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The Securitization Process Asset-Backed 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 Copyright ©2000 Ian H. Giddy The Securitization Process3 Giddy/ABS The Securitization Process/2 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 Copyright ©2000 Ian H. Giddy The Securitization Process5 Giddy/ABS The Securitization Process/3 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. Copyright ©2000 Ian H. Giddy The Securitization Process6 Securitization: The Basic Structure SPONSORING COMPANY ACCOUNTS RECEIVABLE SALE OR ASSIGNMENT SPECIAL PURPOSE VEHICLE ISSUES ACCOUNTS ASSET-BACKED RECEIVABLE CERTIFICATES Copyright ©2000 Ian H. Giddy The Securitization Process7 Giddy/ABS The Securitization Process/4 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? Copyright ©2000 Ian H. Giddy The Securitization Process8 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 Copyright ©2000 Ian H. Giddy The Securitization Process9 Giddy/ABS The Securitization Process/5 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. Copyright ©2000 Ian H. Giddy The Securitization Process10 The Process Key features are: u pooling of a group of similar non-traded financial assets u transfer of those assets to a special-purpose company which issues securities u risk reduction by systematic risk assessment, by diversification, by partial guarantees, etc. u division of the benefits (and risks) among investors on a pro-rataIMPLEMENTATION 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. Copyright ©2000 Ian H. Giddy The Securitization Process11 Giddy/ABS The Securitization Process/6 FinanceFinance CompanyCompany LimitedLimited 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 Copyright ©2000 Ian H. Giddy The Securitization Process13 Giddy/ABS The Securitization Process/7 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 Copyright ©2000 Ian H. Giddy The Securitization Process14 Case Study: Initial Exchanges Finance Co.’s Rating Agency Customers Hire-Purchase Top Rating Servicing Agreement Agreement Finance Co. Ltd Proceeds FCL 1997-A Proceeds Investors (Seller) (Special Purpose Co.) Sale of Assets Asset-Backed Securities Financial Guarantee Trustee Provider Trust Guarantee (if required) Agreement Agreement Copyright ©2000 Ian H. Giddy The Securitization Process19 Giddy/ABS The Securitization Process/8 Case Study: Ongoing Payments Finance Co.’s Customers Hire-Purchase Servicing Fees Payments Monthly HP Monthly ABS Finance Co. Ltd FCL 1997-A Payments Payments Investors (Seller) (Special Purpose Co.) Financial Guarantee Trustee Trustee Guarantee Provider Responsibilities Responsibilities Copyright ©2000 Ian H. Giddy The Securitization Process20 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 Copyright ©2000 Ian H. Giddy The Securitization Process21 Giddy/ABS The Securitization Process/9 Risk-Management Techniques in ABS SPONSORING CREDITCREDIT COMPANY ENHANCEMENTENHANCEMENT ACCOUNTS RECEIVABLE SOVEREIGNSOVEREIGN PROTECTIONSPROTECTIONS SALE OR SPECIAL ASSIGNMENT PURPOSE VEHICLE INTERESTINTEREST RATE/ RATE/ ISSUES CURRENCY ACCOUNTS ASSET-BACKED CURRENCY RECEIVABLE CERTIFICATES HEDGESHEDGES CASHCASH FLOW FLOW REALLOCATIONREALLOCATION Copyright ©2000 Ian H. Giddy The Securitization Process22 Credit Enhancement: An Alternative Approach Rating Agency Top Rating Senior Lower Rating Finance Co. Ltd Proceeds FCL 1997-A Subordinated (Seller) (Special Purpose Co.) Sale of Assets No Rating More Subordinated Financial Guarantee Provider Guarantee (if required) Agreement Copyright ©2000 Ian H. Giddy The Securitization Process23 Giddy/ABS The Securitization Process/10 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 Copyright ©2000 Ian H. Giddy The Securitization Process24 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. Copyright ©2000 Ian H. Giddy The Securitization Process25 Giddy/ABS The Securitization Process/11 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. Copyright ©2000 Ian H. Giddy The Securitization Process26.
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