SECURITIZATION
Securitization of Assets
• Securitization is the transformation of an illiquid
asset into a security.
• For example, a group of consumer loans can be
transformed into a publicly-issued debt security.
• A security is tradable, and therefore more liquid than
the underlying loan or receivables. Securitization of
assets can lower risk, add liquidity, and improve
economic efficiency.
Securitization: The Basic Structure
SPONSORING
COMPANY
ACCOUNTS
RECEIVABLE
SALE OR
ASSIGNMENT SPECIAL
PURPOSE
VEHICLE
ISSUES
ACCOUNTS
ASSET-BACKED
RECEIVABLE
CERTIFICATES
What is the Technique for Creating
Asset-Backed Securities?
• A lender originates loans, such as to a homeowner or
corporation.
• The securitization structure is added. The bank or firm
sells or assigns certain assets, such as consumer
receivables, to a special purpose vehicle.
• The structure is legally insulated from management
• The SPV issues (usually) high-rated debt.
Internal Credit Enhancements
• Subordination – Different class of securities is
made
• Overcollateralization
External Credit Enhancements
• Surety Bonds – Insurance provided by a rated
insurance company
• Third Party Guarantee
• Letters of Credit
The Process
Key features are:
– pooling of a group of similar non-traded financial assets
– transfer of those assets to a special-purpose company
which issues securities
– risk reduction by systematic risk assessment, by
diversification, by partial guarantees, etc.
– division of the benefits (and risks) among investors on a
pro-rata basis
– being offered in the form of a security (rather than, for
example, as a portfolio of loans or receivables)
– on-going servicing of the underlying assets' cash flows
through to the asset-backed security investors.
Key Decisions
Securitize the assets
Decisions
Form of
Form of transfer Form of special Form of credit Form of cash flow
transformation of
of asset purpose vehicle enhancement allocation
cash flows
Getting a Rating: The Risks
• Credit risks
• Liquidity risk
• Service performance risk
• Swap counterparty risk
• Guarantor risk
• Legal risks
• Sovereign risk
• Interest rate and currency risks
• Prepayment risks
Kinds of Securitization
• Mortgage Securitization
• Non-Mortgage ABS
• Intangibles
Asset-Backed Securities:
Legal and Regulatory Aspects
• Legal
– The Transfer
– The Special-Purpose Vehicle
• Taxation
• Accounting Treatment
• Bank Regulatory Treatment
Legal Aspects
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
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.
Taxation Aspects
• If the SPV or the transfer is subject to normal
corporate, withholding, or individual tax rates,
investors or borrowers could in principle be
subject to additional or double taxation
Must avoid double taxation of
• Seller/servicer
• Trust or special-purpose corporation
• Investors
Accounting Treatment
• Sale versus financing
• Consolidation
• Accounting for loan servicing
Sale Treatment
• The transferor relinquishes control of the
future economic benefits embodied in the
assets being transferred
• The SPV cannot require the transferor to
repurchase the assets except pusuant to
certain recourse provisions
• The transferor's obligation under any recourse
provision are confined and can be reasonably
estimated
Separation of Two Businesses: Origination
and Lending
SPONSORING
COMPANY Asset securitization
makes sense when the
assets are worth more
ACCOUNTS
RECEIVABLE
outside the company
than within
But what makes them
worth more outside?
SALE OR
ASSIGNMENT SPECIAL
PURPOSE
VEHICLE
ISSUES
ACCOUNTS
ASSET-BACKED
RECEIVABLE
CERTIFICATES
For Corporations: “Pure Play” Argument
Separate the credit of the assets from the credit of
the originator:
• Identify and isolate good assets from a company
or financial institution
• Use those assets as backing for high-quality
securities to appeal to investors.
• Such separation makes the quality of the asset-
backed security independent of the
creditworthiness of the originator.
Costs Associated with Securitization
• Interest cost of the debt
• Issuance expenses of the debt
• Also:
– Credit enchancement and liquidity support for
the assets
– Structuring fees payable to bankers
– Legal, accounting and tax advice fees
– Rating agencies' fees
– Management time
Asset Backed Securities
• Securities created by pooling loans other
than first-lien mortgage loans:
– Auto-loan backed securities
– Credit Card Receivable-backed securities
– Home Equity Loan-backed securities
• The underlying assets are purchased by a
Bankruptcy-remote Special Purpose Vehicle
(SPV), which issues the ABSs.
• The SPV is typically a wholly-owned
subsidiary of the seller of the collateral.
ABS structure resembling notes
• Chase, in Sep. 1999 sold an $18.5bn pool of
receivables to a master trust, which issued a
certificate, conveying an undivided interest in the
whole pool.
• This certificate was placed in another SPV, which
issued three tranches of bonds:
– $850m of 5-yr senior bonds, rated AAA, priced at 98bp over
Treasuries.
– $48.295m of single-A paper at 128bp over Treasuries.
– $67.615m BBB at 95bp over 1-month Libor.
• The repackaging enabled the tranches to be called
notes and hence all the tranches could meet ERISA
investment guidelines followed by pension funds.
Catastrophe Bonds
• Oriental Land Company placed two $100 million
catastrophe bonds with special purpose reinsurers
to protect against earthquakes.
• First bond has a five-year maturity. Payment
depends upon magnitude, location and depth of
earthquake, regardless of actual property
damage.
• Second provides post-earthquake financing:
Oriental Land will issue a $100 million 5-yr bond
to the reinsurer with no interest for the first three
years.
Weather Bonds
• In Oct. 1999, Koch Ind., of Wichita and Enron
Corp, of Houston issued $200 m. of weather
bonds.
• The interest on the Koch bonds depends on the
weather in the 19 cities in which Koch operates.
• If temperatures are similar to historical levels, the
coupon is 10.5%.
• If temps are colder (warmer) by ¼ degree on
average, the coupon is 10% (11%).
• Koch’s objective: Hedging
• Value for investors: Diversification
Securitizing future cash flow
• This is the purpose of standard bonds.
However, they draw upon the general
cashflows of a company.
• Project financing channels pre-specified
subsets of a company’s cashflows to
bondholders.
• More specialized “projects” like rock-n-roll
bonds.
Rock-n-Roll bonds
• David Bowie, issued February 1997, raised $55 m.
by selling securities.
• Backed solely by expected royalites from future
sales of his first 25 albums.
• 7.9% coupon, 15 yr maturity, 10 yr. av. maturity.
• Investment banker on the deal was David Pullman
at Gruntal & Co.
• Prudential Insurance Co. is purchaser.
• Bonds guaranteed by EMI Group Plc.
Rock-n-Roll bonds
• In 1998, $30 million raised by Motown
songwriting team Holland-Dozier-Holland
• In 2000, eight figure deal for Ronald Isley as
securitization
• Pullman group over the years has
securitized more than 100 artists catalog
• Not so successful in recent times
Tobacco Bonds
• In 1998, 46 states settled a major case against the Tobacco
industry. The agreement was for approximately $205
Billion for 25 years. It is referred to the Master Settlement
Agreement (or MSA).
• States, and various Counties in a few States, have opted to
securitize their payments from the MSA. They have issued
Municipal Bonds and taken an early lump sum payment
instead of waiting for the Tobacco industry payments to
come in over time.
• The bonds secured by these tobacco settlement revenues
are called tobacco bonds.
• The risk for these bond investors is the strength of the
Tobacco industry, cigarette sales and so on.
Train Securitization in the UK
• Earliest deals securitized leases guaranteed by the
UK government in 1994.
• In 1998, Porterbrook securitized unguaranteed
leases on trains still under construction.
• In August 1999, the Royal Bank of Scotland placed
£480m to fund Virgin Rail Group’s purchase of 53
hi-tech trains that were custom-made.
Train Securitization in the UK
• Porterbrook’s deal comprised £140m. of Floating rate loans
in three tranches.
• Royal Bank of Scotland’s financing wing West Coast Train
Finance Plc offered one fixed class of bonds, to be
amortized according a schedule between 2003 and 2015;
av. life = 10.4 yrs.
• A+ rating from Duff and Phelps, AA from Fitch IBCA and A
from S&P.
• The bonds are delinked from the credit risk of the company
operating the trains; permits a higher rating for the bonds
than for the company.
• There is an assurance from the Office of Passenger Rail
Franchising to take over the trains even if Virgin fails.
Special Facilities Bonds
• Most debt issued by airports represents long-term
bonds secured by a pledge of general airport revenues.
• Recently, however, more airports have been issuing
special facilities secured debt where the lender has
recourse only to revenues generated by the special
facility.
• There is no equity investment by the airport authority.
• General airport revenues can be reserved for projects
that are more central to airport operations or can only
be funded through traditional avenues.
JFK Int’l Arrivals Terminal Bonds
• Issued by the Port Authority of NY & NJ
• Secured by Facility Rental Payments made
by the lessee JFK IAT to the Port Authority,
the lessor. However, JFK IAT agrees to set
rates to provide revenues 125% of debt
service on bonds.
• Bondholders have no recourse to JFK IAT, or
the Port Authority, if the project fails to
perform as projected.
Pub Securitization
• In June 1999, Pubmaster, a UK corporation
that owns pubs securitized beer revenues.
• This allows Pubmaster to tailor costs to
revenues, and reduces the probability of
bankruptcy.
• For the investors, it’s possible to obtain
tighter covenants, because the source of
the revenues is more defined.
Miramax – Movie based Securitization
• First-ever US term securitization of a standalone film
library in 2011, for about US$550m, to refinance its
outstanding debt.
• The deal securitized all cashflow from existing contracts
associated with the licensing of those films.
• That included cashflows from the movies' different
distribution channels (television, digital, and
DVD/BluRay), and all future sales associated with the
unsold inventory related to the library -- in other words,
all cashflows associated with their future licensing and
distribution.
Sport Securitization
• Formula One, the British company that
manages the international car-racing
championship has issued $1.4 b. in bonds
securitized by all assets of Formula One’s
business, including its TV and promotional
contracts.
• Shows that intangible assets and
intellectual property rights can be the basis
for securitization.
Justin Wilson
• 2003 – Promising race car driver
• Chosen by Minardi , no sponsorship
• Required $ 2 million dollars
• Set up a company Justin Wilson Plc.
• Offered shares in his company to investors
• Gives the company rights to income from his
career for 10 years
Justin Wilson
• Targeted investors – British Formula one
Fanatics
• Security should provide sufficient financial
resources for Justin Wilson
• Generate attractive returns to investors
• Valuation of such a security ??
• Corporate Governance Problems and Conflicts
of Interests
Some other Examples
• Calvin Klein’s $58-million securitization in 1993, which was linked
to future sales of its perfume products.
• DreamWorks used $1-billion raised from the securitization of
copyright in a film portfolio to refinance outstanding credit
facilities in 2002.
• Walt Disney, which raised about USD 725 million from Industrial
Bank of Japan in 1988 through issuance of bonds against future
earnings of the park for the next 20 years.
• The deal was structured in such a way that the investors had to
bare any shortfall in the revenues and Disney continued to get its
royalties without losing any money. It was the Walt Disney brand
in which investors showed interest, faith and responded positively
in the market.
