Asset Backed Securitization

Asset Backed Securitization (ABS) is a method by which cash flows or claims against
third parties of an entity, either existing or future, are identified, consolidated, separated
from the originating entity, and then fragmented into "securities" to be offered to
inestors! "his is done to make the originator#s uneconomical inestments worthwhile,
while also reducing risk by diersifying the underlying assets! "he bank creates a
portfolio of assets consisting of non$marketable assets (priate loans), like mortgages and
lease financing into publicly tradable assets (i!e! bonds, "%&s, commercial paper)! "he
bank structurally isolates itself from the ownership of these assets and transfers the
inherent risk in those assets to a Special 'urpose (ehicle (S'() to aoid bankruptcy,
regulatory risk or a specific tax! An S'( is usually a separate entity with an asset)liability
structure and legal status that makes its obligations secure een if the parent company
goes bankrupt! "he S'( issues a bond against these assets, which act as collateral! "he
bond is said to be asset$backed since payment of them is based on payments made by
borrowers of the loans! "he purchase price of the pool of assets is generally paid by
means of employing the same funds raised by the S'( from the capital markets through
the placement of the bonds! "he bank sells the bonds through the S'( to the inestors, as
a result generating cash which can be used to increase working capital to make more
loans, improe return on inestment and obtain cheaper forms of financing!
Structure 1: Originator and servicer being the same entity:
*bligors are borrowers who are +obliged, to pay installments to the originator (the entity
that has receiables on the loans)! "he originator sells the pool of assets (the loans
adanced to the obligors) to the S'( (an entity separate from the originator)! "he S'(
issues marketable securities which are backed up by the assets! *bligors pay their
installments to the S'( which makes coupon payments to the inestors! "he S'( gies
the proceeds of the securities to the originator in consideration for the assets it purchased
from the originator! A "rustee acts in between to channel collection and payments!
Structure 2: Originator and servicer being separate entities
"he process flow is the same but the originator delegates the collection function from
loans to the sericer who transfers them to the S'(! "he originator and the sericer act as
two separate entities!
Benefits of Asset-Backed Securitization
Benefits to the bank:
1. estructure the portfo!io of Assets.
-f a bank#s portfolio of assets is heaily concentrated in a particular asset (a type of
loan e!g! auto loan or mortgage loan), the bank can restructure the portfolio of asset
through ABS!
2. "rovides inf!o# on passive investments:
-f a bank#s portfolio of assets contains .on 'erforming /oans (.'/s) or Bad 0ebts,
the bank can generate cash flow by conerting non$tradable assets into tradable assets
(marketable securities)! -t can generate a cash flow 1uickly and cost effectiely which
otherwise would not hae been possible! "he bank is able to generate cash flow
without li1uidating its assets!
$. A %heaper source of financing:
-f a company has a low credit rating but its assets are rated high, its cost of financing
funds through bond issuance would be high! "herefore, ABS helps the bank generate
finance by issuing securities backed up by the assets haing higher credit ratings! -n
this structured finance arrangement, the bank is able to generate finance by haing to
pay lower interest rate rather than the higher interest rate that it would hae to pay if
it went for bond issuance directly!
&. 'mproves the financia! statement representation:
"he bank after selling the assets to the S'( is able to remoe the assets from the
balance sheet! "his in turn improes the capital ratios of the bank! As a result it can
help improe the credit rating of the bank! -n the long run, it will help generate
finance at lower interest rates!
(. "ay off debts:
"he cash flow generated through this structured financing can also be used to payoff
debts which will improe the debt ratios of the company! -n the long run, it will help
generate finance at lower interest rates!
). Off-ba!ance sheet financing:
"he central bank of 'akistan SB' does not allow taking more loans exceeding the
limit! -n such a situation, off$balance sheet financing is a better and sometimes the
only choice!
Benefits to the investor:
1. *ecreases the credit risk e+posure:
ABS allows the inestor to take on credit risk of the asset without taking on corporate
credit risk of the bank! A third party 2S'(# is formed to protect inestors from the
credit risk of the bank! "he S'( then sells the pooled loans to a trust, which issues
interest bearing securities that can achiee a credit rating separate from the bank that
created the loans! "he improed rating encourages inestors to inest in the
marketable securities!
2. "rotection against Bankruptcy of Bank:
-n the eent that the bank goes bankrupt, the inestors are protected as their
inestment is backed up by assets which are now under the custody of S'( or trustee!
$. ,arketabi!ity of securities:
-f the inestors want to li1uidate their inestment in bonds, they can sell the bonds in
the secondary market as they are marketable and readily accepted instrument of trade!
"he banks also benefit as they do not hae to be inoled in redemption before
maturity of the bonds!
isks 'nvo!ved 'n the ABS:
'ncompatibi!ity in the timing of cash f!o#s:
3! "he timing of cash flows promised to inestors on bonds might be different from
timing of payments on the assets!
4! 'ayments on the receiables upon maturity will decrease the pool balance! "his in
turn will under$collateralize total inestor interest, resulting in the amount of
collateral backing up the bonds to decrease!
Asset Backed Securitization- u!es. 1///
"he following are the guidelines made by the commission for an S('! -t emphasizes the
moral and ethical obligations of an S(' to inestors!
"he key terms defined in these rules are as follows5
'nvestor: A person holding any asset backed securities issued by a Special 'urpose
(ehicle!
Originator: A person who transfers to a S'( any assets in the form of present or future
receiables as a conse1uence of Securitization!
Securitization: A process whereby any S'( raises funds by issue of "%&s or any other
instruments with the approal of the &ommission, for such purpose and uses such funds
by making payment to the *riginator and through such process ac1uires the title, property
or right in the receiables or other assets in the form of actionable claims!
Specia! "urpose 0ehic!e: A special purpose ehicle registered by the &ommission for the
purpose of Securitization!
u!es 1overning S"0 :
1. e2uirement for egistration:
6egistration with S7&' is re1uired to commence business as a Special 'urpose (ehicle!
"he originator and S'( should be separate entities!
2. 3!igibi!ity for registration:
"here are three ways in which an S(' can be created!
a! A person or a body corporate is registered as a public limited company
under the *rdinance haing a paid up capital of not less than one hundred
thousand rupees (6s! 388,888)!
b! A trust duly formed under the "rusts Act, 3994 (-- of 3994)!
c! A body corporate formed under any law for the time being in force and
owned or controlled, whether directly or through a company or
corporation, by the %ederal :oernment or a 'roincial :oernment!
$. "rocedure of egistration
A person eligible for registration submit an application with re1uired documents as
notified by the commission! "he commission after in1uiry may grant a certificate of
registration!
&. %ance!!ation of registration.
"he registration of the S'( will be cancelled by the S7&' if following eents occur5
a- %ance!!ation due to breach of contract
A Special 'urpose (ehicle has contraened or failed to comply with any proisions of the
*rdinance, or has otherwise neglected or failed to comply with any re1uirement of these
rules or has failed or neglected to carry out its duties in accordance with law;
b- %ance!!ation due to non-offering of securities:
i- On the re2uest of investors or in pub!ic interest:
-f the &ommission is satisfied that it would be in the public interest
or on the application of the inestors holding not less than ten percent of the securities
issued by such Special 'urpose (ehicle, by order in writing, cancel the registration of the
Special 'urpose (ehicle!
ii- On the discretion of S3%"
-f public offer of securities is not made within time and in the appropriate manner, the
&ommission may after affording a reasonable opportunity of being heard by Special
'urpose (ehicle, cancel its registration!
4ote: -n both cases, the &ommission shall appoint an administrator to manage the
business of the Special 'urpose (ehicle!

(. %onditions of Operation: An S'( shall not5
i! <erge, ac1uire or takeoer any other company unless it has obtained the
prior approal of the &ommission!
ii! 'ledge any of the assets held or beneficially owned by such Special
'urpose (ehicle except for the benefit of the inestors!
iii! <ake a loan or adance money to any person except in connection with its
normal business;
i! 'articipate in a =oint account with others in any transaction;
! Apply any part of its assets to real estate except property for its own use;
i! <ake any inestment with the purpose of haing the effect of esting the
management, or control, in the Special 'urpose (ehicle
ii! :ie guarantee, indemnity or security for any liability of a third party!
). Ob!igations of Specia! "urpose 0ehic!e
An S'( shall5
a) <anage its assets in the interest of the inestors in good faith
b) Be responsible for the acts and omissions of all persons to whom it may delegate
any of its functions as manager as if they were its own acts and omissions!
c) >eep at its registered office, proper books of accounts and records to enable a
complete and accurate iew of its financial position!
d) 'repare and transmit its annual report, together with a copy of the balance sheet
and profit and loss account, and the auditor?s report within three months of closing
of the accounting period to the inestors together with a statement containing the
following information, namely;
(i) total number of inestors; and
(ii) 'articulars of its directors, trustees or executies!
e) @ithin two months of the close of the first half of its year of account, prepare and
transmit to the inestors and the &ommission a profit and loss account for, and
balance sheet as at the end of that half year, whether audited or otherwise;
f) >eep a register of inestors at its registered office!
g) Appoint an auditor or auditors who shall be a chartered accountant proided that
the auditors so appointed shall be a person other than the auditor of the originator!
5. Advertisement and invitations.--
All the adertisements, initations and public announcements, shall be submitted to
the &ommission for approal prior to their issue!
SB" 1uide!ines on Assets Securitization through 6S"0-
1enera! 1uide!ines
Banks)0%-s participating in a securitization transaction in any capacity shall ensure
that5
i) "hey do not own any share capital in the S'(!
ii) "he S'( and the ABS (Assets Backed Securities) issued by it do not carry the same
or similar name as that of the bank)0%-!
Arranger7Structuring Agent
Banks)0%-s performing this role shall ensure that5
i) "he terms of the asset securitization issue protect them from any liability to inestors
in the scheme or the S'(!
ii) Any offering document must contain a statement that the banks)0%-s, sering in this
capacity, do not stand behind the issue or the S'( and will not make good any loss in
the portfolio!
iii) A fee can be charged for the serices performed as per agreement!
Administrator78rustee7Servicing Agent
"he trustee ensures that the rights of inestors are protected! -t collects payments on the
receiables and makes payments to the inestors! -t does not pay by itself rather it acts as
a payment channel!
"he banks)0%-s performing this role shall comply with the following guidelines5
i) "here should be a written contract)agreement between the bank)0%- (acting as
trustee), originator and S'( specifying the serices to be proided and the bank)0%-
is under no obligation to remit funds to the S'( or the inestors in the ABS unless
and until they are receied from the obligor!
ii) Any offering document must contain a statement that the banks)0%-s (acting as
trustee), do not stand behind the issue or the S'( and will not make good any loss in
the portfolio!
iii) "he bank)0%- may receie a performance$related payment and this does not commit
it to any additional obligation!
'nvestor
"he banks)0%-s holding Asset Backed Securities (ABS) hae risk exposure to these
underlying ABS assets!
%ollowing guidelines are proided to inestors who shall ensure that5
i) "he banks)0%-s shall inest in only those ABS, which are listed on the Stock
7xchange and hae a minimum credit rating of A or e1uialent from a &redit 6ating
Agency approed by SB' or an international credit rating agency iz! Standard A
'oor, <oody or %itch! -ssuer (S'() should not be a non$defaulter and confirmation
regarding solency of the issuer can be obtained from &-B department of SB'!
ii) "otal exposure of a bank)0%- towards ABS issued by a S'( shall not exceed BC of
its own paid up capital or 3BC of the total alue of the ABS issued by a S'( which
eer is less! %urther, the aggregate exposure on account of ABS shall not exceed 48C
of the total paid up capital of the bank)0%-!
iii) %or &apital Ade1uacy purposes, the banks holding ABS shall treat them at par with
inestment in "%&s and accordingly apply the risk weights prescribed by State Bank!
Originator
"he banks)0%-s under this role would act as supplier of the assets)receiables that are
securitized! -n this respect they shall comply with the following guidelines5
i) "he banks)0%-s can securitize their assets relating to lease financing, mortgage
financing and toll financing! *ther assets may be securitized by banks with prior
approal of State Bank!
ii) "he transfer of the assets should not contraene the terms and conditions of any
underlying agreement goerning the assets!
iii) "he securitizing bank)0%- is not obliged to support any losses suffered by inestors
in the ABS issued by the S'(!
i) "he assets should be transferred at fair alue! A fixed amount of consideration for the
securitized assets must be receied not later than the time of the transfer of the assets!
) "he originator must effectiely transfer all rights and obligations in the underlying
assets to the S'(!
i) An originator must not hold any e1uity stake and should not hae any director or
employee on board of the S'(! An S'( must hae no recourse to an originator for
losses arising from those assets!
ii) "he originator bears no liability to inestors for securities issued by S'( and will also
not bear the recurring expenses of the transaction! -t also can not underwrite the
securities!
8a+ation 9rame#ork of Securitization in "akistan
According to the Second Schedule of -ncome "ax *rdinance 4883, any income of an
S'( as defined in the Asset$backed Securitization 6ules 3DDD made under the &ompanies
*rdinance 3D9E, is exempt from income tax!
Foweer, if there is any income which accrues in the accounts of the S'( after
completion of the securitization process, it shall be returned to the originator within the
following year and will be taxable to the originator! "he payment receied by the
originator from the S'( is not tax deductible! -f the S'( receies the payment from an
inestor, tax is deducted and credited to the originator! "he financial cost of the
securitization of receiables incurred by the *riginator is tax deductible! A securitization
transaction inoling transfer of assets from the originator to the S'( is treated as a
financing transaction irrespectie of the accounting method adopted by the originator!

:S 1enera!!y Accepted Accounting "rincip!es 61AA"-
"he following outlines the principles obsered in the accounting for Asset$Backed
Securitization as specified by the GS :oernment!
"he accounting of a securitization transaction can be recognized as one of the following5
3! As a sale, when the seller or originator has no continuing inolement with the
transferred assets;
4! As a financing, when the %AS 3E8 re1uirements for sale accounting are not met;
(to 1ualify as a sale, the asset must be beyond the reach of the originator! "o
achiee this, one must demonstrate that there has been a true sale of the assets to
another party (S'()! "rue sale is usually eidenced by a legal opinion! -f a true
sale occurs, the S'( can use the assets freely as an owner! .ext, one must
demonstrate that upon the bankruptcy of the seller, its creditors cannot make a
claim on the assets of the S'(; that is, the S'( is bankruptcy remote entity from
the originator!)
H! As neither a sale nor financing, when no proceeds are inoled other than
interests in the transferred assets such as mortgage$backed securities;
E! As a partial sale, when the originator retains sericing and)or an interest in the
assets and the %AS 3E8 sale criteria are met!
"he last approach is most common and results in the cash funding and assets being
omitted from the balance sheet, while the interest remains on the balance sheet in a new
form such as mortgage sericing rights!
Assets and liabilities of an S'( do not need to be consolidated to the balance sheet of the
obligator!
%AS 3E8 places restrictions on the actiities of the S'( and the assets and deriaties it
may hold! All of the commercial decisions of the S'( are predetermined!
("IA S'(?sJ permitted actiities (3) are significantly limited, (4) were entirely specified in
legal documents that established the S'(, ! ! ! and (H) may be significantly changed only
with the approal of the holders of at least a ma=ority of beneficial interests held by
entities other than any obligator, its affiliates, and its agents!")!
3ffect of ABS on the Ba!ance Sheet of the originator
Assets sold are remoed from the balance sheet!
6ecognize deferred consideration, subordinated loan, and mortgage sericing
rights at fair alue!
Asset$backed securities can not be recognized on the balance sheet of the
*riginator!
3ffect of ABS on the 'ncome Statement of the originator
:ain on sale is recognizable!
Ad=ustments to fair alues recognized on yearly basis!
S"0s
"hese entities hae operations different from those of an operating company! "hey do not
typically produce traditional financial statements! "he &ommission has acknowledged the
uni1ue operating structure of S'(s and has allowed them to comply with the 7xchange
Act reporting obligations by filing modified periodic reports! S'(s file modified annual
reports of %orm 38$> and current reports of %orm 9$> that are tied to the payments on the
securities! "hese modified reports generally disclose specific information about the
performance of the assets that serice the payment obligations of the asset backed
securities!
S'(s hae been permitted to file monthly sericing or pooling reports under %orm 9$> in
lieu of regular reports! -n addition, the &ommission stated that in the case of asset$backed
securities, the re1uirement that would otherwise mandate the aailability of specified
financial information may instead be satisfied with information concerning the structure
and assets of the securitization!
A sericing asset or liability shall be amortized oer the period of estimated net sericing
income (if sericing reenues exceed sericing costs) or net sericing loss (if sericing
costs exceed sericing reenues)!
9inancia! *isc!osure
Originator:
3! 6egarding the collateral5
a) -f the entity has entered into repurchase agreements or securities lending
transactions, its policy for re1uiring collateral or other security!
b) -f the entity has pledged any of its assets as collateral that are not
reclassified and separately reported in the statement of financial position.
the carrying amount and classification of those assets as of the date of the
latest statement of financial position is presented!
c) -f the entity has accepted collateral that it is permitted by contract or
custom to sell or re$pledge, the fair alue as of the date of each statement
of financial position presented of that collateral and of the portion of that
collateral that it has sold or re$pledged, and information about the sources
and uses of that collateral!
4! -f debt was considered to be extinguished by in$substance annulment, a general
description of the transaction and the amount of debt that is considered
extinguished at the end of the period so long as that debt remains outstanding!
H! -f assets are set aside solely for satisfying scheduled payments of a specific
obligation, a description of the nature of restrictions placed on those assets!
E! -f it is not possible to estimate the fair alue of certain assets obtained or
liabilities incurred in transfers of financial assets during the period, a description
of those items and the reasons why it is not practicable to estimate their fair
alue!
B! %or all sericing assets and sericing liabilities5
a) "he amounts of sericing assets or liabilities recognized and amortized
during the period!
b) "he fair alue of recognized sericing assets and liabilities for which it is
practicable to estimate that alue and the method and significant
assumptions used to estimate the fair alue!
c) "he risk characteristics of the underlying financial assets that are used to
classify a hierarchy for recognizing sericing assets for purposes of
measuring impairment!
d) "he actiity in any aluation allowance for impairment of recognized
sericing assetsKincluding beginning and ending balances, aggregate
additions charged and reductions credited to operations, and aggregate
direct write$downs charged against the allowancesKfor each period for
which results of operations are presented!
L! -f the originator has securitized financial assets during any period presented and
accounts for that transfer as a sale, for each ma=or asset type (for example,
mortgage loans, credit card receiables, and automobile loans) it needs to
proide5
a) -ts accounting policies for initially measuring the retained interests, if any,
including the methodology (whether 1uoted market price, prices based on
sales of similar assets and liabilities, or prices based on aluation
techni1ues) used in determining their fair alue!
b) "he characteristics of securitizations (a description of the originator#s
continuing inolement with the transferred assets, including, but not
limited to, sericing, recourse, and restrictions on retained interests) and
the gain or loss from sale of financial assets in securitizations!
c) "he key assumptions used in measuring the fair alue of retained interests
at the time of securitization (including, at a minimum, 1uantitatie
information about discount rates, expected prepayments including the
expected weighted$aerage life of pre$payable financial assets, and
anticipated credit losses, if applicable)
d) &ash flows between the securitization S'( and the originator, unless
reported separately elsewhere in the financial statements or notes
(including proceeds from new securitizations, proceeds from collections
reinested in reoling$period securitizations, purchases of delin1uent or
foreclosed loans, sericing fees, and cash flows receied on interests
retained)!
M -f the entity has retained interests in securitized financial assets at the date of the
latest statement of financial position presented, for each ma=or asset type (for
example, mortgage loans, credit card receiables, and automobile loans)5
a) -ts accounting policies for subse1uently measuring those retained interests,
including the methodology (whether 1uoted market price, prices based on sales of
similar assets and liabilities, or prices based on aluation techni1ues) used in
determining their fair alue
b) "he key assumptions used in subse1uently measuring the fair alue of those
interests (including, at a minimum, 1uantitatie information about discount rates,
expected pre$payments including the expected weighted$aerage life of pre$
payable financial assets, and anticipated credit losses, including expected static
pool losses, if applicable)!
c) A sensitiity analysis or stress test showing the hypothetical effect on the fair
alue of those interests of two or more unfaorable ariations from the expected
leels for each key assumption that is reported under (b) aboe independently
from any change in another key assumption, and a description of the ob=ecties,
methodology, and limitations of the sensitiity analysis or stress test!
d) %or the securitized assets and any other financial assets that it manages together
with them5
(i) "he total principal amount outstanding, the portion that has been
derecognized, and the portion that continues to be recognized in
each category reported in the statement of financial position, at the
end of the period
(ii) 0elin1uencies at the end of the period
(iii) &redit losses, net of recoeries, during the period
(i) 0isclosure of aerage balances during the period is encouraged,
but not re1uired!
'nternationa! 9inancia! eporting Standards 6'9S-
-%6S is an international financial reporting standard which outlines the policies relating
to the disclosure of financial information!
%onso!idation of S"0s:
3! %actors that would normally indicate control5
a) Actiities of the S'( are on behalf of the originator, so that the originator obtains
benefits from the S'(
b) "he originator has decision making powers to obtain the ma=ority of benefits of
the S'(
c) "he originator has rights to obtain the ma=ority of the benefits of the S'(
d) "he originator retains the ma=ority of residual) ownership risks of the S'(!
4! Actiities of the S'( are on behalf of the originator, so that the originator obtains
benefits from the S'(! "he actiities of the S'( are in substance being conducted
according to its specific business needs
7xamplesN S'( is principally engaged in proiding a source of long term funding to
support ongoing operations
H! "he originator has decision making powers to obtain the ma=ority of benefits of the
S'(! "he obligator has decision making powers to control or obtain control of the
S'( or its assets! Autopilot mechanisms may represent delegated authorities that
indicate control has been exercised for the benefit of the original party
7xamplesN 'ower to dissole an S'(N 'ower to change S'(#s charterN 'ower to
eto changes to the S'(#s charter
E! "he originator has rights to obtain the ma=ority of the benefits of the S'( through a
statute, contract, agreement or trust deed!
7xamplesN 6ight to a ma=ority of economic benefits distributed by an obligator in the
form of future net cash flows, earnings, net assets!N 6ights to ma=ority residual
interests in scheduled residual distributions or in li1uidation of the S'(
B! "he obligator retains the ma=ority of residual )ownership risks of the S'(! %re1uently
an originator guarantees a return or credit protection to outside inestors who proide
substantially all the capital to the S'(! -n substance, the inestors are only lenders
because of limited exposure to gains and losses!
7xamplesN &apital proiders do not hae significant interest in underlying net assets
or future economic benefitsN &apital proiders mainly receie a lenders return
through a debt or e1uity interest

*e-recognition of a financia! Asset:
3! &ontractual rights to cash flows expire; or
4! A financial asset is transferred if it5
a) "ransfers contractual right to receie cash flows; or
b) 6etains contractual right to receie cash flows but assumes contractual
obligation to pay the cash flows
%omparison of :S 1AA" and '9S on the treatment of S"0;s
According to -%6S a Special purpose ehicle (S'() is consolidated where the substance
of the relationship indicates that an entity controls the S'(! -ndicators of control arise
where5
O the S'( conducts its actiities on behalf of the entity;
O the entity has the decision$making power to obtain the ma=ority of the benefits of the
S'(;
O the entity has other rights to obtain the ma=ority of the benefits of the S'(; or
O the entity has the ma=ority of the residual or ownership risks of the S'( or its assets!
*n the other hand, according to GS :AA' the consolidation of an S'( is re1uired by its
primary beneficiary when the S'( meets the definition of5 a ariable interest entity ((-7)
and the primary beneficiary has a ariable interest in the entity that will cause it to absorb
a ma=ority of the (-7#s expected losses, receie a ma=ority of the (-7#s expected residual
returns, or both! "here are seeral scope exceptions to this rule (such as pension, post$
retirement or post$employment plans)! Specific criteria also permit the transfer of
financial assets to an S'( that is not consolidated by the transferor! "he S'( should be a
1ualifying S'( (PS'(), and the assets should be financial assets!