asset securitisation introduction for iimc icsi

8/8/2019 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

asset securitisation introduction for iimc icsi

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