The subjects involved in a Securitization transaction
The main subjects involved in a securitization transaction are:
- The Originator
- The Special Purpose Vehicle (SPV)
- The issuer of the securities, when these are not issued directly by the SPV
- Assets / liabilities transferred
- The person in charge of debt collection (servicer)
- The person in charge of the classification (rating company)
- Any suppliers of guarantees (credit enhancer)
In addition to these other figures, they are involved in the operation, such as the organizers of the operation (arrangers), law firms, the trustee, the intermediary bank, the agent for listing on the stock exchange, and many others.
The greater the complexity of the financial underlying, the greater the number of subjects involved.
He is the original holder of the assets. Law 130/99 does not set specific limits regarding the characteristics of this subject. It can be a subject of public or private law, an industrial or financial company, even if most of the operations have seen banks in this role. Since the costs of a securitization transaction are quite high, it is more convenient for the originator if the credits to be securitized have a significant volume. For this reason, many times it happens that it is made up of several subjects who can exploit the advantages of the operation in a pool, which then becomes a "multioriginator".
Since the originator is a multiple-faced person, the classes of assets to be securitized are also of various kinds; some examples are shown in table 1.1.
Table 1.1 Subjects and types of assets suitable for securitization
The list proposed is not exhaustive, the types of credit suitable for being securitized are among the most varied and the range of possible originators is so wide that even natural persons have participated in these transactions.
The common features of the assets to be divested are:
- long residual life (more than 12 months or better yet 24 months)
- fair diversification (geographic, sectoral, socio-economic), in order to reduce the vulnerability of the transferred portfolio with respect to the performance of the macroeconomic context
- clear and defined repayment plan (For example, the securitization of assets from credit cards, precisely because of the unpredictable repayment flows and the high percentage of insolvency, is still not easy to implement today.)
- individually of small size
One aspect worth pointing out is the nature of the credits to be securitized. These may be performing or non-performing, ie credits characterized by a situation of insolvency of the debtor; the law does not specify which may be subject to securitization, therefore both can be securitized.
However, the securitization transactions of "Non Performing Loans" (NPL = bad loans), even if they would allow the originator to eliminate the most problematic positions from its financial statements, are a sporadic phenomenon. The cause is to be found in the fact that securitizing non-performing loans does not favor the increase in turnover and the expansion of the market due to the low rating of the securities issued which makes them unattractive to investors. This operation therefore, if carried out, has the sole purpose of "cleaning" the balance sheet structures, improving some indices. Only by performing performing loan transactions is it possible to increase the market and make it competitive, with periodic operations to be carried out as soon as the portfolio containing the performing loans has reached a certain consistency.
The following discussion will focus almost exclusively on performing loans, leaving out the category of non-performing loans.
The Vehicle Company (SPV)
After identifying the activities to be securitized, the originator transfers them in bulk to the Special Purpose Vehicle. The SPV (or simply vehicle company) is a separate legal entity, already existing or created ad hoc, which issues and sells ABS securities that are guaranteed by the activities it received from the originator, with which it must not have any legal link.
The SPV is generally both a credit transferee and a securities issuer and has the sole purpose of raising funds that will be used only and exclusively for the purchase of the particular portfolio of loans identified. Furthermore, the flows deriving from the transferred portfolio will only be used to repay the capital and interest of the issue. In fact, the main feature of the vehicle is the fact that it has as its exclusive object the realization of one or more credit securitization operations.
Another aspect to be determined concerns the assignment of receivables which can take place both without recourse and without recourse. In this regard, it is underlined that one of the purposes for which the securitization is carried out is the elimination, from the assets of the transferor, of the credits subject of the transaction, the so-called "off-balance-sheet" or "off-balance sheet treatment" effect; this effect can only be obtained through an effective transfer of the portfolio to the SPV, that is, through a transfer without recourse. If, on the other hand, the assignor remains exposed, even only partially, to the risk of insolvency of the assigned debtors, we are in a situation of recourse transfer, in which the originator guarantees the solvency of the assigned debtors and therefore maintains the risk of non-payment.
The disposals are made mainly without recourse, for obvious advantages, and in any case, regardless of the type of assignment, it is very rare in practice that the assignor does not provide any guarantee on the assigned receivables.
Another important aspect is that the receivables relating to each securitization transaction must constitute a separate asset with respect to both the vehicle and that originating from other operations. So when the SPV issues the securities, the size of its capital for the success of the operation is irrelevant, given that the guarantee of repayment of the interest and of the capital to the investors subscribing the bonds is given not by the vehicle capital but by the ability of the selected loan portfolio to cope with debt service.
In summary, we can say that the main roles of the SPV are:
- Principal debtor to lenders (periodic repayment of the securities)
- Counterparty in the contracts underlying the transaction;
- Holder of the project's cash flows (funding collection and collection of credits)
During each collection period (usually quarterly or half-yearly), and in the hypothesis that there are no early repayments or cases of insolvency for the securities issued, the amounts collected by the vehicle in its account are used exclusively to pay the accrued interest, the reimbursement of planned capital, certain commissions and expenses; excess availability is returned to the originator.
Closely connected to the SPV is the figure of the trustee, a company that deals with the SPV on behalf of investors (safeguards their interests), for the placement of securities and for the payment of principal and interest on maturity. He is the guarantor of the correct fulfillment by the vehicle of all the commitments entered into. This role is usually held by a bank or a Corporate Financing company specializing in the provision of these services and has extensive powers in the management of the vehicle's activities.
Rating agencies estimate the likelihood of investors seeing their investment satisfied. They have the task of expressing a synthetic judgment on an issuer or an issue through a symbol (e.g. AAA) and an accompanying analysis that explains the reasons. The intervention of a rating agency is fundamental since there is the need to have a judgment that allows an effective assessment of the relationship between risk and return on the security, in particular it is an essential element for the investor who, through the rating, can assess whether a given security has a level of risk in line with the investment objectives set.
It should be noted that within a securitization transaction, the presence of one of a rating company is not essential. In fact, many Originators, because of the exorbitant costs of these agencies, give up on it.
The four American rating agencies that provide international ratings for structured transactions are - Standard & Poor’s Rating Group
- Moody’s Investors Service Limited
- Duff & Phelps Credit Rating Co.
Not all rating companies use the same symbology. The following table shows the correspondences of the symbols used by Standard & Poor’s and Moody’s.
Table 1.2 Symbology: correspondences between Moody’s and Standard & Poor’s.
The ratings are divided into two classes: investment and speculative. The first category includes all the ratings between 'AAA' and 'BBB'; the second all lower ratings, from 'BB' to 'D'. The AAA symbol denotes a very high credit quality, i.e. maximum solidity and maximum ability to pay interest. As you go down to double and single A, the credit quality decreases, even if it remains good up to triple B. In the latter case, the securities offer adequate security regarding the payment and repayment of the capital. , but the solvency of the issuer could be affected if there were worsening in the general economic situation or in the sector to which it belongs. Turning to the speculative level, the BB rating indicates that there is no danger of insolvency in the immediate future but the issuer is very vulnerable to changes in general economic and financial conditions. The favorable exogenous conditions are also decisive for the persistence of the solvency of the B-rated securities. Proceeding towards the C categories one encounters issuers with liquidity difficulties and the insolvency can easily materialize, this scenario worsens in the securities marked with the symbol D.
Regarding the rating, the law is expressed as follows: "In the event that the securities involved in the securitization transactions are offered to non-professional investors, the transaction must be subjected to the evaluation of the creditworthiness by third party operators6". The obligation to evaluate therefore applies only to offers addressed to the public, not to securities intended for professional investors, for which it is sufficient to draw up the prospectus according to the criteria established by law 130/99; however, the rating is required even when the law does not require it as it makes placement on the market easier.
The purpose of the agencies' analysis of the securitization transaction is, on the one hand, to assess the probability that the vehicle regularly makes interest and principal payments on the bonds issued, on the other, it allows the quantification and the determination of the type of guarantees that ensure the best coverage of the security issued.
There are no fixed and specific analysis criteria by the rating agencies, although despite the diverging methodologies, the main stages of the analysis are common to all.
The analysis mainly concerns: the solidity of the legal structure of the transaction, the quality of the loan portfolio and the risks associated with the various participants in the transaction. The first step is to analyze the performance of the transferred portfolio, the better the valuation of the securities to be issued, the greater the chances that investors will subscribe for the securities. In assessing the assigned credits, a qualitative and quantitative analysis is carried out. The latter consists of an analysis of the historical performance (usually a period of 5-10 years is considered significant) of portfolios of loans similar to those to be transferred, trying to project the results offered by the analysis also on the transaction to be fulfill. For example, collections, insolvencies, the rate of late payments and that of debt collection will be evaluated.
The qualitative analysis, on the other hand, takes into account the intrinsic characteristics of the assets, evaluating the interest rate of the loans, the sectoral concentration of the loans and the debtors. In fact, there are various factors that contribute to improving the judgment on the quality of the portfolio, such as:
- low concentration (geographic, by industry, by amount ..)
- collateral guarantees (e.g. real estate mortgages, collateral, bank guarantees)
- high quality debt (for example, companies with ratings, supranational entities, debtors domiciled in countries with high ratings)
- availability of regional or national statistics on the performance of the sector of reference of the activities.
Once the characteristics of the pool of securitized assets have been studied, the financial structure of the issue is analyzed: the cash flows and their allocation between the various classes of investors are mainly analyzed. Obviously the characteristics of the flows and their transfer to investors depend on the structure of the operation, which must however ensure that the deadlines relating to the financial flows deriving from the assets sold are such as to allow the timely payment due to the subscribers of the securities.
In evaluating cash flows, vintage analysis is often used, that is, a historical analysis of "aging" of the underlying assets. Following this technique, the assets that are placed as collateral for the securities issued are subjected to historical analysis and their progress is studied, the loss rates recorded in the past and the process of their creation by the originator. The ideal would be to have monthly data, but an analysis of this type implies the need to find a large number of data and therefore too many costs, therefore data is generally used on a half-yearly basis. The historical investigation is not essential but contributes to eliminating some sources of uncertainty and therefore to reach higher ratings. Another approach, which is not based on historical data, which is often used for consumer credit, is the credit scoring system. Here the study of cash flows focuses on the stress-scenario, that is, different scenarios of late payments and suffering are defined, and the probability is calculated. The determination of several negative scenarios allows to test which are the most vulnerable points of the structure; other factors that influence the performance of the asset and that depend on the type of securitized asset are also considered. In fact, a security that has residential mortgage loans as an underlying will be influenced by the interest rate, the probability of early repayment, rather than by late payments, time frames and loss percentages as in the case of securities issued against loans. commercial. Table 1.3 illustrates the main variables used to construct the scenarios, taking into account the peculiarities of the securitized asset.
Table 1.3 Active classes and related variables
The determination of the scenarios weighted by the probability of occurrence makes it possible to establish whether the level of credit enhancement, i.e. guarantees, with which the structure is equipped is sufficient or not. If it is not, further guarantees will be required in order to reach a certain rating (with a consequent rise in costs). The credit enhancement will be constructed in such a way as to cover both the capital losses on the debt and any reduction in collections that occurs up to the liquidation of the assets.
After collecting all this information, the rating agency determines its opinion on the basis of the worst-case scenario, that is, assuming the worst conditions under which the work can survive. Only after a long procedure, a "vote" is recognized, represented by the rating attributed to the issue which expresses the opinion on the riskiness of the obligation.
If the opinion of the rating agencies is negative, the solution usually consists either in increasing the collateral guarantees present in the structure, or in reducing the sale price of the loans or in verifying the financial stability of the transaction at lower rating levels.
The assignment of the rating favors both investors and issuers. Investors, in fact, having the need to maximize their return on the basis of their risk appetite, need correct, timely and easily interpretable information that can be easily obtained through the rating issued by international agencies of recognized reliability and independence.
In addition, the rating, thanks to its extreme conciseness, allows the investor to avoid costs for risk analysis and to quickly reach investment choices; in this way the creation of a more liquid market is favored thanks in particular to the access of international investors who, trusting in the ratings of the rating agencies, can avoid a direct and particularly expensive analysis.
By shifting attention to the issuing entity, obtaining a high rating allows him to check lower interests by virtue of the presumed greater solvency guaranteed by the high judgment of the agencies. In this way, the rating contributes to reducing the cost of debt thanks to the lower risk perceived by private and institutional investors. The same issuer can contact multiple agencies in order to obtain an overall judgment on the quality of the debtor or limited to a single issue; the presence of different judgments increases for investors the reliability of the assessments issued.
It should be emphasized that the rating does not constitute a guarantee of payment, nor can it be interpreted as a recommendation to buy or sell a particular security. Furthermore, the rating says nothing about the adequacy of a certain investment to the financial needs of a particular investor since this depends on his preferences and his risk appetite. The evaluation does not even provide a judgment on the adequacy of the market price of a certain financial instrument; for example a triple A security listed at 150 could be a good investment as a bad deal, it all depends on market conditions.
So even if the role of the rating agencies is fundamental for the negotiation of the ABS and, in general, for the good functionality of the markets, their evaluation must be correctly interpreted, also taking into account its limits.
Rating companies play an important role even after issuing the judgment, as they constantly monitor the progress of the credit standard of the issuer or of the issue, and promptly report any improvements (upgrades) or worsening (downgrades).
It constitutes the set of guarantees to be incorporated into the securitization structure, with the aim of limiting the risks on securitized credits and therefore ensuring the holders of the securities the payments provided for in the contract at the established deadlines.
In fact, if the objective is to obtain a high rating, the agency may request additional guarantees with respect to the "intrinsic" ones, that is, the separation of the assets represented by the assigned credits, the exclusivity of the corporate object and the other peculiar characteristics of the issuing-assignee company.
So another category of subjects to be analyzed in the discussion is that of credit enhancers11. Various credit enhancement tools are available, each of which, due to its intrinsic characteristics, will be more suitable for a certain type of asset rather than another. Of course, only a part of the transferred portfolio will be covered by a guarantee otherwise the costs would be such as to make the operation uneconomic.
We can divide credit enhancement tools into two large groups: internal and external credit enhancement. In the first case, the guarantees are provided by the originator himself, while in the second, third parties intervene to provide forms of guarantee in support of the operation.
The first category includes three main guarantee mechanisms:
▪ Overcollateralisation: The value of the portfolio of assets sold is higher than the value
of issue of the securities on the market. This creates an excess in the assets, and the SPV will have the means at its disposal to make up for any bad debts and repay the underwriters of the securities. For example, if the value of an asset portfolio is $ 100 against which $ 75 of senior securities are issued on the market, the overcollateralisation is 33% 12. In the event that no losses are incurred, the remaining funds will be returned to the originator at the end of the operation.
▪ Credit tranching: consists of a diversified issue of securities. In fact, it is quite frequent that different tranches of securities are issued, each of which has a different maturity, different degree of risk and therefore also a different rating. This type of issue allows investors to choose the solution that best suits their needs and objectives (investment, speculation, etc.).
Generally two tranches of securities are issued, one senior (or tranche A), characterized by a high rating, and one junior or subordinate, built to absorb losses on collateralised credits before they affect the senior class, usually held by the originator13; intermediate classes (mezzanine-class) are also often present.
Following this pattern, the cash flows available to investors are allocated according to an order of priority: the more subordinated tranches absorb the losses before the less subordinate ones, gradually until reaching the senior tranche which will be affected only residually. Therefore third parties (such as for example the administrator, the trustee, etc.) are paid first, then the interest due to the underwriters of securities from tranche A and finally the interest due to the subordinated investors, who therefore do not receive any refund until all the privileged ones have been repaid.
There are some factors that determine whether or not to make a tranche issue, they will be listed below.
First of all, it must be considered that the higher the rating, the lower the cost of issuing the debt. The rating of the most subordinated tranche influences the level of guarantees that must be given by the originator for the first loss. If the rating of the junior tranche is very low, the originator will be asked for a high amount of capital to cover any "first loss", that is, the loss that affects this tranche before the others due to subordination. This implies that the higher this level, the higher the costs of credit enhancement will be because the higher the capital that the originator must provide.
A definitely positive aspect of debt tranches with different ratings is that the securities can be allocated to different demand segments, facilitating their placement on the market.
Liquidity reserve: at the launch of the transaction, an account held in the SPV is opened on which part of the subscription proceeds of the securities is deposited, to cover any cash deficits of the SPV itself. The amount of funds to be deposited depends on the rating of the transaction, therefore it is decided in accordance with the criteria of the rating agencies. When, on the other hand, the credit enhancer is an external entity, letters of credit are often used (specific guaranteed line of credit whose possible use can provide full or partial coverage of the obligations of the SPV), insurance policies or derivative contracts, frequently swap contracts . The latter are financial hedging transactions, in which two counterparties undertake to exchange future cash flows. The agreement defines the dates on which payments are exchanged and how they are to be calculated. The two main types of swaps are: on currencies (currency swaps) and on interest rates (Interest Rate Swaps).
The latter serves to hedge against interest rate risk and its mechanism can be summarized as follows.
A party, A, enters into an agreement with counterparty B to pay them, for a certain number of years and on the basis of a reference capital called notional capital, a predetermined fixed rate. Part B in turn undertakes to pay A, on the same notional capital and for the same period of time, a variable rate, usually equal to the Euribor (3 or 6 months) plus a margin, determined from time to time .
This mechanism is becoming increasingly necessary within the structuring of a securitization.
Another credit enhancement tool is the back-up servicer. It is a servicer company that intervenes in the administration activity in case of failure or poor performance of the original servicer. This replacement mechanism confers an additional guarantee of proper functioning of the structure and ensures the continuity and regularity of the collection and monitoring of the assigned credits.
External credit enhancement can provide total or only partial financial support and its advantage over internal credit enhancement is represented by the fact that it allows the originator not to re-assume the risk of the portfolio transferred without thereby renouncing the improvement in the opinion on the issue. by the rating agency.
Below, in table 1.4, there is a brief description of the main risks inherent in a securitization transaction and the forms of credit enhancement that can be used.
Table 1.4 Risks and protection mechanisms in a securitization transaction
Figures for organization and control
Operator in charge of carrying out consultancy services aimed at defining the size, times, methods and risk profile of an operation, in order to make it acceptable to all lenders. In fact, having obtained the mandate, he draws up a timetable, that is, a complete list of the subjects involved, the times and steps necessary for the realization of each single phase of the operation. Once the process has started, this represents an excellent tool for checking compliance with the agreed timing.
The arranger bank is the institution or pool of banking institutions with a predominant role in the organization of the loan. It has the function of assisting the transferring customer in the structuring of the securitization transaction, of maintaining relations with the other counterparties involved (rating agencies, law firms, any providers of additional guarantees). Usually the arranger is also responsible for pricing, underwriting and allocating the securities issued to a group of selling banks.
It performs an important function of supervision and control of the regularity of the operation, ensuring the correct performance of the operations in the interest of the holders of securities and the market.
Normally it is established that the servicer must carry out the following control activities:
1) the sums deriving from the securitized assets must reach the SPV accounts dedicated to the operation, there must be no confusion with the assets of the special purpose vehicle and with the assets relating to the other securitization transactions;
2) The protection of the interests of the holders of the securities must be ensured at every stage of the operation. Particular attention will be given to the hypothesis of conflict of interest;
3) You must monitor the amount of the collections, particular attention must be paid
compliance with the scheduled deadlines.
In most securitization transactions it is the originator who performs this role, but of course requires the appropriate skills and procedures since the correct performance of this assignment is crucial for the regular performance of the transaction as a whole.
SECURITIZATION: GENERAL ASPECTS
1.2.1 The originator
1.2.2 The Special Purpose Vehicle
1.2.3 The rating company
1.2.4 Credit Enhancement
1.2.5 Figures for administration and control
1.3 Main advantages obtainable through securitization
1.3.1 Benefits for the originator
1.3.2 Benefits for investors
1.4 Birth and evolution of the securitization market
SECURITIES ANALYSIS ISSUED BY THE SECURITIZATION
2.1 General characteristics
2.1.1 The main ABS structures
2.2 The ABS placement market
THE ASSIGNMENT OF RATING IN SECURITIZATION OPERATIONS
3.1 Data analysis and modeling
3.2 Binomial Expansion Tecnique
3.2.1 Application of the "BET" method to a group of credits
ANALYSIS OF A SECURITIZATION OPERATION:
4.1 Analysis of the initial loan portfolio
4.2 Issuing of ABS
4.3 Forms of credit enhancement within the transaction
4.4 Transaction flows