securitization colloquium
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Securitization Colloquium. Spring, 2003. What’s asset securitization?. What is securitization? What is the history of securitization? Why do entities securitize? What is the profile of an ordinary securitization? Why are law and accounting so important for securitization?. - PowerPoint PPT PresentationTRANSCRIPT
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Securitization Colloquium
Spring, 2003
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What’s asset securitization?
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• What is securitization?
• What is the history of securitization?
• Why do entities securitize?
• What is the profile of an ordinary securitization?
• Why are law and accounting so important for securitization?
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• Process: The pooling of assets and the issuance of securities
to finance those assets
• Substance: The use of superior data on a pool of assets in
order to finance the assets, or distribute risk, more efficiently, usually by means of the use of “structure”
What is Securitization?
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What goes into predicting whether GM will repay its unsecured debt:
• Automobile industry in general
• North American, European, Asian, and Latin American automobile industries
• GM v. domestic & international competitors
Example: General Motors
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• Politics and international trends
• Management
• Unions
• Balance sheet and income statement
• Luck!
Example: General Motors
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How about GMAC, where financial assets reside?
• Fewer variables
• More dependent on interest rates, quality of receivables as opposed to quality of autos
• Multiple businesses + residential and commercial mortgage businesses
Example: General Motors
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How about the senior debt of GMAC?
• Focus on specific financial assets
• Law prevents exclusive focus on those assets
Example: General Motors
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Securitization involves:• Isolation of pool of assets from financial fortunes of originator
• Focus on historical data with similarly situated assets
• Predicting the future behavior of the pool at hand
Securitization
PurchaserIssuer
Special PurposeEntity
Originator
transfer ofpool transfer of
pool or interest in pool
issuance ofsecurities
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Securitization
• Efficiency #1: Isolation in order to enable investor to predict
behavior
• Efficiency #2: Unbundling and allocation of risks/rewards to
different populations
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Credit Risk
• Securities precisely targeted to credit risk profile desired by investors
SpecialPurposeEntity
PurchaserIssuer
Retained
Unrated
AAA
BBB
B
Investor
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Credit Risk; Tenor
• Securities precisely targeted to tenor profile desired by investors
PurchaserIssuer
6 mo.
1 year
5 years
3 mo.bullet
bullet
bullet
amortizable, etc.
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Further Allocation of Credit Risk
PurchaserIssuer
CreditEnhancer
Special PurposeEntity
Originator
transfer ofassets
transfer ofassets
securitiesinvestors
1) 1st loss originator
2) 2nd loss credit enhancer
3) 3rd loss investors by category
Allocation
of
Risk
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Servicing Risk
PurchaserIssuer
Special PurposeEntity
Originator
transfer ofassets
transfer ofassets
securities
• Retention of servicing risk by originator
100% ownershipinterest
servicer of assets
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Allocation of Interest Rate Risk
PurchaserIssuer
Special PurposeEntity
Originator
transfer offixed rate assets
transfer ofassets
issuance ofsecurities
floating rate
Swap Provider
fixedrate
floatingrate
potentialback-to-back swap
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What is the History of Securitization?
MBS:• 1970s securitization of residential mortgages
Government sponsored entities (“GSEs”)• Federal Home Loan Mortgage Corporation (FHLMC/“Freddie
Mac”)• Federal National Mortgage Association (FNMA/“Fannie Mae”)
• Allocation of credit risk to GSEs
• Retention of interest rate risk by originators
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What is the History of Securitization?
ABCP:
• Early 1980s securitization by “Multi-Seller Commercial Paper Vehicles”
• Capital arbitrage• Allocation of risk as in paradigm
ABCP VehicleOriginator transfer ofinterest in assets
issuance ofCP
SponsoringBank
liquidity andcredit
enhancementfacilities
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What is the History of Securitization?• Middle 1980s securitization of non-mortgage related assets, or ABS
• Late 1980s securitization of commercial mortgage related assets, or CMBS
• Allocation of risk/rewards as in above paradigm
• Trade receivables, autos, credit cards, home equity loans, manufactured housing, leases, commercial loans, cross-border
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0
100000
200000
300000
400000
500000
600000
700000
800000
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
U.S. Public Mortgage Backed Activity, 1980-2002(Proceeds in millions)
Source: Thompson Financial
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0
50000
100000
150000
200000
250000
300000
350000
400000
1985 1987 1989 1991 1993 1995 1997 1999 2001
U.S. Public Asset Backed Activity, 1985-2002(Proceeds in millions)
Source: Thompson Financial
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U.S. Public Asset Backed Activity 1996by Type of Assets Securitized
Credit Card Rec.Home EquityAuto LoansEquip. LeasesMfgd. HousingStudent LoansAll Others
31%
24%20%
6%
5.5%5.5%
8%
Source: Thompson Financial
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U.S. Public Asset Backed Activity 2002by Type of Assets Securitized
Home EquityCredit Card Rec.Auto LoansMfgd. HousingStudent LoansEquip. LeasesAll Other
39.4%
17.9%
22.9%
1%
6%1.5%
11.3%
Source: Thompson Financial
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U.S. Public Mortgage Backed Assets 1996by Type of Assets Securitized
FHLMCFNMAResidentialFixed RateComm.GNMAMortgage LoanAll Other
27%
25%12%
9%
8%
6.5%
6.5%6%
Source: Thompson Financial
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U.S. Public Mortgage Backed Assets 2002by Type of Assets Securitized
FHLMCFNMAResidentialComm.GNMAMultifamily
39.7%
20.5%
27.1%
4.6%8.6%
Source: Thompson Financial
0.6%
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Why do Entities Securitize?
• Securitization satisfies current macro economic trends
• What are those trends? 3 produced a need for securitization ... Over-regulation of financial institutions
Search for cheaper sources of capital
Convergence of capital markets into one
1 made it possible
Improving computer-based technology
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Why do Entities Securitize?
• Largest trend of all:
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Why do Entities Securitize?
What are the precise, originator-driven motivations?
• Balance sheet relief
• Cheaper cost of financing
• Increased liquidity
• Matching assets and liabilities
• Sources of funds in times of economic stress
• Gain on sale
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Balance Sheet Relief
• FAS 140: Isolation of financial assets
• Why does an issuer want balance sheet relief? Removal of assets and related debt improves
ratios and need for more expensive capital Note rating agency discount
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Securitization of 50 assets & 37.5 of related debt
so reduced capital to 12.5
Assets Liabilities/Capital
50 37.5 Debt
12.5 Capital
50 50
Liabilities/Capital
100 75 Debt
25 Capital
100 100
Assets
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Less expensive capital necessary, or same capital, butcapital/assets ratio improved
Assets Liabilities/Capital
37.5 Debt
25 Capital
62.5*
62.5 62.5
*retained interest of 12.5 in asset pool of 50
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Capital/Assets Ratio
Before: .25
After: .40
Other ratios may improve similarly
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Cheaper Cost of Financing
• GMAC A
• GMAC Securitization Up to 94% of debt rated AAA because of
isolation of assets from bankruptcy risk of parent
• Transactions Cost
• Asset-backed premium AAA = AA+
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Increased Liquidity
• Investors who prefer mix of credit risk and tenor that is different than senior debt
• Originator’s name can be divorced from securities altogether ABCP Credit enhancers
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Sources of Funds in Time of Economic Stress
• Rated v. unrated
• Bankruptcy remote structures
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Matching Assets and Liabilities
Issuer
3 mo.
6 mo.
1 year
3 year revolver
& 5 year bullet, etc.
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Gain on Sale
• FAS 140: Net gain equals proceeds minus basis Allocation of basis based on fair market value sold and
retained portions Valuation of retained portion based on variety of
assumptions• Defaults
• Payment speed
• Interest rates
Ability to “create” regular flow of net income appears to create need for less “other capital”
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Three Steps to Creating our own Securitization
1) Pool and package individual loans or debt instruments
2) Convert the package into securities
3) Enhance the credit of the securities to facilitate their sales to investors
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• A group of significant economic scale and geographic diversity, with
• An unfulfilled or underfulfilled need for funds, and
• A body of historical data about their ability to repay debt
Borrowers
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Borrowers• Securitize loans
collateralized by the future flow of expected earnings
• Discretionary use of funds above and beyond tuition payment
• Defer payment of principal and interest for 1-3 years
• Will not compete with government-sponsored tuition lending programs
GraduateStudents
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• Using technology to streamline the loan application, qualification and approval process
• Use historical information to mitigate risk by isolating the low-risk students -- Best & Brightest
• Package the pool of loans to meet the risk appetites of institutional investors
Originator
Seeks to lower the cost of moving funds from investors to borrowers
B&B.com
Borrowers
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• Verified student I.D.
• Access to records (privacy)
• Variety of means for delivery of funds
• School branding
Offers credit cards over the Internet @ 11% interest to students at qualified graduate schools
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• Law, business, medicine
• Graduation rate
• Placement statistics
• Average starting salaries
• Alumni contribution statistics
• Tuition loan repayment record
• Overall reputation
Acceptance and credit limit depends upon:
Type and Quality of School
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• Degree pursued
• GPA
• Class rank
• Internships
• Anticipated graduation date
• Credit check
Acceptance and credit limit depends upon:
Type and Quality ofStudent
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SPV
• Purchase the debt
• Issue securities
• Administer the collection of cash flows and servicing of debt
• Pass interest and payments on to investors
• Avoid taxation
Originator
Special Purpose Vehicle is created to:
Sub ofB&B, LLC
Borrowers
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Underwriter
SPV
• Knows how to package securities for market
• Sets prices and tranches
• Understands legal requirements of institutional investors
• Works with the rating agency
Originator
Underwriter or issuer prices and markets securities to investors
InvestmentBank A
Borrowers
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Underwriter
SPV
• Sets a defined credit standard
• Protects investors against unknown assumption of risk
• Increases marketability of securities
• Reduces yield that must be paid to investors
OriginatorRating Agency
Poor &Moody
Borrowers
RatingAgency
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Underwriter
SPV
• Historic record of loan defaults
• Rate of bankruptcy
• Size of default losses
• Debt seasoning -- what % of borrowers are now making payments
• Geographic diversification
• Quality of borrowers
Originator
Rating Agency Evaluates
Poor &Moody
Borrowers
RatingAgency
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Underwriter
SPV
Originator To give $100 million pool of securities a AAA rating, Poor & Moody demands a credit enhancement to cover
Poor &Moody
Borrowers
RatingAgency
$15 million in losses
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Underwriter
SPV
• A series of tranches $85 million of senior
securities
$15 million of first-loss subordinated securities
• Insurance protection from a AAA rated surety company
• Spread account
• Letter of credit
• Cash collateral loan
Originator
Options for Credit EnhancementBorrowers
RatingAgency
CreditEnhancer
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Underwriter
SPV
Arrange for Bank B to service the loans -- process payments,
compute interest, issue statements, etc. -- and
SPV provides a $15 million capital
contribution as buffer against investor loss
Originator
Which Option Do We Choose?Borrowers
RatingAgency
CreditEnhancer
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What’s in it for Bank B?
• Preemptive access to high-end financial product consumers
Brokerage services Insurance products Auto loans Jumbo mortgages Business loans
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Underwriter
SPV
• AAA-rated securities
• Fixed-rate or floating rate interest payments
• Short- or long-term debt
• Lower-rated, higher-yield securities
Originator
Investors can buyBorrowers
RatingAgency
CreditEnhancer
Investors
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Loan origination
Fund transfer
Access to historical information
Sale of securities
Superior data on asset pool
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What’s asset securitization?