Chapter One

1
Chapter One

• The Expanding Frontiers of
• Asset Securitization
• Dr. Cary Lin

2
Introduction

• ?Securitization?
• What is asset securitization
• Primary goal of asset securitization
• Advantages of securitization for issuers
• Investment attributes of asset-backed securities
• Concerns raised by securitization

3
What is Asset Securitization?

• Asset securitization the pooling and
  transformation of homogeneous cash flow
  producing, illiquid assets, loans and
  receivables, and issuing credit-enhanced
  marketable securities (claims) backed by assets
  --- Asset Backed Security or ABS.
• In this definition a security is a financing in
  which the originator is not the investor and a
  loan is a financing in which the originator is
  the investor.
• Securitization separates the originator from the
  ultimate investor
• Asset securitization is structured financing it
  combines features of traditional lending system
  and securities system.

4
Asset-Backed Securities

• Asset-Backed Securities (ABS) are debt or equity
  instruments
• which
• Represent interest in a pool of assets sold by
  originator into SPV
• Typically secured by homogeneous assets with
  relatively predictable cash flows
• Assets are legally separated from the
  seller/originator, limiting investor exposure to
  the seller/originator bankruptcy
• Credit enhancements leading to high credit
  ratings
• Structured Finance

5
Sample of Securitized Assets

• Residential Mortgage (Mortgage-Backed
  Securities)
• Commercial mortgages (CMBS)
• Non-Mortgages
• Credit card receivables
• Auto loans
• Student loans
• Trade receivables
• Heath Care receivables

6
Special Purpose Vehicles

• SPV is the operating mechanism of asset
  securitization
• must provide organizational framework for
  securitization
• must isolate the assets from originators
• must achieve true sale of assets
• must not engage in business activities that
  would make it subject of bankruptcy proceeding
• to sum up, SPV must be a bankruptcy-remote and
  bankruptcy proof entity
• so, SPV is essentially the linchpin in asset
  securitization

7
Goals of Asset Securitization

• Primary goal To obtain credit rating for an
  issuance backed primarily on the quality of the
  securitized assets and any credit enhancements
  backing the obligation without regard to
  originators own creditworthiness
• to remove assets from balance sheet (off balance
  sheet) and then further to boost return on assets
  and return on equity
• to channel alternative sources of funding
• to improve leverage ratio

8
Credit Enhancer (Insurance company,
Banks, Internal guarantee, Government entity
Credit enhancement

• Originators
• Commercial banks
• Finance companies

Special Purpose Vehicle (Special Purpose
Trust Special Purpose Company)
Obligors
loan
Investors
transfer
securitization

• Servicer
• Commercial banks
• Finance companies
• Corporations

9
Advantages of Securitization for Issuers

• New and cheaper cost of funding
• Management of regulatory capital
• Book fee income up-front in lieu of spread income
• Management of Interest rate volatility

10
Advantages of Securitization for other Players

• Credit Enhancer
• receives fee for credit enhancement
• pays only when normal losses are exceed
• Servicer
• servicing fee income
• float income
• servicing rights can be sold

11
Advantages of Securitization for other Players
(Cont.)

• Trustee
• fee income to administer the trust
• Increased capital market recognition
• Investor
• high quality liquid investment
• ABS provides qualifying investments for
  institutional investors
• high credit quality rating stability

12
Troublesome Problems

• Window Dressing
• Moral Hazard
• (Adverse Selection)