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Presentation Structure

Basics of structuring
Par and Premium

Concept of Tranching What is credit enhancement Optimizing credit enhancement

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Structuring Concepts

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Structuring Basics
Pool cashflows are homogenous in nature and carry inherent risks Structuring of cashflows gives originators the flexibility to tailor instruments meeting investors requirements
Risk appetite Tenor requirements

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Basic Structuring - Par and Premium


Par Structure
Investor pays a consideration equal to the principal component (par value) of the future cash flows In return, investor is entitled to the scheduled principal repayments from the pool in addition to the contracted yield (called PTC yield) every month Typically, yield of asset > PTC yield which results in generation of excess cash flows every month (called Excess Interest Spread, EIS)

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Par Structure - Illustration


Loan Amount: Rs 1,000; Loan Interest rate: 15%, tenure: 6 years, PTC rate: 7% per annum
Year 0 1 2 3 4 5 6 Total Principal 114 131 151 174 200 230 1,000 Asset side Interest Total (a) 150 133 113 90 64 34 585 264 264 264 264 264 264 1,585 Pool POS 1,000 886 754 603 430 230 Liability side - Par structure EIS (a-b) Principal Interest Total (b) Investor POS 1,000 114 70 184 886 80 131 62 193 754 71 151 53 204 603 60 174 42 216 430 48 200 30 230 230 34 230 16 246 18 1,000 273 1,273 312

Note:
Investor POS = Pool POS EIS flow every month as loan interest rate > PTC rate

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Basic Structuring - Par and Premium

Premium Structure
Investor is entitled to the entire cash flows (EMIs) from the pool every month Investor pays a consideration greater than the principal component of the future cash flows The purchase consideration is the net present value of the entire cash flows discounted at a contracted rate (called PTC yield) No EIS in premium structures

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Premium Structure - Illustration


Year 0 1 2 3 4 5 6 Total Principal 114 131 151 174 200 230 1,000
Pool Asset side Interest Total (a)

150 133 113 90 64 34 585

264 264 264 264 264 264 1,585

Pool POS 1,000 886 754 603 430 230 -

Investor - Premium structure Liability sidePayouts-Premium EIS (a-b) Principal Interest Total (b) Investor POS 1,259 176 88 264 1,083 188 76 264 895 202 63 264 693 216 49 264 478 231 33 264 247 247 17 264 1,259 326 1,585 -

Note: Investor POS = Net present value of cash flows discounted at 7% pa Investor POS <> Pool POS Monthly payouts to investor = Monthly cash flows from loan No EIS

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Comparison of par and premium structures


Par Amount raised Total PTC obligations over the tenure EIS Total payouts

Premium 1,000 1,259 1,273 312 1,585 1,585 1,585

Comparison Upfront amount raised: Higher in premium due to discounting of entire cash flows.

The difference in the form of EIS flows to originator periodically in par structures

Availability of EIS: In par structures, EIS can act as a form of internal credit enhancement reducing cash support requirement Par structures more amenable to complex structuring: due to matching of principal on asset and liability side

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Presentation Structure
Basics: Par and Premium Tranching concepts What is credit enhancement Optimizing credit enhancement

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Tranching Concepts
Tranche means a piece, portion or slice of a securitisation deal Tranching of cash flows: cash flows from securitised assets carved into multiple classes/tranches Tranching can be done to achieve various investor needs

Time Tranching

Risk Tranching

Prepayment Tranching

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Tranching Concepts

Time Tranching:

Sequential tranching Creation of securities having differing durations

Month 1 2 3 4 5 6 7 8 9 10 11 12 Total

Pool cash flows Class A1 Class A2 100 100 0 100 100 0 100 100 0 100 100 0 100 100 0 100 100 0 100 0 100 100 0 100 100 0 100 100 0 100 100 0 100 100 0 100 1200 600 600

Cash flows from securitised assets

6 month PTCs

Originator

SPV

1 year PTCs 5 year PTCs

Investors

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Tranching Concepts

Risk Tranching:
to create instruments with different risk profile senior class accorded first priority on cash flows subordinate class supports payments to senior classes subordinate classes carry lower credit ratings

Cash flows from securitised assets

Senior PTCs AAA(so)

Originator

SPV
Subordinate PTCs BBB(so)

Investors

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Risk Tranching

Month 1 2 3 4 5 6 7 8 9 10 11 12 Total

Pool cash Senior Junior flows PTC PTC 100 90 10 100 90 10 100 90 10 100 90 10 100 90 10 100 90 10 100 90 10 100 90 10 100 90 10 100 90 10 100 90 10 100 90 10 1200 1080 120

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Tranching Concepts
Prepayment tranching: To mirror bonds
All the prepayments allocated to a separate strip called prepayments strip (Series P) Main Investor (Series A) insulated against any volatility arising out of prepayments Volatility of cashflows to Series P is taken care of in pricing of the instrument

Prepayments create volatility in cashflows


Investors have a preference for bond-like payouts

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Presentation Structure
Basics: Par and Premium Tranching concepts What is credit enhancement Optimizing credit enhancement

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What is credit enhancement

A source of funds which protects investors in case losses occur in the securitised assets Is typically stipulated by rating agencies Represents a limited back up support against potential shortfalls Credit enhancements thus improve the credit quality of the securitised instruments in order to achieve the desired credit ratings

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What is credit enhancement

Sources of credit enhancement


Internal Subordinate cash flows Excess interest spread External Cash collateral, Corporate guarantee

A combination of the above forms of credit enhancement is normally used in a typical transaction

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Types of credit enhancement

Cash collateral:
The originator/ third party provides a predetermined amount of
cash, which is put into a reserve account.

Withdrawals can be made from this account to offset


losses/shortfalls on the securitised assets.

The cash collateral is held/operated by the trustee in favour of the


investors.

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Types of credit enhancement

Excess interest spread:


Available in par structures where the interest rate received on underlying loans is higher than the interest rate paid on the PTCs backed by those loans. This gives rise to an excess margin or spread that can be applied to offset shortfalls in the pool collections.

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Types of credit enhancement

Subordinate tranches/ Overcollateral:

Senior-subordinate multiple tranche structure, where the subordinate tranches act as a credit enhancer for the senior tranche. : For example, if Rs 150 million of assets backs Rs 100 million of PTCs, then Rs 50 million is the overcollateral in the transaction. After meeting senior payouts, balance cash is used to make payment on subordinate tranches

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Presentation Structure
Basics: Par and Premium Tranching concepts What is credit enhancement Optimizing credit enhancement

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Optimizing credit enhancements


Our previous example: Loan Amount: Rs 1,000; Loan Interest rate: 15%, tenure: 6 years, PTC rate: 7% per annum Monthly cash flow loss @ 25% Premium structure
Asset side Scheduled cashflows 1 2 3 4 5 6 Total 264 264 264 264 264 264 1,585 Investor payouts 198 198 198 198 198 198 1189 264 264 264 264 264 264 1,585 Liability Side

Cash support needed: 25% of pool cashflows

Year

collections

Shortfalls 66 66 66 66 66 66 396

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Optimizing credit enhancements


Subordination of 10% Monthly cash flow loss @ 25% Premium structure Subordination acts as an internal credit enhancement Lower requirement of external credit support in the form of cash

Asset side Year 1 2 3 4 5 6 Total

Liability Side

Scheduled Senior cashflows payouts Shortfalls collections 264 198 238 40 264 198 238 40 264 198 238 40 264 198 238 40 264 198 238 40 264 198 238 40 238 1,585 1189 1,427

Cash support needed: 15% of pool cashflows

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Optimizing credit enhancements


Par structure Monthly cash flow loss @ 25% Available EIS=20% of cashflows EIS acts as an internal credit enhancement
Cash support needed: 6.5% of pool cashflows

Lower requirement of external credit support in the form of cash


Asset side Year 1 2 3 4 5 6 Scheduled cashflows 264 264 264 264 264 264 1,585 collections 198 198 198 198 198 198 1189 Investor payouts 184 193 204 216 230 246 1,273 Liability Side Shortfalls 6 18 32 48 103 EIS available 80 71 60 48 34 18 312 EIS flow back 14 5 19

Total

If the EIS is trapped, cash support needed will be even lower

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