Asset-Backed Securities: Managing the Credit Risks

Transcription

1 Managing the Credit Risks/1 Asset-Backed Securities Asset-Backed Securities: Managing the Credit Risks Prof. Ian Giddy Stern School of Business New York University Asset-Backed Securities: Managing the Risks Identifying the risks The role of rating agencies Managing the credit risks Managing the sovereign risks Copyright 2000 Ian H. Giddy Managing Credit Risks 3

2 Managing the Credit Risks/2 Identifying the Risks Credit risks Liquidity risk Servicer performance risk Swap counterparty risk Guarantor risk Legal risks Sovereign risk Interest rate and currency risks Prepayment risks Copyright 2000 Ian H. Giddy Managing Credit Risks 4 Managing the Risks FIRST LOSS PROVIDER SPECIAL INSURER (HAZARD, ETC.) ORIGINATOR SERVICER POOL PERFORMANCE GUARANTOR OWNER SUB- ORDINATED INVESTORS INTEREST & PRINCIPAL GUARANTOR SELL ASSETS (MAY ADD MORE) 3 2 ASSETS OVER- COLLATERAL Special Special Purpose Purpose Company Company (or (or Trust) Trust) 1 SENIOR INVESTORS LIQUIDITY FUND RESERVE FUND CAP OR COLLAR PROVIDER SWAP COUNTER- PARTY PERMITTED INVESTMENTS Copyright 2000 Ian H. Giddy Managing Credit Risks 5

3 Managing the Credit Risks/3 Form of credit enhancement Pre-securitization risk reduction Credit risk reduction of the asset Credit risk reduction at the trust level Legal structure based credit risk reduction Form of credit enhancement Pre-securitization risk reduction Screening of assets to be included in the portfolio Diversification of the portfolio Issuer-provided enhancement Credit risk reduction of the asset Third party credit guaranty Pooler credit guaranty Credit risk reduction at the trust level Senior/subordinated ABS Repackaging of cash flows Legal structure based credit risk reduction Legal insulation from originator default Legal insulation from servicer default

4 Managing the Credit Risks/4 Form of credit enhancement Pre-securitization risk reduction Screening of assets to be included in the portfolio Diversification of the portfolio Replacement of sub-standard assets Issuer-provided enhancement Direct recourse Credit risk reduction of the asset Overcollateralization Third party partial enhancement Third party credit guaranty Third party full enhancement Pooler credit guaranty Credit risk reduction at the trust level Senior/subordinated ABS Repackaging of cash flows Legal structure based credit risk reduction Legal insulation from originator default Legal insulation from servicer default Rating Agencies Why a rating? compare alternatives across different ratings categories; obtain a relative as well as an absolute measure of credit risk be reasonably sure of a market to sell the security. Copyright 2000 Ian H. Giddy Managing Credit Risks 9

5 Managing the Credit Risks/5 Managing the Risks: Role of the Rating Agencies Asset portfolio analysis Legal structure of the transaction Credit quality of the originator The trustee The cash flow structure The counterparties Copyright 2000 Ian H. Giddy Managing Credit Risks 10 Key Factors Agencies Examine the quality of the pool of assets, evaluated as a portfolio the credit quality of all the parties to the deal. operational support for servicing, transfer, recording, follow-up, etc; credit enhancement legal structure sovereign risks market price risks payment timing risks Copyright 2000 Ian H. Giddy Managing Credit Risks 11

6 Managing the Credit Risks/6 Aspects of the Business Reviewed by Rating Agencies and the Credit Enhancer Organization and management structure Financial performance Business strategy and planning processes Controls and procedures Asset origination and credit assessment procedures Quality of its loan documentation Credit administation and debt recovery procedures Copyright 2000 Ian H. Giddy Managing Credit Risks 12 Role of Originator's Review Systems Produce historical information on the assets to be securitized Identify and segregate the securitizable assets and track their cash flows Report on the performance of the securitized assets Copyright 2000 Ian H. Giddy Managing Credit Risks 13

7 Managing the Credit Risks/7 Rating Agency Requirements - 1 Legal Structure Information on parties involved in the ABS issuance, namely, the originator(s), servicer, merchant bank, lawyers, accountants, trustees, credit enhancer, liquidity banks. Proposed legal structure and documentation e.g., type of assets to be securitised, senior/subordination features; passthroughs/pay-throughs, any recourse provisions, corporation/trust, over-collateralisations, other risks and claims structure, etc. Legal and accounting opinions (and subsequently regulator's opinion) on the characterization of the transferred assets i.e., a "true sale" or "pledge". The legal opinion should also extend to opinions on the possible impact of the issuer's bankruptcy on the securitised assets, liability to stamp duty and sales tax. Tax opinions on how to SPV would be taxed and whether investors' investment in the ABS represent debt or equity to the SPV. Copyright 2000 Ian H. Giddy Managing Credit Risks 14 Rating Agency Requirements - 2 Credit Risk 10-year industry statistics/analysis on the assets to be securitised e.g., yield statistics of assets, non-performing loans, ageing/delinquencies, customer demographics and repossession rate. Summarized 10-year historical records/statistics on the originator's HP portfolio, focusing on portfolio performance and characteristics including the following: growth yield underwriting standards and loan terms/maturity recourse provisions to motor-vehicle dealers ageing/delinquencies rate collection and recovery procedures (including repossession rate) customer profile/demographics new versus used equipment prepayment history Copyright 2000 Ian H. Giddy Managing Credit Risks 15

8 Managing the Credit Risks/8 Rating Agency Requirements - 3 Credit Risk (continued) Information on the intended pool selection process including the following: maturity period seasoning loan to value of assets whether insured, types of policy, insure amount delinquency factor any previous extension and rewrites interest rate Cash Flow Structure Cash flow mechanics/control Timing of receipts and payments Liquidity support Copyright 2000 Ian H. Giddy Managing Credit Risks 16 Managing the Credit Risks The assets are chosen and the legal structure designed to get an investment grade rating. Internal credit improvement, eg. the SPV's debt is "overcollateralized", or the parent agrees to replenish the asset pool if its value falls, or the SPV has a subordinated debt tranche External credit improvement, eg. a guarantee or letter of credit is purchased from a third party Copyright 2000 Ian H. Giddy Managing Credit Risks 17

9 Managing the Credit Risks/9 Asset-Backed Securities: Managing the Risks LOCs and and puts puts Cash Cash collateral Overcollaterization Over- First-Loss Protection Second- Loss Protection Senior/ subordinate structure Recourse to to originator Copyright 2000 Ian H. Giddy Managing Credit Risks 18 Over-Collateralization/ Subordinated Tranche SPECIAL-PURPOSE VEHICLE COLLATERAL POOL SENIOR ASSET-BACKED SECURITIES OVER-COLLATERAL SUBORDINATED ABS (may be owned by seller) Copyright 2000 Ian H. Giddy Managing Credit Risks 19

10 Managing the Credit Risks/10 Senior/Subordinated Structure with Cash Reserve Account Cash Collateral Account Proceeds Seller/Servicer Proceeds Receivables Residual Interest Subordinated Investor Interest Principal and Interest Subordinated Certificates Grantor Trust Principal and Interest Senior Certificates Senior Investor Interest LOC Credit Enhancement Copyright 2000 Ian H. Giddy Managing Credit Risks 20 Use of a Cash Reserve Account Borrower 1 Originating Bank 2 4 Letter of Credit Bank 7 Trustee Reserve Account Investors 8 Copyright 2000 Ian H. Giddy Managing Credit Risks 21

11 Managing the Credit Risks/11 Use of a Cash Reserve Account Borrower 1 Bank Letter of Credit Trustee 6 Reserve Account 5 3 Investors 8 1 The payments are made to the bank, as before the sale 2 The bank passes the payments on to the trustee 3 The trustee pays investors their interest 4 The trustee pays the bank a fee for servicing the loan 5 The difference between the porfolio yield, the investor interest and the servicing fee is paid to the reserve account 6 The reserve account is used to reimburse the letter of credit bank for 7 draws occasioned by defaults by borrowers on the loans 8 When the reserve account reaches its cap, excess funds flow back to the selling bank. Copyright 2000 Ian H. Giddy Managing Credit Risks 22 Managing the Sovereign Risks Secure sovereign guarantees Employ offshore jurisdictions Securitize foreign-source assets or cash flows Obtain a guarantee from a foreign financial institution Copyright 2000 Ian H. Giddy Managing Credit Risks 28

12 Managing the Credit Risks/12 Managing the Risks: Offshore Purchase Agreement YPF (Latin American oil producer) Oil (under sales agreement) US$ Oil (under purchase agreement) Oil Trading Co. (Cayman Is. SPV) Highly rated U.S. oil buyer Notes US$ US$ Noteholders Trust Fixed debt payments Copyright 2000 Ian H. Giddy Managing Credit Risks 29 Asset-Backed Securities Asset-Backed Securities: Role of Financial Guarantees Prof. Ian Giddy Stern School of Business New York University

13 Managing the Credit Risks/13 Role of Financial Guarantees Why use guarantees? The guarantors: banks, pool insurers, financial guarantors What do they guarantee? Who guarantees the guarantors? Getting a guarantee Cost of a guarantee Ongoing monitoring by the guarantee companies Copyright 2000 Ian H. Giddy Managing Credit Risks 31 The Financial Guarantors Banks General property/casualty companies providing "pool" insurance Specialized financial guaranty companies Copyright 2000 Ian H. Giddy Managing Credit Risks 32

14 Managing the Credit Risks/14 What do they Guarantee? Full principal and interest guarantee Partial guarantees Copyright 2000 Ian H. Giddy Managing Credit Risks 33 Who Guarantees the Guarantors? Regulatory controls Rating the guarantors Role of reinsurance Copyright 2000 Ian H. Giddy Managing Credit Risks 34

15 Managing the Credit Risks/15 Practical Aspects of Financial Guarantees Getting a guarantee Cost of a guarantee Ongoing monitoring by the guarantee companies Copyright 2000 Ian H. Giddy Managing Credit Risks 35 globalsecuritization.com Ian H. Giddy Stern School of Business New York University 44 West 4th Street, New York, NY 10012, USA Tel ; Fax ian.giddy@nyu.edu Copyright 2000 Ian H. Giddy Managing Credit Risks 38