Structured Finance AssetBacked Securities Prof Ian Giddy New

Structured Finance: Asset-Backed Securities Prof. Ian Giddy New York University

Structured Finance Asset-backed securitization l Corporate financial restructuring l Structured financing techniques l Copyright

Asset-Backed Securities: The Typical Structure FORD (SPONSOR) LOANS. Servicing Agreement SALE OR ASSIGNMENT SPECIAL PURPOSE VEHICLE LOANS. Copyright © 2002 Ian H. Giddy ISSUES ASSET-BACKED CERTIFICATES Structured Finance 3

Legal Aspects L A G LE q Goal: 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 © 2002 Ian H. Giddy Structured Finance 4

Three conditions enable the separation AL G E 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 © 2002 Ian H. Giddy Structured Finance 5

The Alternative: Synthetic ABS DB (Originator) REFERENCE POOL OF LOANS (Stay on balance sheet) CREDIT SWAP AGREEMENT SPECIAL PURPOSE VEHICLE TOP QUALITY INVESTMENTS Copyright © 2002 Ian H. Giddy ISSUES ASSET-BACKED CERTIFICATES Structured Finance 6

Credit Enhancement: Guarantee Method Finance Co. ’s Customers Hire-Purchase Agreement Finance Co. Ltd (Seller) Rating Agency Top Rating Servicing Agreement Proceeds FCL 1997 -A (Special Purpose Co. ) Sale of Assets Trustee Copyright © 2002 Ian H. Giddy Trust Agreement Proceeds Investors Asset-Backed Securities Guarantee Agreement Financial Guarantee Provider (if required) Structured Finance 7

Credit Enhancement: An Alternative Approach Rating Agency Top Rating Senior Lower Rating Finance Co. Ltd (Seller) Proceeds FCL 1997 -A (Special Purpose Co. ) Subordinated Sale of Assets No Rating More Subordinated Guarantee Agreement Copyright © 2002 Ian H. Giddy Financial Guarantee Provider (if required) Structured Finance 8

Example: Franchise Loan Securitization Franchisees (Borrowers) Loan Agreement Loan Payments Atherton Capital (Seller) Proceeds Atherton FLF 1998 -A (Special Purpose Co. ) Sale of Assets Servicing Advisor Mellon Mortgage (Servicer) Copyright © 2002 Ian H. Giddy Proceeds Investors Asset-Backed Securities Servicing Agreement Structured Finance 9

Rating Process Issuer/Banker Requests rating List information requirements Due diligence & Meeting with management Pool credit analysis Legal analysis Stress testing Credit enhancement negotiation Deal documentation “Rating CLOs” (Fitch) on Workshop Website giddy. org/abs-hypo. htm Copyright © 2002 Ian H. Giddy Rating committee Presale report Final report Surveillance Structured Finance 10

Example: Ford Credit Owner Trust 1999 -A Copyright © 2002 Ian H. Giddy Structured

Ford Structure Ford Motor Credit Sale Class A-5 and A-6 Ford Credit Auto Rec. Two LP Sale Ford Credit Auto Owner Trust Class A-1 to A 6 Receivables Class B Class D Class C Class D Copyright © 2002 Ian H. Giddy Structured Finance 12

Trade Receivable Backed CP Over $500 billion outstanding in US alone l Key feature is pooling of different companies’ trade receivables, allowing smaller companies to take advantage of ABS market l Need two-tier legal structure – SPV at level of each company’s receivables pool, and at multi-company program (the “conduit”) l Copyright © 2002 Ian H. Giddy Structured Finance 13

Trade Receivable-Backed Commercial Paper (ABCP) Corporation A Trade receivables Pool A Credit enhancement facility provider Fees Corporation C Trade receivables Pool B SPECIAL PURPOSE VEHICLE “CONDUIT” Fees Sponsor/ administrator Copyright © 2002 Ian H. Giddy Corporation B Payments on maturing ABCP INVESTORS Pool C Fees Liquidity facility provider Nominal dividends Legal owner Structured Finance 14

The Process Is the company ready? Are the assets suitable? What pool? What legal

Case Studies Evaluate the pool and legal structure in: l Belenus l Ford Copyright

Belenus What is the nature and value of the assets? l How strong is the legal structure? l Is the collateral sufficient? Would you recommend purchasing the second (B) tranche? l What could go wrong with this deal? What could go right? l Copyright © 2002 Ian H. Giddy Structured Finance 17

Belenus Credit Enhancement Class Orig rating Curr rating A AA Paid Orig C/E Curr

Ford Structure: Default or Loss? Receivables Class A-1 to A 6 Class B Class

Can an ABS SPV Declare Bankruptcy? Only assets in SPV available to protect investors q No need for protection from creditors q Obligations are defined as limited to those available from the assets q No recourse to originator q So default and bankruptcy have different meaning than for normal corporation. q Copyright © 2002 Ian H. Giddy Structured Finance 21

Ford Structure: Waterfall Receivables Class A-1 to A 6 Class B Class C Class

Ford Structure: Waterfall

Other Deals – Check the Paydown Structure DVI Receivables l Stratford l h c

Paydown: Waterfall vs Soft Bullet Structure Copyright © 2002 Ian H. Giddy Structured Finance

Implications of Waterfall Upgrades l l l 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. 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. An ABS portfolio should be traded much more actively than a corporate loan portfolio to take advantage of its inherent rating volatility. Copyright © 2002 Ian H. Giddy Structured Finance 27

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