Why Securitization? The Benefit to a Bank

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Why Securitization?The Benefit to a
BanksBalance SheetBy Carlos González
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How would you rate your knowledge in
securitization, more specifically mortgage backed?
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Are there securitization laws or by-laws which
regulate mortgage backed securities in your
country of origin (other than US)?
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What is your country of origin?
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What is the level of interest on the topic from
banking regulators or the Government?
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What is the most critical factor to successfully
implement mortgage securitization in your country?
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Todays Agenda

• Securitization Defined
• Typical Structure
• Capital Adequacy Ratio
• Securitization the Benefits to a Bank's Balance
  Sheet
• Why Securitization

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Securitization Defined
Securitization is defined as the pooling and
repackaging by a special purpose entity of assets
or other credit exposures that can be sold to
investors. (1) (1) Definition by the Office
of the Comptroller of the Currency (OCC), the
Federal Deposit Insurance Corporation (FDIC), the
Federal Reserve Board (Board), and the Office of
Thrift Supervision (OTS), Attachment OCC 2002-22.
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Securitization Defined
Securitization consists of the use of superior
knowledge about the expected financial behavior
of particular assets, as opposed to knowledge
about the expected financial behavior of the
originator of the chosen assets, with the help of
a structure to more efficiently finance the
assets. (1) (1) Prof. Jason Kravitt,
Northwestern University School of Law,
Introduction to Securitization.
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Securitization Defined
Securitization is financing mechanism. It
transfers financial assets from their owner
(Originator), to a Special Purpose Entity ("SPE")
that, in turn, funds the acquisition by issuing
publicly rated securities ("Notes") to various
parties ("Investors").
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Typical Structure
Credit Enhancer
Banckrupcy Remote
True Sell
Originator (Seller)
Special Purpose Entity
Investors
Assets
Notes
Cash
Cash
Liberates Capital
Spread Servicing
Contact With Clients
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Typical Structure
Credit Enhancer
True Sell
Originator (Seller)
Special Purpose Entity
Investors
Assets
Notes
Cash
Cash
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True Sale

• It is a legal definition (in the US).
• It occurs when ownership of the assets change
  hands (from originator to the SPE).
• The SPE bears the risk of loss and enjoys the
  benefits of ownership.
• If true sale requirements are not met it will
  most likely be considered secured lending
  (everything is at risk).
• Assets have to be sold at fair market value.
• Purpose Isolate the assets from both the credit
  and operational risk of the originator.

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Typical Structure
Credit Enhancer
Banckrupcy Remote
True Sell
Originator (Seller)
Special Purpose Entity
Investors
Assets
Notes
Cash
Cash
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Bankrupcy Remote Vehicle

• True Sale compliance is critical.
• Acquisition and financing of specific assets
  should be the only purpose.
• They are used to isolate financial and
  operational risk (from the originator).
• However, these vehicles were also used to hide
  debt (Enron).
• Purpose Isolate the assets from both the credit
  and operational risk of the originator.

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Typical Structure
Credit Enhancer
Banckrupcy Remote
True Sell
Originator (Seller)
Special Purpose Entity
Investors
Assets
Notes
Cash
Cash
Liberate Capital
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Capital Adequacy Ratio

• Banks are subject to Basil Capital Adequacy Rules
  and Ratios (CAR).
• CAR A measure of a bank's capital and it is
  expressed as a percentage of a bank's risk
  weighted credit exposures.
• It is used to protect depositors and promote the
  stability and efficiency of financial systems.
• Two types of capital tier one (equity capital
  and disclosed reserves) and tier two (undisclosed
  reserves, general loss reserves, subordinated
  term debt).
• We will focus on the benefits of
  securitization.

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Capital Adequacy Ratio

• Prior to Basil I, CAR was a ratio between capital
  and total debt (the norm being 18)
• Basil I is now a bank's risk weighted credit
  exposures (a ratio between capital, debt and the
  quality of the assets).
• It requires banks to allocate its credit exposure
  into predefined categories (i.e. corporate
  (commercial) loans, mortgage (primary residence)
  loans, mortgage backed securities (investments),
  etc.).
• Securitization is a mean to release capital,
  which allows the bank to grow exponentially (in
  spread, not in assets)
• Securitization is a very effective tool to
  better manage a banks balance sheet.

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Capital Adequacy Ratio (18)
Banks Equity Banks Debt Type of Asset Risk Allocation Banks Total Assets
1.0 MM 8.0 MM Commercial Loans 100 9.0 MM
1.0 MM 16.0 MM Residential Loans 50 17.0 MM
1.0 MM 40.0 MM MBS 20 41.0 MM
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Capital Adequacy Ratio
Banks Equity Banks Debt Type of Asset Risk Allocation Banks Total Assets
1st Scenario 1.0 MM 8.0 MM Res. Loans 50 17.0 MM
2nd Scenario 1.0 MM 16.0 MM No Loans 0 17.0 MM (Cash)
3rd Scenario 1.0 MM 16.0 MM 1/Res.Loans 2/Spread of Securitized Mortgages 50 21.0 MM 20.0 MM
Assets not reflected in Banks balance sheet but
in the SPEs.
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Typical Structure
Credit Enhancer
Banckrupcy Remote
True Sell
Originator (Seller)
Special Purpose Entity
Investors
Assets
Notes
Cash
Cash
Liberates Capital
Spread Servicing
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Spread Through Servicing

• Securitize mortgages.
• Substitute an asset (mortgage) with a 50
  weighted risk/capital allocation with another
  asset (cash) with a 0 weighted risk/capital
  allocation.
• Generate spread on securitized mortgages through
  a servicing contract.
• Originate new mortgages
• This structure can be replicated n number of
  times.

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Typical Structure
Credit Enhancer
Banckrupcy Remote
True Sell
Originator (Seller)
Special Purpose Entity
Investors
Assets
Notes
Cash
Cash
Liberates Capital
Spread Servicing
Contact With Clients
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Contact with Clients

• Securitize mortgages are no longer in banks
  balance sheet.
• Key factor for the bank is to maintain contact
  with client.
• Bank will have an agreement to service the
  securitized mortgages.
• Bank will continue to maintain client contact.
• Client contact will not be lost.

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Benefits to a Banks Balance Sheet

• Releases capital.
• Its an efficient tool to better manage the
  banks balance sheet.
• Creates a new source of funding.
• Helps to address the mismatch between assets and
  liabilities.
• Bank will continue to maintain client contact.
• Creates discipline in underwriting guidelines for
  a bank (standardization is critical for
  securitization).
• Eliminates default risk.

• Size doesnt matter.

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What can Stewart do for Securitization in LatAm?

• We can issue a lenders policy on every mortgage.
• This brings liquidity to a highly illiquid asset.
• Structuring costs are substantially reduced.
• A title insured mortgage portfolio from the best
  rated company in America may be considered a
  credit enhancement.
• All of this may result in a lower cost of
  funding for the bank.

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Final Comment
"Most of the poor already possess the assets
they need to make a success of capitalism () If
the richest country in the world (the US) were to
give the UN-recommended level of foreign aid, it
would take 150 years to transfer to the world's
poor resources equal to those they already
possess. The problem? The assets owned by the
poor aren't legally held. Ownership rights aren't
documented. Titles aren't registered. Property
can't be traded or used as security for a loan,
or as a share for investment. (1) (1) Hernando
de Soto, President of the Institute for Liberty
and Democracy in Lima, Peru
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Contact InformationCarlos Gonzálezcgonzalez_at_s
tewartlat.comcgonzalez_at_gonur.com