Asset -Backed Securitiespages.stern.nyu.edu/~igiddy/ABS/cost-benefit.pdf · Asset -Backed Securities. ... ACCOUNTS RECEIVABLE ACCOUNTS RECEIVABLE ISSUES ASSET-BACKED ... Effect on

Asset-Backed Financing:Cost-Benefit Analysis

Prof. Ian GiddyStern School of Business

New York University

Asset-Backed Securities

Copyright ©2003 Ian H. Giddy ABS Cost/Benefit 2

Separation of Two Businesses: Origination and Lending

SPONSORINGCOMPANY

SPECIALPURPOSEVEHICLE

ACCOUNTSRECEIVABLE

ACCOUNTSRECEIVABLE

ISSUESASSET-BACKEDCERTIFICATES

SALE ORASSIGNMENT


For Corporations: “Pure Play” Argument

Separate the credit of the assets from the credit of the originator:

q Identify and isolate good assets from a company or financial institution

q Use those assets as backing for high-quality securities to appeal to investors.

q Such separation makes the quality of the asset-backed security independent of the creditworthiness of the originator.


Sears: Asset-Backed Financing?

SEARS


The Keys to Successful Asset Securitizationq The economic elements that make this

technique work areu to isolate the assets, thus making them more

identifiable, secure and liquid, u to transfer risks to those best able to evaluate and

bear them, and u to create tradeable securities

q Adds economic efficiency through cost savings to borrowers, creation of investment opportunities for investors, and development of the capital market.


Prerequisites to Successful Asset Securitization (cont.)

qMonitoring is not impaireduincentive for the originator to keep defaults

to a minimumumonitoring role for rating agencies,

guarantors and trustees.

q Legal and tax framework ufacilitates asset sale and separationuprotects both issuers and investors


Costs Associated with Securitization

q Interest cost of the debtq Issuance expenses of the debtqAlso:uCredit enchancement and liquidity support

for the assetsuStructuring fees payable to bankersuLegal, accounting and tax advice feesuRating agencies' feesuSystems modificationsuManagement time


The Key Lies in the Excess Servicing Fees

SPONSORINGCOMPANY

SPECIALPURPOSEVEHICLE

ACCOUNTSRECEIVABLE

ACCOUNTSRECEIVABLE

ISSUESASSET-BACKEDCERTIFICATES

SALE ORASSIGNMENT

ExcessServicingFees


Sample Cost/Benefit Analysis

With securitization Without securitizationPortfolio yield 18.50% 18.50%Funding cost -7.22% -9.00%Default rate -5.00% -5.50%Amortized upfront issuance costs -0.10% -0.05%Amortized upfront securitization costs -0.20%Annual costs of guarantees and credit lines -0.25%Annual additional costs (systems, reporting, trustee fees, etc) -0.25%Effect on sponsor's marginal cost of capital 0.00%

Profits 5.48% 3.95%

Net savings from securitization 1.53% per annum


Ford Credit Auto Owner Trust

qWhat are the economic benefits and costs to Ford in this ABS deal?

qWhat do the underlying assets earn?qWhat rates do the securities pay?qOther costs?qWho gets the excess spread?



q Interest costq Underwriting feesq Rating agency and other securitization costsq Servicing feesq Other costsq Default losses….compare with Ford Credit’s alternative



Size 1,462,716$ FORD 1999-A Underwriting fees 2,311,593$ 0.08%

Other costs 1,000,000$ 0.03%Total upfront costs 0.11%WAM 3.941667 yearsPortfolio yield 9.80%Funding cost 5.30%Default rate 1.50%Servicing fee 1%Total upfront costs 0.03%Excess servicing fee 1.97%

A 1855 93% 5.20% 4.82%B 69 3% 5.79% 0.20%C 39 2% 6.52% 0.13%D 39 2% 8.00% 0.16%

2002 5.30%

Ford Credit

Ford Credit Auto Rec 2 LP Trust 1998-B

Receivables

Receivables ReceivablesClass A - AAA

93%

Class B - AA3%

Class C - BBB2%

Class D - NR2%


Corporation or Financial Institution requires additional funds to givecustomers financing or to finance a future revenue stream.

Are funds freely available from banks ?

Does the firm/FI have good, self-liquidatingassets ?

Do the assets have a sufficiently high yieldto cover servicing and other costs ?

Would the assets be worth more (have a cheaper all-in funding cost) if they were

isolated from the company/FI ?

Securitize the assets

Borrow frombanks

Issue equity ormezzanine capital

Get out of thefinancingbusiness

Use assets as collateral for on-balance

sheet debt

No

Yes

Yes

Yes

Yes

No

No

No

The Decision Process


For Banks: Capital Requirements

q In a perfect world, adding good assets would require little additional capital, since creditors would not see any increase in the bank's risk

q But if regulatory capital requirements penalize banks for holding such assets, they should: usecuritize the good assetsuprofit from origination and servicing

q In general, regulatory costs or rigidities create an incentive for banks to shrink their balance sheets by securitizing loans


A Bank’s Capital Savings

Securitization Cost-Benefit Analysis(for a regulated financial institution)

Gain/cost($ millions)

Funding cost savings C Two-year bank notes vs pass-though rate

1.1

Upfront costs C UnderwritingC SEC filing, legal fees, etc

(2.6)

Ongoing costs C Letter-of-credit fee (0.5)

Capital charge C Cost of capital at 25% (15%after tax)

7.7

Net benefit 5.7


Basel 2 for Investing Banks

AAA to AA- 20%A+ to A- 50%BBB+ to BBB- 100%BB+ to BB- 150%B+ and below Deducted from capital

Source: Basel Committee on Banking Supervision, January 2001


Basel 2 and Loan Securitization

qOriginating banks (“clean break”)q Investing banks (use of ratings)qSponsor banks (for ABS conduits)qSynthetic securitization (degree of risk

transference)

How will this affect Asian banks?


Banks – Capital Savings

For banks:

Credit Enhancement Calculation

Assets LiabilitiesLoan Portfolio Securities Classes

From A From BB+From B

A 50 AAA 47.5 52.5 32.8 132.8BB+ 100 AA 0B 100 NR 117.2

250 250

Capital: 20 Capital: 9.376

Cost CostDebt 7% ABS 5%Equity 15% Debt 8%

Equity 16%Total 7.64% Total 6.71%


Investor Viewpoint: Spread Analysis


Spread Analysis


Spread Analysis


Belenus Credit Enhancement

38

48

62

Orig C/E12/96

75.6AA-BBBC

95.5AA+AB

0PaidAAA

CurrC/E11/98

Curr rating

Orig rating

Class

Ford Structure: Waterfall


Implications of Waterfall Upgrades

q 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.

q 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.

q An ABS portfolio should be traded much more actively than a corporate loan portfolio to take advantage of its inherent rating volatility.


Asiansecuritization.com

Ian H. GiddyStern School of BusinessNew York University44 West 4th Street, New York, NY 10012, USA

Tel [email protected]://giddy.org

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Asset -Backed Securitiespages.stern.nyu.edu/~igiddy/ABS/cost-benefit.pdf · Asset -Backed Securities. ... ACCOUNTS RECEIVABLE ACCOUNTS RECEIVABLE ISSUES ASSET-BACKED ... Effect on