“PROCESS OF TRANSFORMING OTHERWISE FINANCIAL ASSETS INTO MARKETABLE CAPITAL MARKET SECURITIES”...
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Transcript of “PROCESS OF TRANSFORMING OTHERWISE FINANCIAL ASSETS INTO MARKETABLE CAPITAL MARKET SECURITIES”...
“PROCESS OF TRANSFORMING OTHERWISE FINANCIAL ASSETS
INTO MARKETABLE CAPITAL MARKET SECURITIES”
SECURITIZATION
EARLY TYPICAL SECURITES
• GNMA ‘PASS THROUGH’
• AUTOMOBILE LOANS
• CREDIT CARD RECEIVABLES
• COMMERCIAL LEASES
• COMPUTER LEASES
• NOW: BUSINESS LOANS
EXAMPLE
• DAYTON HUDSON CREDIT CARD MASTER TRUST
• GO OVER
SECURITIZATION PROCESS
• LOAN ORIGINATON - SETS TERMS
• TRUST - BUYS LOANS FROM BANK AND ISSUES SECURITIES
• INVESTMENT BANKER - SELLS SECURITIES FROM TRUST
• GUARANTOR -
• INVESTORS
BUSINESS LOAN SECURITIZATION
• VERY SMALL SO FAR:
– LOANS OUTSTANDING - $155 BILLION
– SECURITIZED LOANS - <$900 MILLION
COMPARISON
• TRADITIONAL LENDING - originate, fund, service, monitor
• SECURITIZED LENDING - originate,sell, service
Asset(loan) Securitized
• Illiquid• imprecise valuation• lender monitoring• high operating costs• limited rates/terms• local investor market
• Liquid• efficient market val.• Third party assesses• low operating costs• wide range of rates• national/global market
REQUIREMENTS
• STANDARD CONTRACTS
• RISK RATING SYSTEM
• REPUTABLE CREDIT ENHANCERS
• STANDARDIZED LEGAL FRAMEWORK
• STANDARDIZED SERVICING QUALITY
LOW GROWTH=HIGH COST
• Specific borrower /local condition info. Needed for prediction of repayment
• Lack of standard loan term– line of business/credit quality– loan maturity– pricing/covenants/collateral– bank underwriting standards
• Lack of long term performance info.
SBA GUARANTEED LOANS
• GUARANTEED PORTION = SECURITIZED
• MONEY STORE INC. -$380 MILLION SBA LOANS
• FREMONT FINANCIAL - $330 MILLION IN LOANS SECURED BY A/R, INV. AND F/A
WHY THESE WORKED
• RIGOROUS UNDERWRITING STAND.
• SBA LOANS - VERY STANDARDIZED
• SIMILAR COLLATERAL/DOCUMENT.
• SBA CAN SUPPLY HISTORICAL LOSS EXPERIENCE DATA
• HIGH VOLUME LENDERS
BACKUP REQUIRED
• LOSS PROTECTION ON 11-20% OF THE LOAN POOLS
• OR
• PURCHASE PRIVATE BOND INSURANCE
MAIN BENEFITS TO LOAN ORIGINATOR
• LOANS SOLD/NO FUNDING NEEDED
• REDUCES MONITORING COSTS
• LOWER BORROWING COSTS DUE TO PREDICTABLE CASH FLOW FROM POOL OF ASSETS, NOT ONE
CONT.
• RELEASE BANK CAPITAL TO OTHER PURPOSES
• MANAGE CREDIT RISK
• DIVERSIFY LOAN PORTFOLIO
WHY FIRMS USE ASSET-BASED DEBT
• AVOID ASSET SUBSTITUTION COSTS
• “Mgmt. Often replaces low risk assets with high risk after debt financing. Only the stockholder get the higher return.
• Only securitized debt ties the bond to specific asset - thus, no substitution
Cont.
• Avoid underinvestment
• “Equity holders of stressed companies unwilling to make marginal investment as only bondholders get the return.”
• Use of asset-based security removes general company risk
Cont.
• Secured debt reduces information asymmetry problem of management not acting in bondholders’ interests
ISSUES FACED BY INVESTORS
• GUARANTEE ONLY PROVIDES LIMITED CREDIT PROTECTION
• INTEREST RATE RISK LIMITED BY BUYING “TRANCHES” IN DIFFERENT MATURITIES
CONT.
• LIQUDITY RISK NOT A PROBLEM
• PERFORMANCE RISK - EX. CREDIT CARD RECEIVABLES IN A RECESSSION
CONT.
• PREPAYMENT RISK - PARTICULARLY IN SECURITIES BACKED BY MORTGAGES
• GEOGRAPHIC CONCENTRATION
MAIN BARRIERS TO BANK LOAN SECURITIZATION
• SIZE CONSIDERATIONS– MIN. POOL FOR PRIVATE PLACE. -$50m– MIN. POOL FOR PUBLIC OFFER.-$100m
• RECOURSE - INVESTOR HAS CLAIM IF SECURITY DEFAULTS
• RISK EXPOSURE - POOLED ASSETS ARE DIFFICULT TO MONITOR
Cont.
• Lack of long term performance information