IMPLEMENTATION. Asset-Backed Securities. The basic idea What s needed? The technique ABS around the world. The Securitization Process/1

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1 The Securitization Process/1 Asset-Backed Securities Asset-Backed Securities The Securitization Process The basic idea What s needed? The technique ABS around the world Prof. Ian Giddy Stern School of Business New York University The Securitization Process3 Range of Debt Markets Securitization: The Basic Structure SPONSORING COMPANY Illiquid Highly liquid Nontradable private placement Tradable private placement Commercial paper Public issue Actively traded bonds SALE OR ASSIGNMENT VEHICLE ISSUES ASSET-BACKED CERTIFICATES The Securitization Process4 The Securitization Process5 Securitization is the transformation of an illiquid asset into a security. For example, a group of consumer loans can be transformed into a publically-issued debt security. 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. IMPLEMENTATION BANK Pool of mortgage loans COMPANY OR TRUST Assetbacked securities INVESTORS The Securitization Process6 The Securitization Process7

2 The Securitization Process/2 Asset Securitization: Features Key features are: pooling of a group of similar non-traded financial assets transfer of those assets to a special-purpose company which issues securities risk reduction by systematic risk assessment, by diversification, by partial guarantees, etc. division of the benefits (and risks) among investors on a pro-rata basis being offered in the form of a security (rather than, for example, as a portfolio of loans or receivables) on-going servicing of the underlying assets' cash flows through to the asset-backed security investors. Interest and principal BANK Interest and principal VEHICLE Interest and principal INVESTORS The Securitization Process8 The Securitization Process9 Characteristics of Assets Needed to Securitize Form of transfer of asset Form of special purpose vehicle Securitize the assets Decisions Form of credit enhancement Form of Form of cash flow transformation of allocation cash flows The Pool of Assets Should Have: Volume which is sufficiently large and homogenous to facilitate statistical analysis A stable history of rates, defaults, delinquencies, prepayments and so forth Sufficient diversification--for example, geographic and socio- economic-- to reduce vulnerability to economic stresses Basic lender s credit quality standards that are capable of being evaluated and approved by rating agencies and specialized financial guaranty companies 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. The Securitization Process10 The Securitization Process11 Finance Company Limited Case Study: The Company (Finance Company Limited) Corporate commitment Management depth Track record (loan program administration) Internal systems (origination, servicing, and collection) Information (on company and collateral) Market position Origination capacity Technology The Securitization Process14

3 The Securitization Process/3 What is the Technique for Creating Asset-Backed Securities? A lender originates loans, such as to a homeowner or corporation. The securitization structure is added. The bank or firm sells or assigns certain assets, such as consumer receivables, to a special purpose vehicle. The structure is legally insulated from management The SPV issues (usually) high-rated debt. The Securitization Process15 The Securitization Process16 Servicing Sale of Assets Asset-Backed Securities Trust The Securitization Process17 The Securitization Process18 Rating Agency Rating Agency Servicing Top Rating Servicing Top Rating Sale of Assets Asset-Backed Securities Sale of Assets Asset-Backed Securities Trust Trust Guarantee Guarantee Provider (if required) The Securitization Process19 The Securitization Process20

4 The Securitization Process/4 Case Study: Ongoing Managing the Risks Servicing Fees Monthly HP Responsibilities Monthly ABS Guarantee Responsibilities Guarantee Provider Credit risks Liquidity risk Servicer performance risk Swap counterparty risk Guarantor risk Legal risks Sovereign risk Interest rate and currency risks Prepayment risks The Securitization Process21 The Securitization Process22 Risk-Management Techniques in ABS SPONSORING COMPANY CREDIT CREDIT ENHANCEMENT SOVEREIGN PROTECTIONS Charming Shoppes, Ohio GPA, Ireland SALE OR ASSIGNMENT VEHICLE ISSUES ASSET-BACKED CERTIFICATES INTEREST RATE/ RATE/ CURRENCY HEDGES HEDGES CASH CASH FLOW FLOW REALLOCATION YPF, Argentina News Corp, Australia The Securitization Process23 The Securitization Process24 USA UK, France, other Europe Australia, Japan, Thailand, Indonesia, Philippines, India, etc Other developing countries Eurobonds The Securitization Process25 The Securitization Process26

5 The Securitization Process/5 The U.S. Market ABS in the USA The Securitization Process27 The Securitization Process28 ABS in the USA USA UK, France, other Europe Australia, Japan, Thailand, Indonesia, Philippines, India, etc Other developing countries The Securitization Process29 The Securitization Process30 The Market in Europe Why Has the European MBS Market Not Developed Faster? Despite steady issuance since the mid-1980s, securitization volume in Europe has lagged US rates, for a variety of reasons: Many institutions have not faced strong incentives to remove assets from balance sheets, because of favorable funding rates and excess capital; The severe recession in Europe in the early 1990s led to a sharp drop in loan originations, further diminishing pressure on balance sheets; A lack of legal and regulatory frameworks hinders securitization; Few analytic tools and an infrastructure exist for timely reporting of deal information to investors; A diversity of mortgage terms and conditions from country to country, such as different prepayment penalties, diminish the appeal of MBSs backed by loans from one country to investors in other countries; Currency differences have hindered cross-border transactions in the past; and Many European investors have tended to focus on sovereign debt, rather than spread products. The Securitization Process31 The Securitization Process32

6 The Securitization Process/6 Many of These Impediments to Growth Have Been Diminishing The introduction of the Euro is having a major impact, because it will gradually eliminate much of the existing sovereign bond markets, shift investor attention to spread products, especially MBSs and ABSs because of their high credit quality, and eliminate currency concerns; In the past few years, various countries have made legal and regulatory changes that facilitate securitization, and this trend is expected to continue; Competitive and regulatory pressures on institutions are mounting, leading to more focus on measures such as return on equity and on efficient balance sheet management; Gradual improvements in MBS deal information reporting systems and more familiarity with cash-flow characteristics should contribute to increasing investor comfort levels with MBS and ABS products There has been a continuing broadening of the types of assets being securitized for example, sub-prime mortgages, student loans, soccer receivables, pub leases, and so on. Asset-Backed Securities: Asian Applications Mortgage Securitization Non-Mortgage ABS Infrastructure and Project Financing The Securitization Process33 The Securitization Process34 Mortgage Securitization: Dragon MBS Auto Securitization: Thai Cars Merrill Lynch (swap counterparty) Brilliant Oscar Ltd. (servicer) HK$ HK$ US$ interest and principal Dragon MBS Ltd. HK$ interest and principal US$ Principal+interest US$ Interest US$ Principal (after Class A1 completely redeemed) Class A1 US$32M Class A2 US$17.6M 1 month US$ LIBOR + 0.9% 1 month US$ LIBOR % Notes US$ Cash Yen Loan Cash Thai Cars Ltd Tru Way Tru Lease Issuer TISCO (initial principal balance Baht notes/loan equal to yen equivalent of the initial principal (initial aggregate principal balance balance of the notes ) equal to the baht equivalent of the initial principal balance of the Yen Loan) Baht Cash HP/Lease s Car Buyers/ Lessors Floating-rate residential mortgages (Tin Shui Wai,Hong Kong) HK$ Interest HK$ Principal (after Class A2 completely redeemed) Class A3 HK$131.7M HK$ Prime rate + 0.5% The Securitization Process35 The Securitization Process36 Credit Card Securitization: Chase Manhattan Hong Kong FSA Credit Card (HK$) Receivables Purchase (HK$) Pooling & Servicing (HK$ ) Hong Kong Credit Card Obligors Manhattan Card Co.Ltd. (Servicer) Manhattan Card Funding Corp. (Seller/Cayman Island SPV) HK$ Swap Hong Kong Card Master Trust (US Based Issuer) Guaranty Insurance US$ Swap Policy (US$) US$ Principal/Interest HK$ Spread Account Chase Manhattan Bank N.A. (Swap Bank/Back-up Servicer) Japan: Asset-Backed CP Japan Guarantor USA Overcollaterlalization, Bank back up Rating agency third party quaranty line rating Inter-office Issue of ABCP Sale of receivables loan (Y) Originator SPC SPC ($) Commercial paper Servicer (Japan branch) (US head office) Purchase price dealer Payment (Y) Redemption Fund ($) CP purchase Sale of Payment of collections price products CP redemption Payment payment Administration Administrative Swap Obligor Company Company Counterparty (Japan) (U.S.) The Securitization Process37 The Securitization Process38

7 The Securitization Process/7 Infrastructure Securitization: Panjang Bridge Dah Sing/Hong Kong SAR Panjang toll bridges Toll revenues Constructs and operates the toll bridges under 20-year concession of notes PBDIC (operator) Renminbi shortfall funds ASIA Ltd Guarantee Dah Sing Seller/Servicer Mortgage portfolio Hong Kong SAR Res Mort. Ltd US$ FRN PBCo. Ltd. (issuer) Renminbi Bank (to convert funds) US dollars (offshore) Currency Swaps Guarantees US dollars General Re ASIA Ltd CapMac of notes The Securitization Process39 The Securitization Process40 Why Has the Asian ABS Market Not Developed Faster? Despite a gradual increase since the early 1990s, securitization volume in Asia has lagged US and European rates, for a variety of reasons: A lack of legal and regulatory frameworks that would facilitate securitization; Tax obstacles to the transfer of financial assets and inter-company interest payments; Few analytic tools and an infrastructure exist for timely reporting of deal information to investors; A diversity of mortgage and hire-purchase terms and conditions from country to country; A wait-and-see approach by the monetary authorities who feared easier consumer credit conditions; Sovereign risk considerations have hindered cross-border transactions in the past; Many institutions have not faced strong incentives to remove assets from balance sheets, because of favorable funding rates and excess capital; The severe recession in Asia in the late 1990s led to a sharp drop in loan originations, further diminishing pressure on balance sheets. Belenus Securities What are the underlying assets? What types of securities have been issued? What is the legal structure? Who is the issuer? The sponsor? What is the issuer s relationship to the sponsor? Why was this deal done? ABS in Europe: Case Study The Securitization Process41 The Securitization Process42 Ian H. Giddy Stern School of Business New York University 44 West 4th Street, New York, NY 10012, USA Tel ; Fax ian.giddy@nyu.edu The Securitization Process44