse cash flow on the underlying assets.
- Structuring Agent: a sort of general contractor for the securitization process (de facto advisor); the agent will be responsible for the security design (maturity, desired credit rating, credit enhancement) and forecasting the P&I cash flows.
- Underwriter: the underwriter is responsible for marketing and distributing the securities.
- Rating Agencies: rating agencies offer both issue and issuer credit ratings. shadow ratings or nonpublished ratings can be provided.
- Law Firms: law firms provide legal advice on structuring the assets, jurisdictional issues, proper accounting and regulatory compliance, etc.
- Regulatory Agencies
- External risk transfer and Risk finance counterparties: securitization may itself create new risks. If exteernal risk transfer is required, additional counterparties may become involved in the securitization process
**Banks act as the originator of the assets, the servicing agent, sponsors or managers to securitization programs, a trustee, a swap counterparty, undrwriter or investor.
2. Issuing Securitized Products
For the securitization transaction, an entirely new legal entity (SPV or SPE) is constructed. The additional entity is created to further distance the originator from the issuer and the underlying assets. The SPE may be designated as a corporation or a trust. Under a trust arrangement, two distict SPEs are created. SPE1 is organized as a master trust or SPC and purchases the assets from originator. SPE1 deposits the assets it purchased into SPE2, a grantor trust.
2-1. SPV
- bankruptcy remote
- limited & predetermined activity
- orignator surrenders control
- SPV can pledge/resell/exchange assets
3. Securitization Guidelines
3-1. FAS 140 (Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities) lists four guidelines to determine if there was a true sale. If satisfied, the SPE does not have to be consolidated on the originator's balance sheet.
- the asset will not be affected in bankruptcy (SPE is bankruptcy remote)
- permissible activities of the SPE must be significantly limited, must be specified at deal inception/incorporation of the vehicle, and can be changed only with approval of a majority of interest holders other than the originator or its afiliates or agents
- the originator must surrender effective control over the assets
- the SPE must have the right to pledge/resel/exchange the assets acquired from the originator
3-2. QSPE (qualified SPE)
- the SPE must be demonstrably distinct from the originator and any affiliates of the originator
- the SPE may hold only passive financial assets and passive derivatives used for hedging
- sale or disposition of assets by the QSPE must be prescribed in deal documents and may never be discretionary
3-3. FIN46R - The Anti-Enron Rule
FIN46R defines certain types of SPEs as VIEs(variable interest entities) if the SPE is nonpassive and requires subordinated financial support for its activities above and beyond the equity issued by the entity. a VI(variable interest) in a VIE is defined as any contract that changes in value when the NAV of the VIE changes and may include equity, subordinate debt, subordinated interests and compensation, credit protection and credit support instruments, derivaties, etc. The holder of VI that is exposed to the largest expected loss or gain is the primary beneficiary (PB) of the VIE and must consolidate the VIE on its financials.
4. Credit Enhancements
4-1. Internal Credit Enhancement
4-1-1. Overcollateralization(O/C): the assets exceed the fixed liabilities or debt
Losses up to the difference will be absorbed by the O/C.
4-1-2. Direct Equity Issue
The SPE issue the equity to an investor for the C/E, but the appetite for the equity tranche is fairly limited
4-1-3. Holdback
The originator fund without creating consolidation, accounting, tax, and control problem. The SPE pay less than fair value for the assets
4-1-4. Cash Collateral A/C (CCA)
The CCA is reserves set aside by the originator to cover losses in the pool
4-1-5. Excess Spread
Difference between interest earned on the collateral assets and interest paid on the debt liabilities of the SPE. The excess spread is the cash flow equivalent of retained earnings for the structure.
- net excess spread: gross excess spread minus senior fees and expenses
4-2. External Credit Enhancement
- Insurance, wraps and guaranties
- Letters of credit (LOC)
- Credit Default Swaps
- Put Options on Assets
**wrap: Generally, the purpose of a wrap is to achieve a higher (AAA) rating for part or all of a transaction. The transaction issuer pays a premium/fee to the guarantor, and this increase in cost is usually more than offset by the reduction of interest on the securities issued. The presence of a wrap is an added structural protective feature for the investor. In the case of structured instruments, such as asset backed securities, they are used as one form of external credit enhancement. However, they are also used for other plain vanilla products
**first-loss exposure: the debt issued by the securitization trust is less than the value of the assets, and the difference between the two is called first-loss
e.g.) subordinated interests in trusts, cash reserves, and deposits due from trusts
5. Liquidity Support
Liquidity risk is a major risk endemic to many securitization structures. Liquidity risk is the risk that the underlying portfolio of assets acting as collateral for an ABS issue may not generate enough cash to service the P&I obligations fo the ABSs issued by the tranferee SPE
5-1. Two Common Internal Support Mechanisms
- Maturing structuring: managing credit risk via subordination.
5-2. Liquidity Reserves
Cash is set aside for the sole purpose of smothing liquidity problems that may arise
5-3. Letters of Credit with recourse
5-4. Asset Swaps
6. Interest Rate Risk and Currency Risk
Interest rate risk may arise when the assets and liabilities of the structure have a fixed-rate/floating-rate basis mismatch. Interest rate changes can erode the net spread in a structure.
7. MBS and ABCP
7-1. MBS
Securitized assets backed by a pool of residential mortgage
7-2. ABCP (Asset-Backed Commercial Paper)
Trade receivables from one or more companies are pooled together and short-term, typically between 90 and 180 days, commercial paper is issued to investors. ABCP does not trade in an active secondary market.
- short investment horizon
- ABCP continually purchases new assets and offers new issues
ABCP conduit: http://www.youtube.com/watch?v=KvG3X7KPb3M
Minimum Criteria for Removing Securitised Assets from the Calculation of its Risk-Based Capital Ratio
- the bank must transfer the assets legally or economically via a true sale (novation, assignment, declaration of trust or subparticipation)
- the transferred assets must be legally isolated from the transferor
- the transferee is a qualifying SPV and the holders of the beneficial interests in that entity have the right to pledge or exchange those interests
- the transferor does not maintain effective or indirect control over the transferred assets
Minimum Capital Requirements for Investments in ABS
- AAA ~ AA-: risk weighted at 20%
- A+ ~ A-: 50%
- BBB+ ~ BBB-: 100%
- BB+ ~ BB-: 150%
- B+ or below or unrated: regarded as credit enhancement (deducted from capital)
- AAA ~ AA-: risk weighted at 20%
- A+ ~ A-: 50%
- BBB+ ~ BBB-: 100%
- BB+ ~ BB-: 150%
- B+ or below or unrated: regarded as credit enhancement (deducted from capital)
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