The Handbook of European Structured Financial...

The Handbook ofEuropean

StructuredFinancial Products

FRANK J. FABOZZI

MOORAD CHOUDHRYEDITORS

John Wiley & Sons, Inc.

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THE FRANK J. FABOZZI SERIES

Fixed Income Securities, Second Edition by Frank J. FabozziFocus on Value: A Corporate and Investor Guide to Wealth Creation by James L.

Grant and James A. AbateHandbook of Global Fixed Income Calculations by Dragomir KrginManaging a Corporate Bond Portfolio by Leland E. Crabbe and Frank J. FabozziReal Options and Option-Embedded Securities by William T. MooreCapital Budgeting: Theory and Practice by Pamela P. Peterson and Frank J. FabozziThe Exchange-Traded Funds Manual by Gary L. GastineauProfessional Perspectives on Fixed Income Portfolio Management, Volume 3 edited

by Frank J. FabozziInvesting in Emerging Fixed Income Markets edited by Frank J. Fabozzi and

Efstathia PilarinuHandbook of Alternative Assets by Mark J. P. AnsonThe Exchange-Traded Funds Manual by Gary L. GastineauThe Global Money Markets by Frank J. Fabozzi, Steven V. Mann, and

Moorad ChoudhryThe Handbook of Financial Instruments edited by Frank J. FabozziCollateralized Debt Obligations: Structures and Analysis by Laurie S. Goodman

and Frank J. FabozziInterest Rate, Term Structure, and Valuation Modeling edited by Frank J. FabozziInvestment Performance Measurement by Bruce J. FeibelThe Handbook of Equity Style Management edited by T. Daniel Coggin and

Frank J. FabozziThe Theory and Practice of Investment Management edited by Frank J. Fabozzi and

Harry M. MarkowitzFoundations of Economic Value Added: Second Edition by James L. GrantFinancial Management and Analysis: Second Edition by Frank J. Fabozzi and

Pamela P. PetersonMeasuring and Controlling Interest Rate and Credit Risk: Second Edition by

Frank J. Fabozzi, Steven V. Mann, and Moorad ChoudhryProfessional Perspectives on Fixed Income Portfolio Management, Volume 4 edited

by Frank J. FabozziThe Handbook of European Fixed Income Securities edited by Frank J. Fabozzi

and Moorad Choudhry

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FRANK J. FABOZZI

MOORAD CHOUDHRYEDITORS

John Wiley & Sons, Inc.

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Copyright 2004 by Frank J. Fabozzi. All rights reserved.

Chapters 15, 16, 17, 18, 22, 27, 32 copyright Moodys Investors ServiceChapters 20, 21, 28, 33 copyright Standard & Poors Corporation

Published by John Wiley & Sons, Inc., Hoboken, New JerseyPublished simultaneously in Canada

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or oth-erwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rose-wood Drive, Danvers, MA 01923, 978-750-8400, fax 978-750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Per-missions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, e-mail: [email protected].

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v

Contents

About the Editors xiContributing Authors xiii

PART ONE

Structured Finance and Securitisation 1

CHAPTER 1Introduction 3Frank J. Fabozzi and Moorad Choudhry

CHAPTER 2The Concept of Securitisation 9Iain Barbour and Katie Hostalier

CHAPTER 3Mechanics of Securitisation 19Alexander Batchvarov, Jenna Collins, and William Davies

CHAPTER 4Credit Derivatives Primer 57Frank J. Fabozzi, Moorad Choudhry, Mark J.P. Anson, and Ren-Raw Chen

CHAPTER 5True Sale versus Synthetics for MBS Transactions:The Investor Perspective 77Iain Barbour, Katie Hostalier, and Jennifer Thym

CHAPTER 6A Framework for Evaluating a Cash (True Sale) versus Synthetic Securitisation 93Iain Barbour and Katie Hostalier

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vi Contents

CHAPTER 7Assessing Subordinated Tranches in ABS Capital Structure 117Alexander Batchvarov, Jenna Collins, and William Davies

CHAPTER 8Key Consideration for Master Trust Structures 131Alexander Batchvarov, Jenna Collins, and William Davies

CHAPTER 9Trust and Agency Services in the Debt Capital Markets 143Nick Procter and Edmond Leedham

PART TWO

Asset-Backed Securities 175

CHAPTER 10European Credit Card ABS 177Markus Niemeier

CHAPTER 11European Auto and Consumer Loan ABS 201Markus Niemeier

CHAPTER 12European Public Sector Securitisations 223Christopher Flanagan, Edward Reardon, and Doreen Tan

CHAPTER 13Italian Lease-Backed Securities 233Andrew Dennis

CHAPTER 14European Mezzanine Loan Securitisations 251Alexander Batchvarov, Jenna Collins, and William Davies

CHAPTER 15Stock Securitisations 263Carole Gintz

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Contents vii

CHAPTER 16Rating Trade Receivables Transactions 273Jean Dornhofer and Everett Rutan

CHAPTER 17Moodys Approach to Analysing Consumer Loan Securitisations 291Nikoletta Knapcsek and Valentina Varola

CHAPTER 18Nonperforming Loan Securitisation and Moodys Rating Methodology 305Antonio Serpico, Alex Cataldo, and Hernan Quipildor

PART THREE

Whole Business Securitisation 327

CHAPTER 19Whole Business Securitisation 329Anant Ramgarhia, Miray Muminoglu, and Oleg Pankratov

CHAPTER 20Principles for Analysing Corporate Securitisations 349Elena Folkerts-Landau, Pascal Bernous, Adele Archer,Anthony Flintoff, and Apea Koranteng

CHAPTER 21Balancing Cash Flow Predictability and Debt Capacityin Corporate Securitisations 361Blaise Ganguin, Apea Koranteng, Michael Wilkins, and Adele Archer

CHAPTER 22Credit Analysis of Whole Business Securitisations 373Benedicte Pfister

CHAPTER 23Securitisation of UK Pubs 389Andrew Dennis

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viii Contents

PART FOUR

Mortgage-Backed Securities 411

CHAPTER 24European Residential Mortgage-Backed Securities 413Phil Adams

CHAPTER 25Italian Residential Mortgage-Backed Securities 449Andrew Dennis

CHAPTER 26European Commercial Mortgage-Backed Securities 471Phil Adams

CHAPTER 27Rating Approach to European CMBS 487Benedicte Pfister

CHAPTER 28Differentiating CMBS from Other Real Estate Securitised Financings 513Elena Folkerts-Landau, Clayton Hunt, Ronan Fox, Adele Archer, and Ian Bell

CHAPTER 29The German Pfandbrief and European Covered Bonds Market 523Graham Harry Cross

PART FIVE

Collateralised Debt Obligations 551

CHAPTER 30Structured Credit: Cash Flow and Synthetic CDOs 553Oldrich Masek and Moorad Choudhry

CHAPTER 31Single-Tranche Synthetic CDOs 593Barnaby Martin, Alexander Batchvarov, and Atish Kakodkar

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Contents ix

CHAPTER 32Rating Methodology for Collateralised Debt Obligations 633Henry Charpentier and Hernan Quipildor

CHAPTER 33CLOs and CBOs for Project Finance Debt: Rating Considerations 653Arthur F. Simonson, William H Chew, and Henry Albulescu

CHAPTER 34Independent Pricing of Synthetic CDOs 675Farooq Jaffrey and David Jefferds

PART SIX

Credit-Linked Notes and Repacks 699

CHAPTER 35Credit-Linked Notes 701Moorad Choudhry and Frank J. Fabozzi

CHAPTER 36Structured Credit Products and Repackaged Securities 715Alessandro Cocco

INDEX 739

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xi

About the Editors

Frank J. Fabozzi, Ph.D., CFA, CPA is the Frederick Frank Adjunct Profes-sor of Finance in the School of Management at Yale University. Prior tojoining the Yale faculty, he was a Visiting Professor of Finance in theSloan School at MIT. Professor Fabozzi is a Fellow of the InternationalCenter for Finance at Yale University and the editor of the Journal ofPortfolio Management. He earned a doctorate in economics from the CityUniversity of New York in 1972. In 1994 he received an honorary doctor-ate of Humane Letters from Nova Southeastern University and in 2002was inducted into the Fixed Income Analysts Societys Hall of Fame. He isthe honorary advisor to the Chinese Asset Securitization Web site.

Moorad Choudhry is Head of Treasury at KBC Financial Products (UK)Limited in London. He previously worked as a government bond traderand Treasury trader at ABN Amro Hoare Govett Limited and HambrosBank Limited, and in structured finance services at JPMorgan ChaseBank. Moorad is a Fellow of the Centre for Mathematical Trading andFinance, CASS Business School, and a Fellow of the Securities Institute.He is author of The Bond and Money Markets: Strategy, Trading, Analy-sis, and a member of the Education Advisory Board, ISMA Centre, Uni-versity of Reading.

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xiii

Contributing Authors

Phil Adams Barclays CapitalHenry Albulescu Standard & PoorsMark J.P. Anson CalPERS Adele Archer Standard & PoorsIain Barbour Commerzbank SecuritiesAlexander Batchvarov Merrill LynchIan Bell Standard & PoorsPascal Bernous Standard & PoorsAlex Cataldo Moodys Investors ServiceHenry Charpentier Moodys Investors Servive Ren-Raw Chen Rutgers University (New Brunswick)William H Chew Standard & PoorsMoorad Choudhry KBC Financial Products UK LimitedAlessandro Cocco JPMorgan Chase Jenna Collins Merrill LynchGraham Harry Cross YieldCurve.comWilliam Davies Merrill LynchAndrew Dennis UBS Jean Dornhofer Moodys U.K.Frank J. Fabozzi Yale University Christopher Flanagan JPMorganAnthony Flintoff Standard & PoorsElena Folkerts-Landau Standard & PoorsRonan Fox Standard & PoorsBlaise Ganguin Standard & PoorsCarole Gintz Moodys FranceKatie Hostalier Commerzbank SecuritiesClayton Hunt Standard & PoorsFarooq Jaffrey CreditTradeDavid Jefferds CreditTradeAtish Kakodkar Merrill LynchNikoletta Knapcsek Moodys ItaliaApea Koranteng Standard & Poors

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xiv Contributing Authors

Edmond Leedham JPMorgan Chase BankBarnaby Martin Merrill LynchOldrich Masek JPMorgan Securities Ltd.Miray Muminoglu JP MorganMarkus Niemeier Barclays CapitalOleg Pankratov ABN AMROBenedicte Pfister Moodys ItalyNick Procter JPMorgan Chase BankHernan Quipildor Moodys Investors ServiceAnant Ramgarhia ABN AMROEdward Reardon JPMorganEverett Rutan Moodys U.S.Antonio Serpico Moodys Investors Service Arthur F. Simonson Standard & PoorsDoreen TanJennifer ThymValentina Varola Moodys ItaliaMichael Wilkins Standard & Poors

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PART

OneStructured Finance and

Securitisation

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CHAPTER 1

3

IntroductionFrank J. Fabozzi, Ph.D., CFA

Frederick Frank Adjunct Professor of FinanceSchool of Management

Yale University

Moorad ChoudhryHead of Treasury

KBC Financial Products UK Limited

ecuritisation has been one of the most exciting developments in fixedincome markets and illustrates perfectly the dynamic and flexible

nature of the market itself. First introduced in the United States domes-tic market in 1969, it arrived in Europe in the 1980s and has witnesseddramatic growth right from inception. The application of securitisationtechniques gives rise to structured finance securities, which nowencompass a wide class of products, each of which deserves separatetreatment in its own right.

In simple terms, securitisation is a procedure by which financialassets such as loans, consumer instalment contracts, leases, receivables,and other relatively illiquid assets with common features that are heldon the balance sheet of a bank, financial institution, or other corporateentity are used as collateral backing for a package of securities that areissued to investors. The economic interest in the financial assets arethereby transferred to investors via the securitisation process. At thesame time, illiquid financial assets are transformed into liquid securitiesthat trade, to a varying degree, in a secondary debt capital market.While the actual process may be quite complex, involving a number ofthird-parties such as lawyers, credit rating agencies, insurers, accoun-

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4 STRUCTURED FINANCE AND SECURITISATION

tants, and trustee service providers, as a concept it is straightforward. Ithas resulted in an enhanced range of corporate finance options, as wellas advanced the process of disintermediation by which the users of capi-tal are brought closer together to the providers of capital.

The motivations behind securitisation are covered in detail in thisbook, so we need not go into them here. Investors are attracted to suchengineered securities mainly because of their desirable investment andmaturity characteristics. However, the higher yield is associated withinvestors bearing some degree of prepayment, early amortisation, credit,and liquidity risk.

THE EUROPEAN STRUCTURED FINANCE MARKET

The first securitisation in the United States market used residential mort-gage assets assets. The success of the securitisation process in the residentialmortgage markets as a funding source and the acceptance of the derivedsecurities by the investor base led to the application of this technology toother assets, such as credit cards, home equity loans, automobile loans,lease instalment contracts, and manufactured housing loans, to name a fewon the ever expanding list of securitisable assets. The first nonmortgageasset-backed security, a computer lease-backed transaction, was issued inMarch 1985. Later in that same year, the first auto loan-backed securitieswere issued. Two years later, in 1987, the first credit-card backed securitywas issued. Since then, the asset-backed market has expanded.

In Europe the first asset classes to be securitised were residentialmortgages in the United Kingdom in 1987. Since then, a wide range ofassets have been repackaged into structured finance securities, including:

Commercial mortgages

Corporate bank loans

Government assets such as lottery receipts and public sector housingreceipts

Credit card debt

Car-loan (auto-loan) receivables

Corporate assets such as nursing home and funeral home receivables

Equipment (such as photocopiers and other office equipment) leasereceivables

Consumer loans

The flexibility and applicability of the securitisation concept itself,together with the inventiveness of investment bankers, means that virtually


Introduction 5

any asset is a candidate for transformation into structured finance securi-ties. The type of asset that is being securitised determines what the issuedbond is called. Generally speaking, the structured financial product marketis composed of asset-backed securities (ABS), mortgage-backed securities(MBS), collateralised debt obligations (CDO), and repackaged securities.As we shall see later, the MBS market is subdivided further into residential(RMBS) and commercial (CMBS) securities, while the CDO asset class alsocomprises a number of different types too. As a rule of thumb, the nature ofthe originating institution, as well as the asset class itself, determines whatthe issued securities are called. Speaking generally, banks originate RMBSand CMBS, while corporates issue ABS. Insurance companies and fundmanagers issue CDOs.1

In Exhibit 1.1 issue volumes for the European market are shown,along with issue volumes in all currencies shown as USD-equivalent.Exhibit 1.2 shows the breakdown of issuance by original asset class.Securitisation has been introduced in a number of countries acrossEurope, both inside and outside the Eurozone.2 Exhibit 1.3 shows theissuance breakdown by country, with the largest issuers shown to be theUnited Kingdom and Italy.

A more recent development in the European market, again follow-ing the trend in the United States, was that of CDOs. The CDO marketis sometimes considered as distinctly separate from the ABS and MBS

1 Like all rough rules of thumb, there are exceptions. Bank originators of corporateloans would be issuing ABS, for example, and banks have also been large issuers ofCDOs. Government-sponsored issues are usually classed ABS.2 During 2003 the newest countries in Europe to witness securitisation were Greeceand Poland, while during 2000 Portugal saw its first transaction.

EXHIBIT 1.1 European Issuance Volume, 19962003 YTD

Source: Securitization.Net, JPMorgan Chase Bank.



market, but it follows the same principles used for the earlier products.Its growth has been dramatic, given that the first CDOs were only issuedin Europe in 1998. Like the other products, it has been introduced inseveral forms. The main distinction within CDOs has been about thetype of assets originated, whether loans (collateralized loan obligationsor CLOs) or bonds (collateralized bond obligations or CBOs), and themotivation behind deal issuance, whether arbitrage or balance sheet.These distinctions are discussed in detail later in this book.

Exhibit 1.4 shows CDO transaction issuance in the European mar-ket from 2000. Exhibit 1.5 shows the type of collateral originated dur-ing 2002.

EXHIBIT 1.2 Collateral Type During 2002


EXHIBIT 1.3 Origination of Assets in Europe 2002



Introduction 7

EXHIBIT 1.4 European CDO Issuance, 20022003


EXHIBIT 1.5 CDO Collateral Type During 2002


Part V of this book looks in detail at CDOs, including the newestCDO type known as a synthetic CDO, which combines traditional secu-ritisation techniques with credit derivatives.

ORGANISATION OF THIS BOOK

This book is organised into six parts. Part I introduces structured financeproducts and the concept of securitisation. This includes chapters on themechanics of a securitisation transaction, as well as separate chapters thatanalyse structured finance products from the point of view of investorsand originators. Included in Part I is a chapter on the various agency



services required, by investors, in a securitisation deal, and which are pro-vided by specialist banks known as trust banks.

The following parts are split by products. Part II looks at ABS andthe various asset classes that have been originated as ABS. It includeschapters on credit card ABS, consumer loan ABS, auto loan ABS, leasesecuritisations, and mezzanine loan securitisations. There is also a chap-ter on public sector transactions, which have been dominated by issu-ance from the Italian government. Information about other types ofsecuritisation backed by trade receivables, corporate stock, and non-performing loans, is also included.

A special type of ABS is whole business securitisations. (A specificexample of this type is U.K. pubs). This is covered in Part III.

Part IV focuses on residential and commercial MBS. Because of thesize of the Italian RMBS market, a chapter on that market is covered inthe book.

In Part V we look at CDOs, both cash and synthetic CDOs. Thisincludes a chapter on valuing CDOs. Because synthetic CDOs make exten-sive use of credit derivatives, we have included an introductory chapter onthese instruments in Part I.

Finally, Part VI looks at structured credit products in the form ofcredit-linked rates and repackaged transactions. In all parts we havealso considered the analysis of structured financial products, primarilycredit analysis from the rating agency perspective.


CHAPTER 2

9

The Concept of SecuritisationIain Barbour

Global Head of SecuritisationCommerzbank Securities

Katie HostalierHead of Structured Finance Research

Commerzbank Securities

ecuritisation has become a widely used term to describe many mecha-nisms through which risks are transferred between various parties.

The description encompasses the sale of risk assets in absolute form, aswell as the synthetic transfer of specific aspects of risk. This chapterseeks to bring a definition to the word securitisation. We seek to definethe various contexts in which the word is used, the parties to such con-tracts, and their motivations. From this high-level background to themarket it is apparent that the world of securitisation is still beingdefinednew asset classes and new mechanisms are being created, withnew counterparties coming to the market regularly.

WHAT IS SECURITISATION?

Securitisation is effectively a process through which loans, receivables,and other assets are pooled. The related cash flows and economic valuesare employed to support payments on related securities. These securitiesare issued in the public and private markets by or on behalf of issuers,who utilise securitisation to finance their business activities. These secu-rities are generally referred to as asset-backed securities (ABS).

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The investors risk is therefore linked to the assets which back thesecurities he invests in. The primary source of interest payments andrepayment of principal of the ABS does not rely on the issuers generalrevenues, but on the specific cash flows generated by the assets. Theinvestors credit analysis therefore focuses on a defined pool of assets.

Most securitisation transactions seek to isolate the financial assetsthat support payment flows on the related ABS. Isolation ensures thatpayments on the ABS are derived exclusively from the performance of aspecific, and often segregated, pool of financial assets.

The pool of assets securitised is frequently enhanced, either bymeans of internal structural measures or with the help of outside par-ties, from a credit perspective. Liquidity facilities may provide somecredit enhancement, but usually provide a mechanism to streamline cashflows on the transaction, ensuring a smoother flow of payments toinvestors, especially where underlying payment flows on the securitisedassets are subject to some volatility.

This is why ABS are usually issued by special purpose vehicles(SPVs) whose purpose is to hold a specific pool of assets and issue secu-rities against these assets.

The basic concept of securitisation may be applied to virtually anyasset which has a reasonably ascertainable value, or that generates areasonably predictable future stream of revenue. As a result, securitisa-tion has been extended beyond the typical asset classes (see Exhibit 2.1)to less well-known asset classes, including insurance receivables, obliga-tions of shippers to railways, obligations of purchasers to natural gasproducers, and future rights to entertainment royalty payments, amongmany others.

The fundamentals of securitisation are relatively homogeneous,being common to most transaction types. As a result, securitisationstructures and the roles and functions of key transaction participants aresimilar wherever the securitisation concept is applied. This is the caseregardless of jurisdiction, despite different regulatory and legal environ-ments. We discuss some generic securitisation transaction features andcompare true sale and synthetic securitisation structures later in thisdocument.

Securitisation may therefore be distinguished from other, more tra-ditional forms of debt and equity financing, in which returns to inves-tors are generally derived from the claims-paying ability or profit-making potential of an ongoing business enterprise.

The ABS market can also be distinguished from the corporate debtand equity markets because of the regular return of principal exhibited.ABS require investors to assess the impact of alternative potential future


The Concept of Securitisation 11

cash flows (including prepayments) in making a meaningful evaluationof a securitys yield.

ORIGINATOR CLASSIFICATION

Originators have encompassed many guises. The most common assetoriginators in the securitisation world are banks, mortgage originators,specialist consumer credit originators, asset managers, and, increasingly,corporates. Exhibit 2.1 summarises most classes of potential origina-tors, the possible range of asset classes they could consider securitising,and their motivations.

The most significant European originators, from a volume perspec-tive, are the banks. Their leading motivation to date has been achievinggreater regulatory capital efficiency. However with the proposed changesto the Basel Capital Adequacy Guidelines, this primary motivation islikely to refocus towards liquidity, business growth, prepayment risktransfer, and credit risk transfer.

There are various categories of issuing vehicles for structured trans-actions, which range from direct issuance by the originators themselvesto multiseller conduit structures. These categories can be summarised asfollows.

The United States and, increasingly, the European market have seensignificant securitisation flows via the conduit market, whereby severaloriginators effectively club together under a single sponsored issuanceprogramme. This clearly generates economies of scale for the origina-tors, and is especially efficient for short-dated receivables which areoriginated by corporates. Additionally, where an originator wishes topreserve some degree of anonymity this can be achieved under somestructures. The risk is still transferred to investors, who typically pur-chase credit-enhanced commercial paper, with credit enhancementeither provided by publicly issued securities, or subordinated loans.

In the context of securitisation, these are companies established solelyfor the purpose of purchasing risk or cash flows from the originator, androuting it to investors. They are often domiciled offshore, and usuallybankruptcy remote from the asset originator. This effectively segregatesthe assets being securitised from the originators other business assets.

On occasions the originator itself will issue the notes, with the noteperformance correlated to the performance of specific assets maintainedon their balance sheet. Key to the success of such structures is the origi-nators ability to eliminate other assets from the risk equation. Otheroccasions where the originator will also act as issuer are where theirwhole business is being securitised.



EXHIBIT 2.1 Originator Classification, Target Asset Classes, and Motivation

Source: Commerzbank Securities.

Originator Type Asset Class Motivation

Banks Mortgage loans (residential and commercial); loans (con-sumer and corporate); bond and credit derivative portfo-lios; leases

Risk transfer; capital effi-ciency; new business; liquid-ity; prepayment risk transfer

Specialistmortgageoriginators

Mortgage loans (residentialoften nonconforming and subprime)

Liquidity; new business; risk transfer; capital efficiency; prepayment risk transfer

Consumerfinanceproviders

Credit card loans; auto finance loans; personal loans; leases

Liquidity; new business; risk transfer; capital efficiency; prepayment risk transfer

Companies Exports; receivables; inven-tory; leases

Capital efficiency; liquidity

Leisure andretailoperators

Pub receivables; theatre cash flows; retail cash flows; fran-chise revenues

New business and liquidity; capital efficiency; profit

Real estatedevelopers

Debt finance for offices; hotels; shopping malls; care homes

Capital efficiency; liquidity; term and cost

Municipalities Social security contributions; taxes; parking tickets; hospi-tals; specific assets

Capital and balance sheet effi-ciency; liquidity; term and cost

Governments Privatisation debt (e.g., PFI in the UK); export credits

Capital and balance sheet effi-ciency; liquidity; term and cost

Utilities Receivables; real estate Capital efficiency; liquidity; term and cost

Projects Cash flows post completion Capital efficiency; liquidity; term and cost

Asset managers Bond, credit derivative and loan portfolios

Risk transfer; capital effi-ciency; new business; liquidity

Hedge funds andalternativeinvestmentvehicles

Bond, credit derivative and loan portfolios; fund of fund structures; structured prod-ucts

New business and liquidity; capital efficiency; profit

HousingAssociations

Real estate portfolios and resultant cash flows


Healthcare Real estate portfolios and resultant cash flows



The Concept of Securitisation 13

ORIGINATOR MOTIVATION

Understanding originator motivation and decision-making criteria arefundamental to assessing whether to invest in a structured finance trans-action. A successful transaction creates a partnership between origina-tor, servicer, and investor. This partnership must transcend all threeparties throughout the life of the transaction, with each ideally under-standing each others motivations.

The key reasons for securitising can be summarised as follow. For banksand corporates, traditional balance sheet risk management requires optimalliability management. Securitisation enables risk capital usage to be opti-mised, focusing capital utilisation on residual economic risk coupled withallocations for operational and day-to-day business management risks.

Through the effective transfer of credit risk, capacity for incrementalcredit risk is created, freeing counterparty limits. Two of the most significantconstraints on business growth are capital and risk appetite. In optimisingcapital usage, and reducing credit risk, business capacity is effectively created.One of the most misunderstood motivations. It can be achieved essentiallythrough routing existing revenues, less the cost of the transaction, towardsgenerating a return on the reduced capital allocation.

An added bonus for many is the access to a significant, alternativesource of liquidity from an often-new range of investors. For lowerrated organisations, securitising selected funded assets possessing aninherently stronger credit quality than their own, this funding may alsobe less expensive. Furthermore, the liquidity generated may be longerterm, and create enhanced matching of assets and liabilities.

We will also discuss later in this chapter some alternative methodsof meeting these objectives (outside of securitisation), and contrast thesewith securitisation techniques.

SECURITISATION TRANSACTION CATEGORIES

As the market matures there are, in our opinion, three broad categoriesof securitisation transactions. These are described below.

Financing and Capital Management TransactionsFinancing and capital management transactions represent the core transac-tion type in the securitisation arena. In Chapter 6, we present a relativevalue framework for analysing this transaction type.

Originators generate assets such as loans and receivables which areultimate payment obligations of their customers (debtors). When securitis-ing such assets (or an interest in these assets), the originator receives liquid-



ity. The issuer in turn uses the assets to collateralise the ABS. The customerswill not usually be aware that the assets have been securitised, and thatthere has therefore been an effective change in control of their liabilitythechange may in fact not ever be made public, as a synthetic structure may infact not lead to any change in control, but merely a transfer of risk.

Repackaging for ArbitrageRepackaging transactions typically take the form of a series of notesissued in the form of an ABS, backed by a portfolio of bonds (includingABS themselves), credit derivatives, loan portfolios, and other forms ofcredit risk. The arbitrage operates between the yield on the underlyingand the required all-in cost of the notes, and success is often measuredby comparing the relative costs of holding the assets on balance sheetrelative to through a securitised structure.

Market-Value TransactionsIn market-value-based transactions the asset manager must take specificaction, usually selling the collateral, to liquidate assets. This exposesinvestors to liquidity and market risk.

TRANSACTION FEATURES AND PARTICIPANTS

Securitisation structures appear to be complex; however, there are com-mon features which make them easier to understand, facilitating analy-sis and comparison.

An originator extends finance to a borrower to facilitate the origina-tors purchase or use of an asset. This creates a financial asset. Once cre-ated, the originator usually continues with the collection and managementof the asset, in a consistent manner to ongoing credit and collection proce-dures. These activities are generally referred to as servicing, and the partyperforming them is referred to as the servicer.

In order to create ABS, the originator conveys the assets to be secu-ritised to another entity (usually a bankruptcy-remote SPV, but also, fre-quently, a trust)the issuer. The SPV or trust then issues debt securitiesin the capital markets. The securities are usually purchased by institu-tional investors (including banks, conduits, insurance companies, pen-sion plans, and portfolio managers).

The issuer uses the proceeds from the notes to pay the purchase priceof the assets being securitised. The transfer of assets from the originatorto the issuer is generally a true sale. A true sale removes the assets fromwhat would constitute the bankruptcy or insolvency estate of the origi-


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The Handbook of European Structured Financial...

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