Asset Securitisation Introduction for IIMC ICSI
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Transcript of Asset Securitisation Introduction for IIMC ICSI
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Introduction to
Asset Securitisation
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What is securitisation
In traditional methods of corporate finance, a corporation raises
equity/obligations to own assets.
In securitisation, a corporation creates and securitises assets - that is,transfers assets. In form of securities.
The claim is on assets, and not on the entity
Hence, asset-based funding
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Securitisation and corporate finance
N atu re G enera l c la im aga ins t theassets o f an ent i ty
Cla im a gainst speci f icassets o f an e nt i ty , onm utual ly exclus ive basis
O b jec tive T o harne ss the s treng ths o f
the corporate 's ba lancesheet to ra ise funding
To str ip the exces s spread
inherent in assets a ndserv ice them on of f -ba lancesheet basis
In ve sto r r is ks S u bje ct to e ntity -w id e ris ks Is ola te d fro m en tity r is ks
S t ru c ture d fu nd in g L e ss a me n a b le tostructured funding
More am enab le tostructured funding, s inceassets are h ived of f in to aseparate e nt i ty
Leverage Leverage lim ited to en tity -
wide prudent ia l /regula torylimits
Leverage based on
portfol io r isks - usua l lyquite high
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Key features of securitisation
Capital market funding
Use of special purpose vehicles as a transformation
device Structured finance
Meaning of structured financial products: product structuredor made-to-needs of the investor
Key structuring principles:
What are investors rating needs What are investors payback needs/ paydown needs
What is investors appetite for interest rate risk, prepayment risk?
Securitised instruments reorganise investors rights to suittheir needs
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Concept of SPVs
Transferor
Special
purpose
vehicles as
trustee
Investors as
beneficial
owners
Transferor
Special
purposevehicles as
owner
Investors
as debt
investors
Security
trustee
holding
charge for
investors
Pass-through form Pay-through/ CDO/ CLO form
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Use of SPVs Generic use of SPVs - to isolate identifiable assets/risks into a stand alone, self-
sustained entity which is no more than such assets/ risks.
SPVs are used in securitisation transactions as devices ofhiving off assets and
converting assets into securities.
An SPV is no more and no less than incorporated name for specific assets
no more than isolated assets - no other assets or general recourse against the SPV
no less than isolated assets - no other claims to affect the investors rights over assets
Operating companies and SPVs:
SPVs are not companies in substantive operations; they do not have any business
except acting as a legal instrumentality.
This feature is necessary to ensure asset-backed securities
Nature of interest in SPV:
beneficial or proportional, equity-type interest in assets
debt-type interest, collateralized by specific assets
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Use of structured finance devices
Structured finance devices mean re-distribution of risks/rewards or components
of assets into different segments, to churn out securities with different
risk/reward profiles.
Uses of structured finance:
aligning securities to investor needs - term, credit risk, prepayment risk, interestrate risk, etc
credit enhancement
arbitrage
Common structuring devices:
tranching
subordination support classes:
planned amortisation class and support class
floating rate class and inverse floating class
fixed income class and leveraged floating class
debt class and equity class
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Life cycle of asset-backed securitisation
Quasi-financial deals
Unrated, Bilateral transfers
Full originator backing
Purpose: off-balance sheet; exploiting excess spread,
etc
Early-stage securitisation
Advanced-stage securitisation
Synthetics stage
Operating Risk transfers/
Index risk transfers
Transfers through SPV route
High degree of credit enhancement/ cash participation
by originators
Purpose: off balance sheet; better ratings
Credit enhancements dwindle; lower classes take risk
Synthetics; arbitrage activity enter the stage
Purpose: economic capital; better capital/ risk management
Separation of funding and risk transfers
Synthetics answer regulatory concerns more easily
In traditional cash structures, transaction models are builtaround securitisation mechanics; origination/ servicing
split
More stress on risk transfers
risks of operating businesses: retail credits, performance-oriented
businesses are transferred
Distinction bet. banking and insurance becomes less clear
? (possibly, reinvention stage)
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Typical assets securitised
Financial assets
long-term assets
short term assets
revolving assets
Physical assets
using transformation devices
using secured loan structures
Whole business transactions Future flow transactions
Structured investment vehicles:
CDOs of investment products such as hedge funds, privateequity funds, etc.
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Securitisation and borrowing
Legal nature o thetransaction
Trans er o an asset/ severalassets o the originator
ormal monetary obligationo the originator
arties to the transaction To allo the pool o
receivables to be aggregated
and kep t intact, a collectiveinvestment medium, the
is ormed.ence, there are 3 parties to
the transaction - the
riginator, (issuer) and
the investors
There are t o parties to the
transaction - the borro er and
the lender. In case oparticipation o several
persons in the loan, theremight be an indenture trusteeacting as a trustee or the
investors.
elation ith the debtors othe originator
Trans ers claims againstdebtors/ customers o the
originator
o connec tion ith thedebtors o the originator
ature o instrumentacquired by investors
ither a ractional interest inthe pool o receivables held
by the , or a debt
obligation o the
Debt obligation o theoriginator
Legal rights o the in ve stors xe rc isa ble a ga inst the ,
or through the against
the debtors o the originator
xercisable against the
originator
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Securitisation and borrowing
Treatment or regulatorypurposes
ot treated as borro ingrom public
Treated as borro ing rompublic
ect on regulatory capitalrequirement
ormally rees up regulatorycapital
Does not ree regulatorycapital
Bankruptcy o the originator Investors bene icially o nthe pool o assets trans erred
to the
Investors have a claim againstthe originator; usual
bankruptcy/ distressedcompany protection available
to the originatorailure o the debtors o the
originator
Depends upon recourse
eatures; normally investorsill su er a loss
Investors ill not be a ected;
they have a claim against theoriginator
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Why securitisation
Lower cost - inherent cost and weighted average cost
The best example of economics of securitisation is an arbitrage CDO
Alternative investor base -institutional and retail
Matching of assets and liabilities Issuer rating irrelevant
Multiplies asset creation ability
Non-conventional source; may allow higher funding-
Off-balance sh
eet financing - removal of accounts Frees up regulatory capital
Improves capital structure
Higher trading on equity with no increased risk
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Why securitisation -
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Extends credit pool
Not regulated as loan
Reduces credit concentration
Risk management by risk transfers
Arbitraging opportunities - repackaging
transactions
Avoids interest rate risk
Improves accounting profits
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Lower cost due to securitisation
Increased leverage: lower use of equity: leveragearbitrage
Capital market source reduces agency costs
etter rated product: ratings arbitrage
Aligns investment with investor objective: structuralarbitrage
Studies of wheth
er securitisationh
as reducedfunding costs:
Mortgage market is cited as an example
Arbitraging profits in the securitisation market
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Securitisation from Investors viewpoint etter security as direct claims over assets
Tested in several bankruptcies: Japan Leasing, several Thai companies;Philippine Airlines, Turkey cos.
Rating resilience - transition studies confirm A S ratings are more stablethan other fixed incomes.
High rate of default recovery Structuring features: possibility for better risk-return alignment
Rated investment
Very few instances of default in 20 years history: In Europeansecuritisation, no default to date.
Even when underlying obligations default, losses are much lesser: Incase of corporate bonds, 47% of the par value lost -Moodys study
etter yields in emerging markets
Moral responsibility of investment bankers/ rating agencies: case ofAhmsa, Mexican companys default.
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Basic elements of securitisation structures Transfer of assets to bankruptcy-remote entities:
Cash versus synthetic structures
secured loan structures
Two-tier transactions
Cash inflow and outflows: pass- throughs and bond structures
Determination and form of credit enhancements
Classes of securities and coupon of each
Profit extraction devices
Liquidity enhancements Structural protections: early payment or de-leverage triggers
Pay down methods:
normal
abnormal - in case of triggers