Asset-Backed Financing:Cost-Benefit Analysis
Prof. Ian GiddyStern School of Business
New York University
Asset-Backed Securities
Copyright ©2003 Ian H. Giddy ABS Cost/Benefit 2
Separation of Two Businesses: Origination and Lending
SPONSORINGCOMPANY
SPECIALPURPOSEVEHICLE
ACCOUNTSRECEIVABLE
ACCOUNTSRECEIVABLE
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
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For Corporations: “Pure Play” Argument
Separate the credit of the assets from the credit of the originator:
q Identify and isolate good assets from a company or financial institution
q Use those assets as backing for high-quality securities to appeal to investors.
q Such separation makes the quality of the asset-backed security independent of the creditworthiness of the originator.
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Sears: Asset-Backed Financing?
SEARS
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The Keys to Successful Asset Securitizationq The economic elements that make this
technique work areu to isolate the assets, thus making them more
identifiable, secure and liquid, u to transfer risks to those best able to evaluate and
bear them, and u to create tradeable securities
q Adds economic efficiency through cost savings to borrowers, creation of investment opportunities for investors, and development of the capital market.
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Prerequisites to Successful Asset Securitization (cont.)
qMonitoring is not impaireduincentive for the originator to keep defaults
to a minimumumonitoring role for rating agencies,
guarantors and trustees.
q Legal and tax framework ufacilitates asset sale and separationuprotects both issuers and investors
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Costs Associated with Securitization
q Interest cost of the debtq Issuance expenses of the debtqAlso:uCredit enchancement and liquidity support
for the assetsuStructuring fees payable to bankersuLegal, accounting and tax advice feesuRating agencies' feesuSystems modificationsuManagement time
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The Key Lies in the Excess Servicing Fees
SPONSORINGCOMPANY
SPECIALPURPOSEVEHICLE
ACCOUNTSRECEIVABLE
ACCOUNTSRECEIVABLE
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
ExcessServicingFees
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Sample Cost/Benefit Analysis
With securitization Without securitizationPortfolio yield 18.50% 18.50%Funding cost -7.22% -9.00%Default rate -5.00% -5.50%Amortized upfront issuance costs -0.10% -0.05%Amortized upfront securitization costs -0.20%Annual costs of guarantees and credit lines -0.25%Annual additional costs (systems, reporting, trustee fees, etc) -0.25%Effect on sponsor's marginal cost of capital 0.00%
Profits 5.48% 3.95%
Net savings from securitization 1.53% per annum
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Ford Credit Auto Owner Trust
qWhat are the economic benefits and costs to Ford in this ABS deal?
qWhat do the underlying assets earn?qWhat rates do the securities pay?qOther costs?qWho gets the excess spread?
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Ford Credit Auto Owner Trust
q Interest costq Underwriting feesq Rating agency and other securitization costsq Servicing feesq Other costsq Default losses….compare with Ford Credit’s alternative
Copyright ©2003 Ian H. Giddy ABS Cost/Benefit 12
Ford Credit Auto Owner Trust
Size 1,462,716$ FORD 1999-A Underwriting fees 2,311,593$ 0.08%
Other costs 1,000,000$ 0.03%Total upfront costs 0.11%WAM 3.941667 yearsPortfolio yield 9.80%Funding cost 5.30%Default rate 1.50%Servicing fee 1%Total upfront costs 0.03%Excess servicing fee 1.97%
A 1855 93% 5.20% 4.82%B 69 3% 5.79% 0.20%C 39 2% 6.52% 0.13%D 39 2% 8.00% 0.16%
2002 5.30%
Ford Credit
Ford Credit Auto Rec 2 LP Trust 1998-B
Receivables
Receivables ReceivablesClass A - AAA
93%
Class B - AA3%
Class C - BBB2%
Class D - NR2%
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Corporation or Financial Institution requires additional funds to givecustomers financing or to finance a future revenue stream.
Are funds freely available from banks ?
Does the firm/FI have good, self-liquidatingassets ?
Do the assets have a sufficiently high yieldto cover servicing and other costs ?
Would the assets be worth more (have a cheaper all-in funding cost) if they were
isolated from the company/FI ?
Securitize the assets
Borrow frombanks
Issue equity ormezzanine capital
Get out of thefinancingbusiness
Use assets as collateral for on-balance
sheet debt
No
Yes
Yes
Yes
Yes
No
No
No
The Decision Process
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For Banks: Capital Requirements
q In a perfect world, adding good assets would require little additional capital, since creditors would not see any increase in the bank's risk
q But if regulatory capital requirements penalize banks for holding such assets, they should: usecuritize the good assetsuprofit from origination and servicing
q In general, regulatory costs or rigidities create an incentive for banks to shrink their balance sheets by securitizing loans
Copyright ©2003 Ian H. Giddy ABS Cost/Benefit 15
A Bank’s Capital Savings
Securitization Cost-Benefit Analysis(for a regulated financial institution)
Gain/cost($ millions)
Funding cost savings C Two-year bank notes vs pass-though rate
1.1
Upfront costs C UnderwritingC SEC filing, legal fees, etc
(2.6)
Ongoing costs C Letter-of-credit fee (0.5)
Capital charge C Cost of capital at 25% (15%after tax)
7.7
Net benefit 5.7
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Basel 2 for Investing Banks
AAA to AA- 20%A+ to A- 50%BBB+ to BBB- 100%BB+ to BB- 150%B+ and below Deducted from capital
Source: Basel Committee on Banking Supervision, January 2001
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Basel 2 and Loan Securitization
qOriginating banks (“clean break”)q Investing banks (use of ratings)qSponsor banks (for ABS conduits)qSynthetic securitization (degree of risk
transference)
How will this affect Asian banks?
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Banks – Capital Savings
For banks:
Credit Enhancement Calculation
Assets LiabilitiesLoan Portfolio Securities Classes
From A From BB+From B
A 50 AAA 47.5 52.5 32.8 132.8BB+ 100 AA 0B 100 NR 117.2
250 250
Capital: 20 Capital: 9.376
Cost CostDebt 7% ABS 5%Equity 15% Debt 8%
Equity 16%Total 7.64% Total 6.71%
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Investor Viewpoint: Spread Analysis
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Spread Analysis
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Spread Analysis
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Belenus Credit Enhancement
38
48
62
Orig C/E12/96
75.6AA-BBBC
95.5AA+AB
0PaidAAA
CurrC/E11/98
Curr rating
Orig rating
Class
Ford Structure: Waterfall
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Implications of Waterfall Upgrades
q The capital allocated to a well-balanced ABS portfolio should slowly decrease over time, whereas the same cannot be said of a similar corporate loan portfolio.
q Rating upgrades should be the norm in the ABS world, and downgrades the exception (currently, the situation is exactly the opposite). In the corporate world, we should rather expect downgrades to equal upgrades over long time intervals.
q An ABS portfolio should be traded much more actively than a corporate loan portfolio to take advantage of its inherent rating volatility.
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Asiansecuritization.com
Ian H. GiddyStern School of BusinessNew York University44 West 4th Street, New York, NY 10012, USA
Tel [email protected]://giddy.org