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Giddy/SIM Asset Securitization/1
Prof. Ian GiddyNew York University
Financing withAsset-Backed Securities
SIM/NYUThe Job of the CFO
Copyright ©2001 Ian H. Giddy Asset Securitization 2giddy.org
Asset-Backed Securities
l The technique
l Legal, tax and accounting issuesl The economics
l An application
l ABS in Asia
Giddy/SIM Asset Securitization/2
Copyright ©2001 Ian H. Giddy Asset Securitization 3giddy.org
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 publicly-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 ©2001 Ian H. Giddy Asset Securitization 4giddy.org
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.
Giddy/SIM Asset Securitization/3
Copyright ©2001 Ian H. Giddy Asset Securitization 5giddy.org
SPONSORINGCOMPANY
SPECIALPURPOSEVEHICLE
ACCOUNTSRECEIVABLE
ACCOUNTSRECEIVABLE
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
Securitization: The Basic Structure
Copyright ©2001 Ian H. Giddy Asset Securitization 6giddy.org
The Process
Key features are:upooling of a group of similar non-traded financial
assetsu transfer of those assets to a special-purpose company
which issues securitiesu risk reduction by systematic risk assessment, by
diversification, by partial guarantees, etc.udivision of the benefits (and risks) among investors on
a pro-rata basisubeing offered in the form of a security (rather than, for
example, as a portfolio of loans or receivables)uon-going servicing of the underlying assets' cash flows
through to the asset-backed security investors.
IMPLEMENTATION
Giddy/SIM Asset Securitization/4
Finance Company LimitedFinance Company Limited
Copyright ©2001 Ian H. Giddy Asset Securitization 8giddy.org
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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Securitize the assets
Form of transferof asset
Form of creditenhancement
Form oftransformation of
cash flows
Form of cash flowallocation
Decisions
Form of specialpurpose vehicle
Key Decisions
Copyright ©2001 Ian H. Giddy Asset Securitization 14giddy.org
Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
Investors
Financial GuaranteeProvider
(if required)
Servicing Agreement
Proceeds
Sale of Assets
Proceeds
Asset-BackedSecurities
GuaranteeAgreement
Rating Agency
Top Rating
TrusteeTrust
Agreement
Finance Co.’sCustomers
Hire-PurchaseAgreement
Case Study: Initial Exchanges
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Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
Investors
Financial GuaranteeProvider
Monthly HPPayments
GuaranteeResponsibilities
TrusteeTrustee
Responsibilities
Monthly ABSPayments
Servicing Fees
Finance Co.’sCustomers
Hire-PurchasePayments
Case Study: Ongoing Payments
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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
Giddy/SIM Asset Securitization/7
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SPONSORINGCOMPANY
SPECIALPURPOSEVEHICLE
ACCOUNTSRECEIVABLE
ACCOUNTSRECEIVABLE
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
CREDITENHANCEMENT
CREDITENHANCEMENT
SOVEREIGNPROTECTIONS
SOVEREIGNPROTECTIONS
INTEREST RATE/CURRENCY
HEDGES
INTEREST RATE/CURRENCY
HEDGES
CASH FLOWREALLOCATION
CASH FLOWREALLOCATION
Risk-Management Techniques in ABS
Copyright ©2001 Ian H. Giddy Asset Securitization 18giddy.org
Finance Co. Ltd(Seller)
FCL 1997-A(Special Purpose Co.)
Senior
Proceeds
Sale of Assets
Rating Agency
Top Rating
Credit Enhancement:An Alternative Approach
Subordinated
More Subordinated
Lower Rating
No Rating
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Choose a Structure to Suit the Type of Assets to be Securitized
l Mortgage Securitization
l Non-Mortgage ABSl Intangibles
l Infrastructure and Project Financing
Copyright ©2001 Ian H. Giddy Asset Securitization 20giddy.org
Asset-Backed Securities: Legal and Regulatory Aspects
l LegaluThe Transfer
uThe Special-Purpose Vehicle
l Taxation
l Accounting Treatmentl Bank Regulatory Treatment
Giddy/SIM Asset Securitization/9
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Legal Aspects
l Goal: Credit quality must be solely based on the quality of the assets and the credit enhancement backing the obligation, without any regard to the originator's own creditworthiness
l Otherwise, quality of the ABS issue would be dependent on the originator's credit, and the whole rationale of the asset-backed security would be undermined.
LEGAL
Copyright ©2001 Ian H. Giddy Asset Securitization 22giddy.org
Three conditions enable the separation of the assets and the originator
l The transfer must be a true sale, or its legal equivalent. If originator is only pledging the assets to secure a debt, this would be regarded as collaterized financing in which the originator would stay directly indebted to the investor.
l The assets must be owned by a special-purpose corporation, whose ownership of the sold assets is likely to survive bankruptcy of the seller.
l The special-purpose vehicle that owns the assets must be independent
LEGAL
Giddy/SIM Asset Securitization/10
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What Makes it a Sale?
l The form and treatment of the transaction
l The nature and extent of the benefits transferred
l The irrevocability of the transfer
l The level and timing of the purchase price,
l Who possesses the documents
l Notification when the assets are sold
LEGAL
Copyright ©2001 Ian H. Giddy Asset Securitization 24giddy.org
What Makes it Likely to be Consolidated?
l The difficulty of segregating and ascertaining individual assets and liabilities
l The presence or absence of consolidated financial statements
l The comingling of assets and business functions
l The existence of parent and intercorporateguarantees and loans
l The transfer of assets without strict observance of corporate formalities.
LEGAL
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Taxation Aspects
l If the SPV or the transfer is subject to normal corporate, withholding, or individual tax rates, investors or borrowers could in principle be subject to additional or double taxation
Must avoid double taxation ofl Seller/servicerl Trust or special-purpose corporationl Investors
TAX
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Accounting Treatment
l Sale versus financing
l Consolidationl Accounting for loan servicing
ACCOUNTING
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FASB Sale Treatment
l The transferor relinquishes control of the future economic benefits embodied in the assets being transferred
l The SPV cannot require the transferor to repurchase the assets exceptpusuant to certain recourse provisions
l The transferor's obligation under any recourse provision are confined and can be reasonably estimated
ACCOUNTING
Copyright ©2001 Ian H. Giddy Asset Securitization 28giddy.org
Consolidation Treatment
l International accounting standards hold that consolidated financial statements are more meaningful than separate ones
l "Nonhomogeneous operation" exception
l Finance, insurance, real estate and leasing subsidiaries can generally be left apart
ACCOUNTING
Giddy/SIM Asset Securitization/13
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Fees
l Loan-origination fees. These are deferred and recognized over the life of the loan as an adjustment of yield.
l Commitment fees. These are to be deferred.
l Syndication fees. These should be recognized when the syndication is complete unless the originator retains a portion of the syndicated loan.
ACCOUNTING
Copyright ©2001 Ian H. Giddy Asset Securitization 30giddy.org
Bank Regulationand Capital Requirements
l Goal: Ensure that the substance and not the form of the asset transfer is what governs capital requirements.
The regulatory authorities may assess capital or reserve requirements as if the financing was a secured borrowing:
Giddy/SIM Asset Securitization/14
Copyright ©2001 Ian H. Giddy Asset Securitization 31giddy.org
Bank Regulation: Issues in Asia
l Avoid excessive bank risk-taking
l Discourage speculative investments
l Prevent financial market scandals
l Prevent circumvention of deposit regs
l Encourage financing of capital investment
l Discourage financing of consumption
l Promote development of capital markets
Asset Securitization:Cost-Benefit Analysis
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Separation of Two Businesses: Origination and Lending
SPONSORINGCOMPANY
SPECIALPURPOSEVEHICLE
ACCOUNTSRECEIVABLE
ACCOUNTSRECEIVABLE
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
Copyright ©2001 Ian H. Giddy Asset Securitization 34giddy.org
Separation of Two Businesses: Origination and Lending
SPONSORINGCOMPANY
SPECIALPURPOSEVEHICLE
ACCOUNTSRECEIVABLE
ACCOUNTSRECEIVABLE
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
Asset securitization makes sense when
the assets are worth more outside the
company than withinBut what makes them
worth more outside?
Giddy/SIM Asset Securitization/16
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For Banks: Capital Requirements
l In a perfect world, adding good assets would require little additional capital, since creditors would not see any increase in the bank's risk
l But if regulatory capital requirements penalize banks for holding such assets, they should:
usecuritize the good assets
uprofit from origination and servicing
l In general, regulatory costs or rigidities create an incentive for banks to shrink their balance sheets by securitizing loans
Copyright ©2001 Ian H. Giddy Asset Securitization 36giddy.org
A Bank’s Capital Savings
Securitization Cost-Benefit Analysis(for a regulated financial institution)
Gain/cost($ millions)
Funding cost savings C Two-year bank notes vs pass-though rate
1.1
Upfront costs C UnderwritingC SEC filing, legal fees, etc
(2.6)
Ongoing costs C Letter-of-credit fee (0.5)
Capital charge C Cost of capital at 25% (15%after tax)
7.7
Net benefit 5.7
Giddy/SIM Asset Securitization/17
Copyright ©2001 Ian H. Giddy Asset Securitization 37giddy.org
For Corporations: “Pure Play” Argument
Separate the credit of the assets from the credit of the originator:
l Identify and isolate good assets from a company or financial institution
l Use those assets as backing for high-quality securities to appeal to investors.
l Such separation makes the quality of the asset-backed security independent of the creditworthiness of the originator.
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Sears: Asset-Backed Financing?
SEARS
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Why Did Chrysler Use ABS in 1992?
l Downgraded to B+ in early 1992l Lost access to its normal funding
sourcesl Needed to continue to fund its car loansl Only way to do this was to securitize the
loansl “Firms that securitize tend to have
considerably weaker credit quality than other firms.”
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Costs Associated with Securitization
l Interest cost of the debtl Issuance expenses of the debtl Also:uCredit enchancement and liquidity support
for the assetsuStructuring fees payable to bankersuLegal, accounting and tax advice feesuRating agencies' feesuSystems modificationsuManagement time
Giddy/SIM Asset Securitization/19
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Costs Needed to Measure the Annual Pre-Tax Impact of Securitization
l The interest on the securitized fundingl The annual costs of credit enhancement/liquidity linesl Any guarantees to enhance the credit rating of any
interest rate or foreign exchange swap counterpartyl Amortized front-end fees (debt issuance, credit
enhancement, liquidity lines)l Amortized transaction costs (legal, accounting,
structuring, rating, etc.)l Opportunity costs relating to any temporary cash
retention in any guaranteed investment contract (GIC)
l Annual systems/accounting/rating agency costs etc.
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Sample Cost/Benefit Analysis
With securitization Without securitizationPortfolio yield 18.50% 18.50%Funding cost -7.22% -9.00%Default rate -5.00% -5.50%Amortized upfront issuance costs -0.10% -0.05%Amortized upfront securitization costs -0.20%Annual costs of guarantees and credit lines -0.25%Annual additional costs (systems, reporting, trustee fees, etc) -0.25%Effect on sponsor's marginal cost of capital 0.00%
Profits 5.48% 3.95%
Net savings from securitization 1.53% per annum
Giddy/SIM Asset Securitization/20
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Corporation or Financial Institution requires additional funds to givecustomers financing or to finance a future revenue stream.
Are funds freely available from banks ?
Does the firm/FI have good, self-liquidatingassets ?
Do the assets have a sufficiently high yieldto cover servicing and other costs ?
Would the assets be worth more (have a cheaper all-in funding cost) if they were
isolated from the company/FI ?
Securitize the assets
Borrow frombanks
Issue equity ormezzanine capital
Get out of thefinancingbusiness
Use assets as collateral foron-balancesheet debt
No
Yes
Yes
Yes
Yes
No
No
No
The Decision Process
Project Financing
Prof. Ian GiddyStern School of Business
New York University
Asset-Backed Securities
Giddy/SIM Asset Securitization/21
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Asset-Backed and Project Financing
l Collateralized debt
l Securitized loansl Non-recourse project debt
l Basic question: Why should a company segregate the cash flows from a particular business, and make it self-financing?
Copyright ©2001 Ian H. Giddy Asset Securitization 46giddy.org
Project Financing
l Stand-alone, non-recourse, multi-stake, "production payment financing"
l Structure?
l Participants?
l Funding sources?
l Risks?
Giddy/SIM Asset Securitization/22
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Project Financing (Summary)
l Stand-alone, non-recourse "production payment financing"
l Sponsor's vehicle company structures multi-stake finance
l Sources: govt development financing, IBRD/IFC, sponsor loans, supplier credits, customer credits, institutional investors, banks, lease financing, equity
l Risks: resource quantity, input costs, technical, timing, pre-completion, demand, operating, forcemajeure, political
l Risk sharing and mitigation
Copyright ©2001 Ian H. Giddy Asset Securitization 49giddy.org
Project Financing
Definitionl Lending to a single purpose entity
for the acquisition and /or construction of a revenue-generating asset with limited or no recourse to the sponser
l Repayment of the loan is solely from the revenues generated from operation of the asset owned by the entity
l Security for the loanu the revenue generating assetu all shares and interests in the
entityu real propertyu all contacts, permitsu authorizations, etc.; and,u all other instruments necessary
for continuing projectoperations
StepsProject Identification
& Resource Allocation
Risk Allocation & Project Structuring
Bidding & Mandating Contracts
Due Diligence & Documentation
Execution & Monitoring
Construction Monitoring
Term Loan Conversion & Ongoing Monitoring
Giddy/SIM Asset Securitization/23
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Benefits of Project Financing
l Limitation of Equity Investment to Project’s Economic Requirement -Enhanced Returns
l Risk Sharing and Diversificationl Accounting Treatment Preserves
Corporate Borrowing Capacityl Access to Long Term Financingl Tax Benefitsl Political Risk Mitigation
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The Risks
l Political
l Resource & inputl Technical
l Construction
l Legal
l Economicn Cost overrunsn Completion delaysn Mounting
interest expenses
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Eurotunnel: The Risks and the Remedies
Category Nature Remedy
Political NationalizationGovt interferenceTaxes & the like
LegalTreaty ratified
Technical ProcessEffect on completionRepairability
Use existing technology
Construction DelaysOverrunsRepairability
Use top expertsPerformance bonds
Legal Access to control in defaultFire, injury, etc liability
Security interestsDefault defn
Economic Price competitionRail links
Market studies
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Sample Structure
Sponsors /Shareholders
SINGLE PURPOSEPROJECT COMPANY
EquipmentSupplier
Contractor
Feed Stock(e.g., fuel)Supplier
Warranties andSupply Agents
Operator
TurnkeyConstruction
Long TermAgreement
Operations &Maintenance Mgmt
Purchaser
SyndicateBanks
Other Project Participants:
Currency and Interest Rate Hedge Providers
Multilaterals and EDA’s
Legal Counsel
Technical Consultants
Offtake (e.g, power purchase) Agreement
Arranging Bank
Giddy/SIM Asset Securitization/25
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Ras Laffan
l Who is the issuer?uRas Laffan LNG Co. Ltd. (Qatar)uBut Security Trustee (IBJ) plays unusually major
role
l What assets does it have?uNatural gas reserves; uLNG take-or-pay Sale and Purchase Agreement
with Korea Gas; uSecurity Trust Agreement; Project Coordination
Agreement; loan refund agreement, etc.
Copyright ©2001 Ian H. Giddy Asset Securitization 55giddy.org
Ras Laffan
l What are the risks, and how are they handled?uQatar/regional interference
uQatar legal system
uDefault on Agreements
uCompletion/timing
uOperating
uEconomic (LNG market)
Giddy/SIM Asset Securitization/26
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Ras Laffan: Natural Gas Project Finance
Ras LaffanLiquified Natural Gas
Korea Gas
Security Trustee
LNG
LNGpayments
Debt servicepayments
Ras LaffanLiquified Natural Gas
Korea Gas
Security Trustee(New York)
Bondholders
Mobil QM(Mobil Corp.)
Qatargas(State of Qatar)
Joint venture agreement
30% 70%
ContractorsContractors
Contractors
LNG
LNGpayments
Debt servicepayments
Residualpayments
Contractpayments
BanksExport Credit
Agencies
Debt servicepaymentsRas Laffan
Giddy/SIM Asset Securitization/27
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nasiansecuritization.com
Copyright ©2001 Ian H. Giddy Asset Securitization 59giddy.org
Ian H. Giddy
Stern School of Business
New York University
44 West 4th Street, New York, NY 10012, USA
Tel 212-998-0332
Fax 917-463-7629
ian.giddy@nyu.edu
http://giddy.org
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