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L-Sec

C)
Comptroller of the Currency
Administrator of National Banks

BORROWER IS PARTY TO SECURITIZATION - PAGE 8

Asset Securitization
Comptroller's Handbook
November 1997

L
Liguidity and Funds Management

Exhibit 1: Parties Involved In Structuring Asset-Backed Securities

Borrower

Orlclnator I Servlcer

I
-

Special
Purpose
EntitylTrultlle

-1

Credit Enhancer

I
Underwriter

I
Investors

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

Comptroller's Handbook

Exhl 3: c.edk .iskdiv...ific.lio.


Talces catastrophiccredit risk

U,ually somemultipl. 01 expected 10""


Can take several forms (letter of credit, CIA, ere.)

I
Oia;"lo.

Credit E.hncer

-Takes marketrisk but

Investor

only minimal creditrisk

Takes first-loss ri!lk


(built[nto security strucbJ reI
latinS Aleney

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 cashflow-driven). Common types of credit enhancements in use today include:
Credit Enhancement Provided by External Parties

Third-party letter of 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

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Comptroller's Handbook

Exhibit 4: The Two Stag. . of a Revolving-Receivable Aet-Backed Security

Revolving p.,lod - ~VtD' prln~.1 p.yments


.re reinvested in new receivables; s.II."'s
~te,.st absorbs 'luclua1lDns ~ trust ba"nces

Amortlu.lIon period - k1vsstors are paid thslr


share of princip.1callectiDns

,,. j

lellsr I lervi,

---- ---~~-----,

, .----- - - -...

.ddltlon.1
receivabl.s

mon""

Pl.,

JI-_,..I

......,

Truat

month t

mon'" 4

\
m_th 28 \ month 32
\
\

\
\
Revolving period ands and
amortization period begins

a.II., /lnvaalor
Certlflcatea

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.

Portfolio yield generally consists of three types of payments: finance

charges, fees, and interchange. Finance charges are the periodic

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Asset Securitization