Structured Finance: Asset-Backed Securities

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

2. Structured Finance • Asset-backed securitization • Corporate financial restructuring • Structured financing techniques

3. Asset-Backed Securities:The Typical Structure FORD (SPONSOR) LOANS. Servicing Agreement SALE OR ASSIGNMENT SPECIAL PURPOSE VEHICLE ISSUES LOANS. ASSET-BACKED CERTIFICATES

4. Legal Aspects LEGAL • 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.

5. Three conditions enable the separation of the assets and the originator LEGAL • 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. • The assets must be owned by a special-purpose corporation, whose ownership of the sold assets is likely to survive bankruptcy of the seller. • The special-purpose vehicle that owns the assets must be independent

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

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

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

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

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

11. Example: Ford Credit Owner Trust 1999-A

12. Ford Structure Ford Ford Motor Credit Sale Class A-5 and A-6 Ford Credit Auto Rec. Two LP Sale Ford Credit Auto Owner Trust Receivables Class A-1 to A6 Class B Class D Class C Class D

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

14. Trade receivables Trade receivables Trade receivables Trade Receivable-BackedCommercial Paper (ABCP) Corporation A Corporation B Corporation C Pool A Pool B Pool C Credit enhancement facility provider Liquidity facility provider Fees Fees SPECIAL PURPOSE VEHICLE “CONDUIT” Nominal dividends Payments on maturing ABCP Fees INVESTORS Sponsor/ administrator Legal owner

15. The Process Is the company ready? Are the assets suitable? What pool? What legal structure? What credit enhancement?

16. Case Studies Evaluate the pool and legal structure in: • Belenus • Ford

17. Belenus • What is the nature and value of the assets? • How strong is the legal structure? • Is the collateral sufficient? Would you recommend purchasing the second (B) tranche? • What could go wrong with this deal? What could go right?

19. Class Orig rating Curr rating Orig C/E 12/96 Curr C/E 11/98 A AA Paid 62 0 B A AA+ 48 95.5 C BBB AA- 38 75.6 Belenus Credit Enhancement

20. Ford Structure: Default or Loss? Receivables Class A-1 to A6 Class B Class C Class D

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

22. Ford Structure: Waterfall Receivables Class A-1 to A6 Class B Class C Class D

24. Ford Structure: Waterfall

25. Other Deals – Check the Paydown Structure • DVI Receivables • Stratford ABSresearch.com

26. Paydown: Waterfall vs Soft Bullet Structure

27. Implications of Waterfall Upgrades • 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.

29. www.stern.nyu.edu

30. www.giddy.org