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Giddy/ABS The Securitization Process/1

Asset-Backed Securities

The Securitization Process

Prof. Ian Giddy


Stern School of Business
New York University

Asset-Backed Securities

l The basic idea


l What’s needed?
l The technique
l ABS around the world

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Securitization of Assets

l Securitization is the transformation of an


illiquid asset into a security.
l For example, a group of consumer loans can
be transformed into a publically-issued debt
security.
l 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.

Copyright ©2000 Ian H. Giddy The Securitization Process4

Range of Debt Markets

Illiquid Highly liquid

Nontradable Tradable Actively


Commercial Public
private private traded
paper issue
placement placement bonds

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What is the Technique for Creating


Asset-Backed Securities?
l A lender originates loans, such as to a
homeowner or corporation.
l The securitization structure is added. The bank or
firm sells or assigns certain assets, such as
consumer receivables, to a special purpose
vehicle.
l The structure is legally insulated from
management
l The SPV issues (usually) high-rated debt.

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Securitization: The Basic Structure


SPONSORING
COMPANY

ACCOUNTS
RECEIVABLE

SALE OR
ASSIGNMENT SPECIAL
PURPOSE
VEHICLE

ISSUES
ACCOUNTS
ASSET-BACKED
RECEIVABLE
CERTIFICATES

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Is the Company Ready for ABS?

l Does the originator currently face a high cost of


funding assets that would be recognized as sound,
cash-generating assets if taken in isolation?
l Does it have a regulatory or capital constraint that
makes freeing up the balance sheet important?
l Does it have data about the assets (required by rating
agencies and financial guarantors)?
l Does it have the servicing process and systems that
can meet the more demanding standards of the asset-
backed market?
l Is the originator willing to undertake a complex, time-
consuming transaction to obtain a broader, potentially
cheaper, ongoing source of funding?
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Is the Company Ready for ABS?

l Corporate commitment
l Management depth
l Track record (loan program administration)
l Internal systems (origination, servicing,
and collection)
l Information (on company and collateral)
l Market position
l Origination capacity
l Technology
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Are the Assets Suitable?

The Pool of Assets Should Have:


n Volume which is sufficiently large and homogenous to facilitate
statistical analysis
n A stable history of rates, defaults, delinquencies, prepayments and so
forth
n Sufficient diversification--for example, geographic and socio- economic--
to reduce vulnerability to economic stresses
n Basic lender’s credit quality standards that are capable of being evaluated
and approved by rating agencies and specialized financial guaranty
companies
n 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.

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The Process
Key features are:
u pooling
assets
ION
of a group of similar non-traded financial

AT
u transfer of those assets to a special-purpose company

NT
which issues securities
E
u risk reduction by systematic risk assessment, by
M
PLE
diversification, by partial guarantees, etc.
u division of the benefits (and risks) among investors on
IM
a pro-rata basis
u being offered in the form of a security (rather than, for
example, as a portfolio of loans or receivables)
u on-going servicing of the underlying assets' cash flows
through to the asset-backed security investors.
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Finance
Finance Company
Company Limited
Limited

Case Study: The Company


(Finance Company Limited)
l Finance company whose growth is
constrained
l Has pool of automobile receivables
l Has track record
l Plans to use this as an ongoing source of
financing

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Key Decisions

Securitize the assets

Decisions

Form of
Form of transfer Form of special Form of credit Form of cash flow
transformation of
of asset purpose vehicle enhancement allocation
cash flows

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Case Study: Initial Exchanges

Finance Co.’s Rating Agency


Customers

Hire-Purchase Top Rating


Servicing Agreement
Agreement

Proceeds Proceeds
Finance Co. Ltd FCL 1997-A
Investors
(Seller) (Special Purpose Co.)
Sale of Assets Asset-Backed
Securities

Financial Guarantee
Trustee Provider
Trust Guarantee
(if required)
Agreement Agreement

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Case Study: Ongoing Payments

Finance Co.’s
Customers

Hire-Purchase Servicing Fees


Payments

Monthly HP Monthly ABS


Finance Co. Ltd Payments FCL 1997-A Payments
Investors
(Seller) (Special Purpose Co.)

Financial Guarantee
Trustee
Trustee Guarantee Provider
Responsibilities Responsibilities

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Getting a Rating: The Risks

l Credit risks
l Liquidity risk
l Servicer performance risk
l Swap counterparty risk
l Guarantor risk
l Legal risks
l Sovereign risk
l Interest rate and currency risks
l Prepayment risks

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Risk-Management Techniques in ABS

SPONSORING CREDIT
CREDIT
COMPANY ENHANCEMENT
ENHANCEMENT
ACCOUNTS
RECEIVABLE

SOVEREIGN
SOVEREIGN
PROTECTIONS
PROTECTIONS
SALE OR SPECIAL
ASSIGNMENT
PURPOSE
VEHICLE
INTEREST
INTERESTRATE/
RATE/
ACCOUNTS
ISSUES CURRENCY
CURRENCY
ASSET-BACKED
RECEIVABLE CERTIFICATES HEDGES
HEDGES

CASH
CASHFLOW
FLOW
REALLOCATION
REALLOCATION

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Credit Enhancement:
Rating Agency
An Alternative Approach
Top Rating

Senior

Lower Rating
Proceeds
Finance Co. Ltd FCL 1997-A
Subordinated
(Seller) (Special Purpose Co.)
Sale of Assets

No Rating

More Subordinated

Financial Guarantee
Provider
Guarantee
Agreement
(if required)

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Choose a Structure to Suit the Type of


Assets to be Securitized

l Mortgage Securitization
l Non-Mortgage ABS
l Intangibles
l Infrastructure and Project Financing

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Possible Time Frame

1 • Determination of structure

• Information Memorandum

• Commencement of documentation
2
• Detailed cash flow analysis

• Preparation for rating process

3
• Result of cash flow analysis
months • Determination of eligible receivables

• Approach rating agencies and introduction of the structure envisaged


4
• Founding of the SPV

• Initiation of stock exchange approval process (in case of a Bond issuance)

5 • Draft of Offering Circular (in case of a Bond issuance)

• Comments of the Rating agencies (Rating confirmation)

• Determination of funding strategy


6
• Publication of Offering Circular (in case of a Bond issuance)

• Marketing (in case of a Bond issuance)

7 • Completion of documentation

This schedule serves as an indication only and may • Purchase of receivables and issuance of securities
vary from transaction to transaction.

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One Bank’s Assessment

l The implementation of a transaction


usually takes between two and six
months, provided all necessary data
and information is readily available.
l This time frame does not take into
account the rating process.

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