The Expanding Frontiers of Asset Securitization

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The Expanding Frontiers of Asset Securitization
Group I Institute of Statistics 914007
Chen, Yu-Huei 914008 Liu, Fang-Yi
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Outline

• What is Securitization?
• What is Asset-Backed Securitization?
• The Collateral Types of ABS
• The Development of the ABS Market
• The Advantages of Securitization
• The Process of Securitization
• Taiwans Difficulties
• Reference

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What is Securitization?
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Securitization

• A company raises money from capital market by
  issuing securities that are backed by specific
  assets.
• In most cases, the underlying assets are loans,
  such as mortgage loans or auto loans.
• The cash flow from the underlying assets
  usually is the source of funds for the
  borrower/issuer to make payments on the
  securities.
• Securitization products generally are viewed
  as including the following asset-backed
  securities, mortgage-backed securities,corporate
  bond, commercial papers, etc.

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Securitization
MBS
Financial Asset Securitization
Auto Loan
General Securitization
Credit Card
Estate Securitization
Securitization
Corporate Bond
Corporate Securitization
Stock
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What is Asset-Backed Securitization?
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Asset-Backed Securitization

• Asset-backed Securities (ABS) are essentially
  securities entitled to the cash flows from a
  specific pool of assets
• These assets can be a variety of loans or
  receivables, such as
• Credit Card receivables
• Auto loans
• Mortgages
• In an ABS deal, the issuer, or loan originator
• transfers assets into a SPV
• the SPV issues securities and sells these
  securities to investors.
• investors are entitled to the cash flow from the
  assets.

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ABS Typical Legal Structure

• The seller transfers assets (receivables/loans)
  to a special-purpose vehicle (SPV).

Loan Originator
True Sale

• The SPV transfers the assets to investors. The
  assets of the SPV will not be consolidated with
  the issuers in case of a bankruptcy.

Bankruptcy Remote SPV

• The SPV then issues securities to investors

• Investors are entitled to the cash flows from the
  assets.

Investors
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True Sale

• An actual sale, as distinct from a secured
  borrowing, which means that assets transferred to
  an SPV are not expected to be consolidated with
  those of the sponsor in the event of the
  sponsors bankruptcy.
• Rating agencies usually require what is called a
  truesale opinion from a law firm before the
  securities can receive a rating higher than that
  of the sponsor.

.
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Example
Original Flow
American Express
Cardholders
Monthly Principal Interest

• Cardholders pay monthly principal and interest to
  American Express for their monthly credit card
  payments, including principal, interests, annual
  charges and other penalty charges.

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Example
Flow After Structuring
Cardholders
SPV
Investors
Monthly Principal Interest
Monthly Principal Interest

• In an ABS deal, American Express transfers its
  rights to a specified pool of receivables into a
  SPV.
• Proceeds from the specified pool of American
  Express cardholders will go to the SPV. The SPV
  in turn pays the investors.
• American Express is no longer entitled to the
  receivables.

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The Collateral Types of ABS
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Assets Types ABS Issuers - I

• Credit Cards
• Receivables from monthly payments by credit card
  holders.
• Issuers include
• Banks which issue VISA or MasterCard
• American Express and Discover
• Saks, Neiman Marcus, Circuit City and similar
  retailers which issue retail cards
• Auto Loans and Leases
• Auto loans for car purchases or leases
• Issuers include
• Financial Subsidiaries of GM, Ford, Honda,
  Nissan, Daimler Chrysler
• Banks such as Banc One, Chase
• Independent finance companies such as Arcardia,
  Union Acceptance Corporation.

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Asset types ABS Issuers - II

• Home Equity Loans
• Liens on homes
• Issuers include independent finance companies
  Residential Funding Corp (RASC), Option One
  Mortgage Corp, Long Beach Mortgage Co,
  Country-Wide Home Loans.
• Manufactured Housing Loans
• Loans on Manufactured Housing
• Mainly issued by Ginnie Mae, a US-Government
  Sponsored Enterprise
• Student Loans
• Loans to university and graduate students to
  finish degree
• Main issuer is the Student Loan Marketing
  Association (Sallie Mae)

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Asset types ABS Issuers - III

• Equipment Loans and Leases
• Loans and leases to finance medium/heavy
  equipment.
• Issuers include ATT, Caterpillar, Case, John
  Deere.
• Aircraft leases
• Leases on commercial aircraft.
• Mainly issued by GPA.
• Insurance Premium Receivables
• Loans to commercial borrowers to finance
  insurance premiums.
• Main issuer is A.I.Credit.

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The Development of The ABS Market
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Development of Asset Securitization

• Began from the Mortgage-Backed Securitization
• 1930s FNMA was launched for estate market.
• 1970s First Mortgage-Pass Through (MPT)
  security was issued.
• 1980s First Collateralized Mortgage Obligation
  (CMO) was issued by
• FHLMC.
• Applied this technology to other assets
• 1985 A computer lease-backed transaction was
  issued by Sperry.
• First public auto loan-backed
  security was issued.
• 1987 First public credit card-backed security
  was issued.
• 1989 First public home equity loan-backed
  security was issued.
• 1993 First student loan-backed securitization.
• 1994 First insurance premium-backed
  transaction.

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Highly Liquid Market
Amounts in millions
275,000
259,600
250,000
221,243
225,000
197,294
189,084
200,000
184,589
175,000
149,560
150,000
125,000
112,041
100,000
75,356
75,000
59,673
50,758
50,341
50,000
42,347
24,707
25,000
15,456
9,763
10,041
1,237
0
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Year
1985 Through 2001
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American Bond Market
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Development of ABS Outside the U.S.

• The U.K. is the leading country for
  securitization in Europe.
• The first MBS has been issuing since 1987.
• Favorable legal and regulatory environment
• France is the second largest issuer of ABSs in
  Europe.
• Other European countries that have issued ABSs
  include Spain, Sweden, and Italy.
• Asset securitization in Canada has grown rapidly
  from 1992.
• Securitization in Japan continues to move at a
  glacial pace.
• Divided receivables cannot be traded in the
  secondary market
• The reluctance of many non-bank finance companies

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Securitization Outside the U.S.
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Diverse Universe of Collaterals
Amounts in millions
275,000
CC
Auto
HEL
MH
Equip
Student
Other
259,600
250,000
221,242
225,000
197,294
189,084
200,000
184,589
175,000
149,560
150,000
112,041
125,000
100,000
75,356
75,000
59,673
50,758
50,000
25,000
0
1993
1994
1995
1996
1997
1998
1999
2000
2001
1992
Year
ABS Supply By Sector
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Expansion of Collateral Types
Student Loans Manufactured Housing
Equipment Insurance Premium Re.
Marine Loans CBO / CLO
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ABS Senior Classes (by Weighted Average Life)
10 Plus Years
Zero to 1 Year
7 to 10 Years
3
13
7
5 to 7 Years
15
1 to 3 Years
35
3 to 5 Years
27
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The Advantages of Securitization
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Advantages of Securitization

• For Issuer
• Capital Efficiency
• Funding Diversification
• Asset-Liability Management
• Gain on Sale
• Off-Balance-Sheet

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Advantages of Securitization

• For Investor
• Attractive Nominal Yield
• Risk Protection
• Generally Low Prepayment risk relative to MBS
• Excellent Liquidity

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Advantages of Securitization

• For Supervisor
• Distribute Capital Efficiency
• Manage Risk Efficiency
• Lower the Management Cost
• More Stable Financial system

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Advantages of Securitization

• For Macro-Economic
• Informational Efficiency
• Allocational and Operational Efficiency
• Pricing Efficiency

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Top 10 Issuers 2001
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Buyers of ABS
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The process of securitization
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Credit Rating Institutions

• Standard and poor
• Moodys
• Fitch
• Duff and Phelps

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The Mechanics of Securitization
debtor
Principals and interests
Cash flows
Special purpose trust
investors
originators
Cash flows
Credit enhancement
Credit rating institutions
Investment bank
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ABS Cash Flow Diagram
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Credit Enhancement

• External
• Corporate Guarantee
• A Letter of Credit
• Pool insurance
• Bond insurance
• Internal
• Reserve Funds
• Cash reserve funds
• Excess servicing spreads accounts

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MPT Mortgage Pass Throughs
Pass Through is the simplest principal repayment
structure. Amortization and prepayment cashflows
from the collateral are transferred directly to
the security holders.
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CMO ( Collaterized Mortgage Obligations)
In a sequential, principal cashflows from the
underlying collateral are allocated to one
tranche at a time. When one tranche is paid off,
the next tranche receives all the principal and
so on. In other words, the tranches
are sequentially allocated principal payments.
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Advantages of CMO(contrast to MPT)

• The portfolio of CMO is bigger that has more
  stable statistical properties.
• Stable investment period.
• Consistency to investors demand.

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PAC(Planned Amortization Class)

• Provide the bonds with highly stable cashflows.

0-3 bond (Companion Securities)
0-1 bond (CS)
0-4 bond (CS)
principal repayment
0-2 bond(PAC)
time
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Advantages of PAC

• Stable cash-flows
• High credit qualities
• High yield

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Floating-rate CMO(FRCMO)

• Attract the Euro dollars and floating-rate bonds
  investors
• Generally issue with Reverse Floaters.
• Caps and floors.

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Example
Floater Reverse
Coupon rate LIBOR0.0065 0.424-4LIBOR
Value 40m 10m
The average weighted interest always
equal 40/50(LIBOR0.0065)10/50(0.424-4LIBOR)
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Advantages of FRCMO

• The price volatility is smaller than fixed
  interest rate bond.
• Balance the assets and liabilities.

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Stripped MBS

• Objectiveshedge and speculation
• Example
• A1(principal)coupon rate5,below par
• A2(interest)coupon rate605,over par
• Cost of funding50.996050.0111
• PO(principal only)
• IO(interest only)

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The influence of interest on PO IO
PO Market rate prepayment Bond price Net effect
PO Market rate Discount rate Bond price Net effect
PO Market rate prepayment Bond price Net effect
PO Market rate Discount rate Bond price Net effect
IO Market rate prepayment Bond price Net effect
IO Market rate Discount rate Bond price Net effect
IO Market rate Prepayment Bond price Net effect
IO Market rate Discount rate Bond price Net effect
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Concerns raised by securitization

• Adverse selection
• Securitize lower risk loans to reduce credit
  enhancement costs and lower due diligence
  expenses.
• Risk shifting
• Sell only the weakest assets through securitized
  structure.
• Moral hazard
• Window Dressing of financial statements
• Legal uncertainties

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Taiwans Difficulties
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Problems of securitization in Taiwan

• Lack of motivations to sell CMO.
• Lack of sufficient data and analysis.
• Lack of sound and economic scale bond market.
• Lack of standard and suitable laws.

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References - I

• Books
• ???????????,???????????? ,?????,2002?8?
• ???,????????????? ,?????????,1995?6?
• Mason?Merton?Perol?Tufano, ? Cases in Financial
  Engineering?,Prentice Hall,1995
• Journals Reports
• ???????,??????????????????,????????15?,2001?9?
• ??,???????????(?)(?)? ,????????????????

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References - II

• ???????,???????????????????? ,?????4?
• ???????,?????????,1997?2?
• ???,??????????? ,?????????????????,2001?3?
• ?????????(ABS)?,Deutsche Bank,2002?11?
• ?Asset-Backed Securities Introduction to the
  Market and its Structures?,Goldman Sachs ABS
  Research,May 1998
• ?The U.S. Asset-Backed Securities Market?, Banc
  of America Securities LLC,2002

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