Free Essay

Asset-Backed Securities

In: Business and Management

Submitted By kritdesai
Words 3451
Pages 14
Asset-Backed Securities

The Securitization Process
Prof. Ian Giddy
Stern School of Business New York University

Asset-Backed Securities q The

basic idea q What’s needed? q The technique q Applications q Typical sequence

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process3

Securitization of Assets
Securitization is the transformation of an illiquid asset into a security. q For example, a group of consumer loans can be transformed into a publically-issued debt security. q 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. q Sometimes,assets are worth more off the balance sheet than on it. q Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process4

What is the Technique for Creating Asset-Backed Securities?
A lender originates loans, such as to a homeowner or corporation. q The securitization structure is added. The bank or firm sells or assigns certain assets, such as consumer receivables, to a special purpose vehicle. q The structure is legally insulated from management q Credit enhancement and rating agency reviews q The SPV issues debt, dividing up the benefits (and risks) among investors on a pro-rata basis q Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process5

Securitization: The Basic Structure
SPONSORING COMPANY

ACCOUNTS RECEIVABLE

SALE OR ASSIGNMENT

SPECIAL PURPOSE VEHICLE ISSUES ASSET-BACKED CERTIFICATES

ACCOUNTS RECEIVABLE

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process6

The Process

Is the company Is the company ready? ready? Are the assets Are the assets suitable? suitable? What pool? What pool? What legal What legal structure? structure? What credit What credit enhancement? enhancement?

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process8

Is the Company Ready for ABS? q q q q

q

Does the originator currently face a high cost of funding assets that would be recognized as sound, cash-generating assets if taken in isolation? Does it have a regulatory or capital constraint that makes freeing up the balance sheet important? Does it have data about the assets (required by rating agencies and financial guarantors)? Does it have the servicing process and systems that can meet the more demanding standards of the assetbacked market? Is the originator willing to undertake a complex, timeconsuming transaction to obtain a broader, potentially cheaper, ongoing source of funding? globalsecuritization.com Copyright ©2001 Ian H. Giddy

The Securitization Process9

Are the Assets Suitable?
The Pool of Assets Should Have: n 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. globalsecuritization.com n

n

n

n

Copyright ©2001 Ian H. Giddy

The Securitization Process11

What is the Technique for Creating Asset-Backed Securities?
A lender originates loans, such as to a homeowner or corporation. q The securitization structure is added. The bank or firm sells or assigns certain assets, such as consumer receivables, to a special purpose vehicle. q The structure is legally insulated from management q Credit enhancement and rating agency reviews q The SPV issues debt, dividing up the benefits (and risks) among investors on a pro-rata basis q IM

E PL

E M

T N

T A

N IO

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process12

Finance Company Limited Finance Company Limited

Case Study: The Company (Finance Company Limited) q Finance

company whose growth is constrained q Has pool of automobile receivables q Has track record q Plans to use this as an ongoing source of financing

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process14

Key Decisions

Securitize the assets
Decisions

Form of transfer of asset

Form of special purpose vehicle

Form of credit enhancement

Form of Form of cash flow transformation of allocation cash flows

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process15

Case Study: Initial Exchanges
Finance Co.’s Customers
Hire-Purchase Agreement

Finance Co. Ltd (Seller)

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process16

Case Study: Initial Exchanges
Finance Co.’s Customers
Hire-Purchase Agreement

Finance Co. Ltd (Seller)

Proceeds

FCL 1997-A (Special Purpose Co.)

Proceeds

Investors

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process17

Case Study: Initial Exchanges
Finance Co.’s Customers
Hire-Purchase Agreement Servicing Agreement

Finance Co. Ltd (Seller)

Proceeds

FCL 1997-A (Special Purpose Co.)

Proceeds

Investors
Asset-Backed Securities

Sale of Assets

Trustee
Trust Agreement

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process18

Case Study: Initial Exchanges
Finance Co.’s Customers
Hire-Purchase Agreement Servicing Agreement

Rating Agency
Top Rating

Finance Co. Ltd (Seller)

Proceeds

FCL 1997-A (Special Purpose Co.)

Proceeds

Investors
Asset-Backed Securities

Sale of Assets

Trustee
Trust Agreement

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process19

Case Study: Ongoing Payments
Finance Co.’s Customers
Hire-Purchase Payments Servicing Fees Monthly HP Payments Monthly ABS Payments

Finance Co. Ltd (Seller)

FCL 1997-A (Special Purpose Co.)

Investors

Trustee
Trustee Responsibilities Guarantee Responsibilities

Financial Guarantee Provider

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process20

Getting a Rating: The Risks
Credit risks q Liquidity risk q Servicer performance risk q Swap counterparty risk q Guarantor risk q Legal risks q Sovereign risk q Interest rate and currency risks q Prepayment risks q Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process21

Risk-Management Techniques in ABS
SPONSORING COMPANY

CREDIT CREDIT ENHANCEMENT ENHANCEMENT

ACCOUNTS RECEIVABLE

SOVEREIGN SOVEREIGN PROTECTIONS PROTECTIONS
SALE OR ASSIGNMENT

SPECIAL PURPOSE VEHICLE

ACCOUNTS RECEIVABLE

ISSUES ASSET-BACKED CERTIFICATES

INTEREST RATE/ INTEREST RATE/ CURRENCY CURRENCY HEDGES HEDGES

CASH FLOW CASH FLOW REALLOCATION REALLOCATION

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process22

Credit Enhancement: Guarantee Method
Finance Co.’s Customers
Hire-Purchase Agreement Servicing Agreement

Rating Agency
Top Rating

Finance Co. Ltd (Seller)

Proceeds

FCL 1997-A (Special Purpose Co.)

Proceeds

Investors
Asset-Backed Securities

Sale of Assets

Trustee
Trust Agreement Guarantee Agreement

Financial Guarantee Provider (if required)

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process23

Credit Enhancement: An Alternative Approach

Rating Agency Top Rating Senior Lower Rating

Finance Co. Ltd (Seller)

Proceeds

FCL 1997-A (Special Purpose Co.)

Subordinated No Rating More Subordinated

Sale of Assets

Guarantee Agreement

Financial Guarantee Provider (if required)

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process24

Asset-Backed Securities

The Rating Process and Credit Enhancement
Prof. Ian Giddy
Stern School of Business New York University

Rating Agencies

n n n n n n

Moodys Moodys Standard & Poors Standard & Poors Fitch Fitch

Why bother with a rating? q Compare equivalent credit risks across different kinds of debt: corporate, sovereign, ABS q Compare alternatives across different ratings levels q Obtain a relative as well as an absolute measure of credit risk q Be reasonably sure of a market to sell the security.
Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process26

Default Matrix

Source: Fitch, “Bank CLOs”

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process27

Rating Reports: Who Pays for Them?
General reports on a sector, like CLOs q Pre-sale report on an individual CLO, once risks have been evaluated but final terms and credit enhancement have not yet been finanized q Final deal report q Periodic updates q Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process28

ABS: Factors Agencies Examine q Asset

portfolio analysis q Legal structure of the transaction q Quality of the originator/servicer q The trustee q The cash flow structure q The counterparties

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process29

Rating Agencies: Business Analysis
Organization and management structure q Financial performance q Business strategy and planning processes q Controls and procedures q Asset origination and credit assessment procedures q Quality of its loan documentation q Credit administation and debt recovery procedures q Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process30

Credit Enhancement or overcollateralization q Reserve and liquidity accounts and lines q Excess cash flow q Third-party guarantees q Senior/Sub

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process31

The Result: Bond Credit Ratings
Standard & Moody’s Poor’s Aaa Aa A Baa Ba B Caa Ca C
Copyright ©2001 Ian H. Giddy

Interpretation High-quality debt instruments Strong to adequate ability to pay principal and interest Ability to pay interest and principal speculative

AAA AA A BBB BB B CCC CC C D

In default globalsecuritization.com The Securitization Process32

Typical Rating Analysis
Originator’s credit underwriting standards

Pre-securitization risk reduction

Screening of assets to be included in the portfolio Diversification of the portfolio

Legal structure based credit risk reduction Credit quality of deal participants

Legal insulation from originator default Legal insulation from servicer default

Originator/Seller/Servicer Trustee, swap counterparties Guarantors

Integrity of cash flow structure

Cash flow sufficiency and mismatches Safeguards and agreements such as swaps or caps

Direct recourse

“Internal” credit enhancement Credit enhancement “Third party” credit enhancement

Senior/subordination or overcollateralization Reserve or spread accounts

Cash collateralized accounts Financial guarantees

Rating
Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process33

Credit Enhancement q Overcollateralization q Senior/Sub

or q Reserve and liquidity accounts and lines q Excess cash flow q Third-party guarantees

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process34

Over-Collateralization Method

SPECIAL-PURPOSE VEHICLE

COLLATERAL POOL

SENIOR ASSET-BACKED SECURITIES “EQUITY” ABS (owned by seller)

OVER-COLLATERAL

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process35

Example of Senior/Sub Structure

Class A1,A2,A-x B C D E F Issuer balance
Copyright ©2001 Ian H. Giddy

Rating AAA AA A BBB BB B NR globalsecuritization.com Subordination 28% 22% 16.5% 12% 8.5% 5.5% 0%
The Securitization Process36

Possible Time Frame
1 2 3
• R e s u lt of cash flow analysis Determination of eligible receivables Approach rating agencies and introduction of the structure envisaged Founding of the SPV Initiation of stock exchange approval process (in case of a Bond issuance) Draft of Offering Circular (in case of a Bond issuance) Comments of the Rating agencies (Rating confirmation) Determination of funding strategy Publication of Offering Circular (in case of a Bond issuance) Marketing (in case of a Bond issuance) Completion of documentation Purchase of receivables and issuance of securities • • • • • Determination of structure Information Memorandum Commencement of documentation Detailed cash flow analysis Preparation for rating process

months 4

• • • •

5

• • • • •

6

7
This schedule serves as an indication only and may vary from transaction to transaction.

• •

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process37

One Bank’s Assessment q The

implementation of a transaction usually takes between two and six months, provided all necessary data and information is readily available. time frame does not take into account the rating process.

q This

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process38

The Securitization Process - 1
One Bank’s List A private placement for a client who has done previous securitizations
Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø
Select securitization counsel and accountants C o n sider tax, accounting and securitization objectives Discuss data fields required for loan data file D e fine data to be audited by accountants Begin drafting Private Placement Memorandum (PPM) Begin drafting legal documents A s s e m ble preliminary pool and create initial data tape C o n sider preliminary bond structure Select rating agencies Perform integrity check on data tape (cracking the tape)

If new client, this would follow screening of corporation and loan pool for suitability Any info used in the PPM or in the pool analysis must be audited. If it’s a public offering, need a public Prospectus or Prospectus Supplement. A discussion with rating agency be necessary for selection of legal structure and pool selection if it’s a new type of ABS.

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

Data from companies come in many different forms. The Securitization Process39

The Securitization Process - 2 Most investment banks active in ABS have
One Bank’s List
Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø
Model cash flow and bond structure Prepare rating agency presentation Select truste e/backup servicer R e c o n cile discrepancies with accountants Distribute rating agency presentations M e et with rating agencies Determine pending loan closings Select rating agencies and sign engagement letters Optimize loan pool and revise bond structure R a ting agency borrower visits (if necessary) R a ting agency due diligence (if necessary) C o m plete loan closings and finalize loan pool Obtain preliminary subordination levels from rating agencies

developed modelling software

Invariably, with the amount of information be supplied by the issuer via the tape, there will be mistakes/discrepancies to resolve, mostly with regard to loan data that’s been provided. During this process, the issuer is still originating collateral going into the deal. The bank has to decide what else it want to include, and has to establish a “cutoff date”. Which asset should not go into the pool? Its not necessarily bad collateral, but it may still hurt the overall profile of the pool
The Securitization Process40

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process - 3
One Bank’s List
Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø Ø
Market transaction to sub-bond buyers (if necessary) Tie out collateral cash flow with accountants

Alternative would be for originator to keep sub tranche

The collateral cash flows in aggregate are structured to pay Final subordination levels from rating agencies bonds. The bonds are Finalize bond structure based on final loan pool and sub-levels then sold based on the likelihood that the Tie out bond cash flows with accountants bonds will receive those payments at a Finalize PPM and legal documents certain period in time. Therefore, the cash Arrange distribution by other banks flows that pay the bonds are what the Finalize internal marketing material investor is purchasing. The bond cash flow Issuer presentation to salesforce characteristics are presented in the Print red herring PPM and distribute to investors prospectus to investors Market transaction to investors and if they aren’t tied out, there is a huge Price bonds and execute Bond Purchase Agreement legal liability for the underwriter and issuer Print final PPM if they aren’t correct.
CLOSE TRANSACTION

Copyright ©2001 Ian H. Giddy

This is the agreement to purchase the bonds from the SPV globalsecuritization.com by the investor or investment banks Process41 The Securitization

Asset-Backed Securities

Asset-Backed Securities: Legal and Regulatory Issues
Prof. Ian Giddy
Stern School of Business New York University

Asset-Backed Securities: Legal and Regulatory Aspects q Legal u The

Transfer u The Special-Purpose Vehicle q Taxation q Accounting

Treatment q Bank Regulatory Treatment

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process43

Legal Aspects q Goal:

AL EG L

Credit quality must be solely based on the quality of the assets and the credit enhancement backing the obligation, without any regard to the originator's own creditworthiness q Otherwise, quality of the ABS issue would be dependent on the originator's credit, and the whole rationale of the asset-backed security would be undermined.
Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process44

Three conditions enable the separation AL EG of the assets and the originator L
The transfer must be a true sale, or its legal equivalent. If originator is only pledging the assets to secure a debt, this would be regarded as collaterized financing in which the originator would stay directly indebted to the investor. q The assets must be owned by a specialpurpose corporation, whose ownership of the sold assets is likely to survive bankruptcy of the seller. q The special-purpose vehicle that owns the assets must be independent q Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process45

The Form of Transfer: True Sale? Form of transfer of asset True Sale Assignment Collateral
Copyright ©2001 Ian H. Giddy globalsecuritization.com

AL EG L

Alternative: Credit swap (Synthetic ABS)

The Securitization Process46

What Makes it a Sale?
The form and treatment of the transaction q The nature and extent of the benefits transferred q The irrevocability of the transfer q The level and timing of the purchase price, q Who possesses the documents q Notification when the assets are sold q AL EG L

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process48

Asset Securitization
CHASE (SPONSOR)
CREDIT CARD RECEIVABLES

SALE OR ASSIGNMENT

SPECIAL PURPOSE VEHICLE ISSUES ASSET-BACKED CERTIFICATES

CREDIT CARD RECEIVABLES

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process49

The Alternative: Synthetic ABS
HVB (Originator)
REFERENCE POOL OF LOANS (Stay on balance sheet)

AL EG L

CREDIT SWAP AGREEMENT

SPECIAL PURPOSE VEHICLE ISSUES ASSET-BACKED CERTIFICATES

TOP QUALITY INVESTMENTS

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process50

Accounting Treatment q Sale

versus financing q Consolidation q Accounting for loan servicing

NG TI UN CO AC

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process51

FASB Sale Treatment q The

transferor relinquishes control of the future economic benefits embodied in the assets being transferred q The SPV cannot require the transferor to repurchase the assets except pusuant to certain recourse provisions q The transferor's obligation under any recourse provision are confined and can be reasonably estimated
Copyright ©2001 Ian H. Giddy globalsecuritization.com

NG TI UN CO AC

The Securitization Process52

Bank Regulation and Capital Requirements
Goal: Ensure that the substance and not the form of the asset transfer is what governs capital requirements. The regulatory authorities may assess capital or reserve requirements as if the financing was a secured borrowing: q u Where

the transfer leaves the bank open to recourse deemed risky by the authorities, u Or where there is potential for a "moral hazard" whereby a bank may shore up potential or actual losses in the sold assets to protect its name even when not legally required to do so.
Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process53

Basel 2 and ABS q Originating

banks (“clean break”) q Investing banks (use of ratings) q Sponsor banks (for ABS conduits) q Synthetic securitization (degree of risk transference)

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process54

Basel 2 for Investing Banks AAA to AAA+ to ABBB+ to BBBBB+ to BBB+ and below 20% 50% 100% 150% Deducted from capital

Source: Basel Committee on Banking Supervision, January 2001
Copyright ©2001 Ian H. Giddy globalsecuritization.com

The Securitization Process55

Example: Ford Credit Owner Trust 1999-A

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process56

Ford Structure
Ford Ford Motor Credit

Sale
Ford Credit Auto Rec. Two LP

Class A-5 and A-6

Sale
Ford Credit Auto Owner Trust Class A-1 to A6 Class B Receivables Class C Class D
Copyright ©2001 Ian H. Giddy globalsecuritization.com

Class D

The Securitization Process57

Ford Structure: Waterfall

Receivables

Class A-1 to A6 Class B Class C Class D

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process58

Ford Structure: Default or Loss?

Receivables Class A-1 to A6 Class B Class C Class D

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process59

Paydown: Soft Bullet Structure

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process60

Example: DBS Singa Deal

DBS Bank Loan portfolio Seller/Servicer

Singa

US$ FRN

Investors

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process61

Dah Sing/Hong Kong SAR

Dah Sing Seller/Servicer

Mortgage portfolio

Hong Kong SAR Res Mort. Ltd

US$ FRN

Investors

Currency Swaps

Financial Guarantees

ASIA Ltd General Re CapMac

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process62

Franchise Loan Securitization
Franchisees (Borrowers)
Loan Agreement Loan Payments

Atherton Capital (Seller)

Proceeds

Atherton FLF 1998-A (Special Purpose Co.)

Proceeds

Investors
Asset-Backed Securities

Sale of Assets Servicing Advisor

Mellon Mortgage (Servicer)

Servicing Agreement

Class A1,A2,A-x B C D E F Issuer balance

Rating AAA AA A BBB BB B NR

Subordination 28% 22% 16.5% 12% 8.5% 5.5% 0%
The Securitization Process63

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

Films (Finance for an Italian
Library of Movies)

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process64

Future-Flow Financing: Offshore Purchase Agreement

YPF (Argentinian oil producer)

Oil (under sales agreement) Oil Trading Co. (Cayman Is. SPV) US$ Oil (under purchase agreement) Highly rated U.S. oil buyer

Notes Noteholders US$ Fixed debt payments US$ Trust

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process65

Asiansecuritization.com
Ian H. Giddy Stern School of Business New York University 44 West 4th Street, New York, NY 10012, USA Tel 212-998-0426 ian.giddy@nyu.edu http://giddy.org

Copyright ©2001 Ian H. Giddy

globalsecuritization.com

The Securitization Process67

Similar Documents

Premium Essay

Securitization

... 1PT10MBA64 INTRODUCTION: Securitization is the process of pooling and packaging Financial Assets, usually Relatively illiquid, into liquid marketable securities. Securitization allows an entity to Assign (i.e. sell) its interest in a pool of financial assets (and the underlying security) to other entities. Securitization in India: While there has been a lot of discussion about the potential of securitization in India, Actual deal activity has not kept pace. While some early adopters like ICICI, TELCO and Citibank have been actively pursuing securitization, almost all the transactions in the market so far have been privately placed with a majority of them being bilateral fully bought out deals. Literature Review: Mr. Manoj Dengla from ICICI Structured Products Group whose valuable insights have been considered for the paper. Mr. Pranay Agrawal and Mr. V. Srikanth of Fractal Technologies Ltd. for narrating their securitization experience. 1. According to reports, the power sector in India needs a funding of about USD 17 billion over the next 10 years 1. 2.A revocable trust (SPV) purchases assets from the Originator and issues Pay Through Certificates to investors. 3. The deal size was Rs. 10.35 billion comprising 11,106 individual housing loans HDFC and LIC Housing Finance Ltd. 4. An ABCP conduit issues commercial paper to finance the purchase of assets ranging from credit card, auto and trade receivables to CBO and CLOs. Objectives: This paper...

Words: 542 - Pages: 3

Premium Essay

Financial Management

...that are secured by cash flows from different kinds of assets. The issued securities are called Asset-Backed Securities (ABS). In essence a pool of payment claims are packaged and are made to securities in order to create a secondary market for the underlying receivables or other various illiquid assets. Securitisation is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or collateralized mortgage obligation (CMOs), to various investors. The principal and interest on the debt, underlying the security, is paid back to the various investors regularly. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS). Therefore, securitization of real estate is the pooling of real estate assets as underlying assets securing a debt, which is issued to investors in return for cash flows from the underlying real estate assets. The illiquid real estate assets that generate a constant cash flow are formed into a tradable security and are floated on the debt market. Securitization process In its most basic form, the process involves two steps. 1. A company with loans or other income-producing assets—the originator—identifies the assets it wants to remove from its balance sheet and pools......

Words: 2716 - Pages: 11

Free Essay

Global Financial Crisis

...liquid assets and then expressing this as a percentage of its total assets” (Gup et al., 2007, p.356). It only considers asset liquidity, and this measure is only one point in time. However, dynamic approach compares projected liquidity needs with projected available liquidity (from both asset and liability sources) for each time period. “This approach is superior to focusing on one or the other parts of the liquidity problem because it evaluates liquidity relative to bank needs” (Gup et al., 2007, p.356). APRA is proposing that banks in Australia hold more liquidity in the event of future crisis. The reason for this is “APRA noted that the financial crisis exposed the limitations of existing liquidity reporting rules when markets are under severe stress” (Baltazar, 2009, para.8). APRA (2009) said the financial crisis has highlighted the need for ADIs to have adequate levels of liquidity and robust liquidity risk management systems, and has provided considerable insights into better practice in this area. APRA supports the Basel Committee’s measures and agrees that greater international consistency in prudential regulation, promoted by the Leaders of the G20, will strengthen Australia’s prudential framework. Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security. It is an important source of liquidity for banks. A typical example of securitization is a mortgage backed security......

Words: 2362 - Pages: 10

Free Essay

Cdos

...According to Forbes, collateralized debt obligations are “investment-grade security backed by a pool of various other securities that can be made up of any type of debt, in the form of bonds or loans”. This process of “pooling in debt to reduce risk and raise returns” is known as collateralized debt obligation. The process of splitting the debt into different tranches to assign the payment priority and interest rate is known as securitization. Investment banks can buy mortgages and assign them to certain entities. They can now sell shares of these mortgages at a certain share price and yield rate. There will always be different investors; there are those who are risk averse and find the shares to be too risky, and those who can afford the higher risk and find the yield to be too low. To accommodate both ends, these shares are sliced into different classes also known as tranches. Since mortgage backed securities all paid the same amount, the class will determine who gets paid first. The higher-rated tranche will have a lower interest rate for lower risk, and the lowest-rated tranche which may even be a junk rating will have a higher interest rate but at the cost of high risk because they may not get paid. It is widely believed that these financial instruments played a big role in the 2008 financial crisis. One problem about collateralized debt obligations is that sometimes they are very complex made up of so many things that nobody really understands what they are and...

Words: 277 - Pages: 2

Free Essay

Liar's Poker

...FI 398 Paper on Liar’s Poker The History of the Secondary Mortgage Market The secondary mortgage market is one of the richest asset classes in the world today. This market is formed by the trading of securities that are backed by commercial and residential mortgages. There are two main assets that are traded. These are Mortgage Backed Securities (MBS), and Collateralized Mortgage Obligations (CMOs). These two distinct asset classes make the market a very profitable one for many large investment corporations. Thanks to legislative action, most notably when Michael Lewis said, “From the early 1930s legislators had created a portfolio of incentives for Americans to borrow money to buy their homes”(121). These legislative policies made owning your own home something more attractive, because borrowing for it went on to benefit you for tax purposes. In the 1970s, the nation’s mortgage portfolio was booming in growth. As Lewis noted, “the volume of outstanding mortgage loans swelled from $55 billion in 1950 to $700 billion in 1976. In January 1980 that figure became $1.2 trillion, and the mortgage market surpassed the combined United States stock markets as the largest capital market in the world”(122). These are truly shocking numbers. The growth in the industry was completely unforeseen. While there are several similarities between mortgages and bonds, particularly after the development of MBS and CMOs, they are also different. The main difference is that......

Words: 1489 - Pages: 6

Free Essay

The Effects of Quantitative Easing on Interest

...NBER WORKING PAPER SERIES THE EFFECTS OF QUANTITATIVE EASING ON INTEREST RATES: CHANNELS AND IMPLICATIONS FOR POLICY Arvind Krishnamurthy Annette Vissing-Jorgensen Working Paper 17555 http://www.nber.org/papers/w17555 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 October 2011 We thank Jack Bao, Olivier Blanchard, Greg Duffee, Charlie Evans, Ester Faia, Simon Gilchrist, Robin Greenwood, Monika Piazzesi, David Romer, Thomas Philippon, Tsutomu Watanabe, Justin Wolfers, and participants at seminars and conferences at Brookings, Chicago Fed, Board of Governors of the Federal Reserve, ECB, San Francisco Fed, Princeton University, Northwestern University, CEMFI, University of Pennsylvania (Wharton), Society for Economic Dynamics, NBER Summer Institute, the NAPA Conference on Financial Markets Research, and the European Finance Association for their suggestions. We thank Kevin Crotty and Juan Mendez for research assistance. This paper was prepared for the Brookings Papers on Economic Activity Fall 2011 issue. We have received an honorarium for the presentation of the paper at Brookings. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. At least one co-author has disclosed a financial relationship of potential relevance for this research. Further information is available online at http://www.nber.org/papers/w17555.ack NBER working......

Words: 18319 - Pages: 74

Free Essay

C & B Team Memo

...Study questions: 1. What are the major assumptions and concepts of the structural frame? The structural frame upholds the notion that organizations are judged primarily on and by the proper functioning of those elements which constitute good organization. For the greater part of the 20th century, the assumptions and concepts of scientific management have informed most theories of practice. One of the earliest precursors of scientific management is Max Weber, hired by Frederick the Great to reorganize the Prussian Army, who conceived the “monocratic bureaucracy” as an ideal form that maximized norms of rationality. His model outlined several major features which include: * A fixed division of labor * A hierarchy of offices * A set of rules governing performance * A separation of personal from official property and rights * The use of technical qualifications (not family ties or friendship) for selecting personnel * Employment as primary occupation and long-term career But, if Max Weber “rationalized” the bureaucracy, Frederick Winslow Taylor “hyper-rationalized’ the bureaucracy. Known as the “father” of scientific management”, he sought an objective, scientific mechanism to improve organizational functioning. Based on these two principal intellectual roots, there are six assumptions of the structural frame: * Organizations exist to achieve established goals and objectives * Organizations increase efficiency and......

Words: 560 - Pages: 3

Free Essay

Hello

...mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs) is most correct: A. MBSs are created from CMOs. B. Creating CMOs does not reduce the overall prepayment risk of a mortgage passthrough security. C. The prepayment option of an MBS benefits the security holder. D. The cash flows received on the MBS are quite similar to those of a callable coupon bond. B. Creating a CMO can redistribute the prepayment risk among tranches but it does not alter the overall prepayment risk of a mortgage passthrough security. Although MBS and callable bonds both have reinvestment risk, the cash flows from an MBS are different in that mortgage loans are amortizing. 2. Compared to the underlying MBS, a collateralized mortgage obligation (CMO) tranche: A. has less prepayment risk. B. has lower duration. C. may have more or less prepayment risk. D. Allows an investor to select an exact maturity. C. CMOs redistribute prepayment risk and/or the expected repayment term of the underlying MBS among the CMO tranches. If some tranches have less prepayment risk, other must have more. 3. A domestic investor is purchasing foreign bonds. Which of the following statements regarding the exchange rate risk and price movement of the asset is most correct? A. The depreciation of both the asset and the foreign currency benefits the domestic investor. B. The depreciation of the asset and the appreciation of the foreign currency benefit the domestic investor. C. The appreciation of the asset......

Words: 923 - Pages: 4

Free Essay

Chinese Economy

...Economic Crises April 26 Final Exam Short Essays 1. Many economists think that a flexible exchange rate acts like a “shock absorber” in the face of external economic shocks. Explain what this means and why it is (or might be) true. Flexible exchange rates act as a “shock absorber” - Canada’s experience following the Asian Crisis - commodity prices and the Canadian dollar world price of raw materials fell by 30 percent, world is prepared to pay less for our raw materials. This led to dramatic depreciation of CAD. - compare BC and Ontario situations. BC produced a lot of raw materials whose demand fell. The core of manufacturing in Canada is in Ontario (and Quebec) and the resource sectors are largely in the West and very East. When Asian economies go under the tank and reduce their demand for raw materials – the BC economy goes down, they can’t sell stuff to Asia anymore. But the Canadian dollar depreciates by 10 or 15 percent. A depreciating currency helps everybody who is exporting given whatever the price you’re exporting at. Depreciation is a net plus to Ontario, because its machines, etc. gets a bump up in exports. The boost to Ontario offsets the negative to BC somewhat. What happened in 2002-2006 when world demand increased (China and India phenomenon and U.S economic boom) drove up prices, the Canadian dollar appreciated. Ontario was damaged while the East and West of Canada boomed. 2. Describe and explain the connection(s) between the “financial......

Words: 2917 - Pages: 12

Premium Essay

Ambac Lawsuit

...now run mortgage divisions of Goldman Sachs, Bank of America, and Ally Financial have been accused of cheating and defrauding investors through the mortgage securities they created and sold while at Bear. According to e-mails and internal audits, JPMorgan had known about this fraud since the spring of 2008, but hid it from the public eye through legal maneuvering. Last week a lawsuit filed in 2008 by mortgage insurer Ambac Assurance Corp against Bear Stearns and JPMorgan was unsealed. The lawsuit's supporting e-mails, going back as far as 2005, highlight Bear traders telling their superiors they were selling investors like Ambac a "sack of shit." They were selling investors like Ambac a "sack of shit." News of internal whistleblowers coming forward from Bear's mortgage servicing division, EMC, was first reported by The Atlantic in May of last year. Ex-EMC analysts admitted they were sometimes told to falsify loan-level performance data provided to the ratings agencies who blessed Bear's billion-dollar deals. But according to depositions and documents in the Ambac lawsuit, Bear's misdeeds went even deeper. They say senior traders under Tom Marano, who was a Senior Managing Director and Global Head of Mortgages for Bear and is now CEO of Ally's mortgage operations, were pocketing cash that should have gone to securities holders after Bear had already sold them bonds and moved the loans off its books. Mike Nierenberg, who ran the adjustable-rate mortgage trading desk at......

Words: 2490 - Pages: 10

Free Essay

Accounting Case

...entire instrument. We will answer these questions by each instrument separately: First, Collateralized Debt Obligation (CDO) Before September30th, 2010, FFC was in an active market, and it determined the fair value of the CDO by using a market-based valuation technique that relies on inputs such as quotes prices for similar CDO securities and requires only insignificant adjustments. After that, there was a significant decrease in the volume and level of activities and the CDO’s market was not active. Besides, significant adjustments are required to determine fair value as of the measurement date given the lack of recent and relevant transactions. The valuation techniques FFC used for CDO is income approach, because this way could maximize the use of relevant observable input and minimize the use of unobservable inputs. There are two factors FFC mainly considered in the fair value measurement. Frist, FFC considered the implied rate of return on September 30, 2010, which is the last date of active market for CDO. This is the Level 1 input. According to ASC820-10-35-40, Level 1 inputs are quoted market prices in active markets for identical assets or liabilities. The other factor considered is two nonbinding indicative quotas for CDO from brokers implied rates of return. This is Level 2 input. According to ASC820-10-35-47, Other observable inputs includes...

Words: 470 - Pages: 2

Premium Essay

Cmbs

...The Current Mbs And Cmbs Markets – A Summary Of Issues, Causes, And Future Markets The Current MBS and CMBS Markets – A Summary of Issues, Causes, and Future Markets With today’s economic difficulties it is no surprise that the markets for MBS and CMBS are down. The financial market crisis has definitely hit our economy and the MBS and CMBS markets are no exception. The credit meltdown has led to a curious pricing disparity in the commercial MBS market: Triple-A paper with a 5-year term is suddenly trading at spreads way above similarly rated 10-year bonds, due primarily to rising concerns about "extension risk." Last Friday, 10-year super-senior CMBS was trading at 1,050 bp over swaps, while the spread on 5-year notes swelled to 1,300 bp. Over the summer, before the credit markets went into a deep tailspin, the difference between the 5- and 10-year spreads generally was only a few basis points. The pricing difference throws bond-market convention on its head. All things being equal, long-term paper normally commands higher spreads to reflect the greater risk associated with holding investments longer. That started to change in the summer of 2007, when the credit crunch caused bond trading to slow. The benchmark classes of 10-year bonds started trading at slightly tighter spreads than 5-year paper because their larger supply offered more liquidity. But more recently, the gap has ballooned, widening to as much as 400 bp. "The trend has really become noticeable over...

Words: 350 - Pages: 2

Premium Essay

Babiboo

...FIFTH EDITION 2005 Transforming Real Estate Finance A CMBS Primer Primary Analysts: Howard Esaki Marielle Jan de Beur Masumi Goldman This book is an overview of the Commercial Mortgage-Backed Securities (CMBS) market. The contents of this publication are over eight years in the making and include excerpts of research reports from as early as 1997. In this fifth edition of our primer, we have reorganized the chapters to highlight the different investment options within CMBS. New material since our last edition includes sections on the various types of AAA CMBS classes, total rate of return swaps, floating rate large loan transactions, and an updated version of the commercial mortgage default study. We hope you find this book useful and welcome comments so that we can improve future editions. FIFTH EDITION 2005 Transforming Real Estate Finance A CMBS Primer Primary Analysts: Howard Esaki Marielle Jan de Beur Masumi Goldman The Primary Analyst(s) identified above certify that the views expressed in this report accurately reflect his/her/their personal views about the subject securities/instruments/issuers, and no part of his/her/their compensation was, is or will be directly or indirectly related to the specific views or recommendations contained herein. This report has been prepared in accordance with our conflict management policy. The policy describes our organizational and administrative arrangements for the avoidance, management and......

Words: 93545 - Pages: 375

Free Essay

Modeling Defaults in Residential Mortgage Backed Securities at Loan-Level

...1. Background Introduction This paper looks into Cox Proportional Hazards model and constructs a mortgage default model to estimate the hazard rates of certain residential mortgage-backed securities (RMBS) on a loan-level basis. We analyze loans from an individual credit perspective instead of pool-level basis so that the model would closely fit each loan. This gives us the flexibility to adjust portfolio by observing individual loans and re-estimate their risks accordingly. Ever since early 2000s, the issuance of residential mortgage-backed securities were steadily climbing due to the record-setting housing boom we have ever witnessed, then reached the peak at $1.2 trillion in 2005 and 2006, and finally became the center of attention during the crisis. Many investors have been trying to come up with newer and better models to monitor the default risk of RMBS ever since. Now that a majority of RMBS have been downgraded by credit-rating agencies since, it is necessary for investors to learn how to estimate the risk of their mortgage-backed securities to react to the adverse situation. We will skip the background of securitization and structure of mortgage-backed securities. In short, a pool of securitized mortgages gets divided into multiple tranches with different seniorities, ranging from AAA to equity. The higher the seniority goes, the lower risk and return the investors have, and they suffer losses after the lower seniorities do. Although investors look at a pool or...

Words: 374 - Pages: 2

Premium Essay

The Current Mbs and Cmbs Markets – a Summary of Issues, Causes, and Future Markets

...The Current MBS and CMBS Markets – A Summary of Issues, Causes, and Future Markets With today’s economic difficulties it is no surprise that the markets for MBS and CMBS are down. The financial market crisis has definitely hit our economy and the MBS and CMBS markets are no exception. The credit meltdown has led to a curious pricing disparity in the commercial MBS market: Triple-A paper with a 5-year term is suddenly trading at spreads way above similarly rated 10-year bonds, due primarily to rising concerns about "extension risk." Last Friday, 10-year super-senior CMBS was trading at 1,050 bp over swaps, while the spread on 5-year notes swelled to 1,300 bp. Over the summer, before the credit markets went into a deep tailspin, the difference between the 5- and 10-year spreads generally was only a few basis points. The pricing difference throws bond-market convention on its head. All things being equal, long-term paper normally commands higher spreads to reflect the greater risk associated with holding investments longer. That started to change in the summer of 2007, when the credit crunch caused bond trading to slow. The benchmark classes of 10-year bonds started trading at slightly tighter spreads than 5-year paper because their larger supply offered more liquidity. But more recently, the gap has ballooned, widening to as much as 400 bp. "The trend has really become noticeable over the past month," one investor said. The new concern about 5-year CMBS is that the timely......

Words: 631 - Pages: 3