1. Prof. Ian Giddy New York University Financing with Asset-Backed Securities SIM/NYU The Job of the CFO

2. Copyright ©2001 Ian H. Giddy Asset Securitization 2 giddy.org Asset-Backed Securities l The technique l Legal, tax and accounting issues l The economics l An application l ABS in Asia

3. Copyright ©2001 Ian H. Giddy Asset Securitization 3 giddy.org Securitization of Assets l Securitization is the transformation of an illiquid asset into a security. l For example, a group of consumer loans can be transformed into a publicly-issued debt security. l 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.

4. Copyright ©2001 Ian H. Giddy Asset Securitization 4 giddy.org What is the Technique for Creating Asset-Backed Securities? l A lender originates loans, such as to a homeowner or corporation. l The securitization structure is added. The bank or firm sells or assigns certain assets, such as consumer receivables, to a special purpose vehicle. l The structure is legally insulated from management l The SPV issues (usually) high-rated debt.

5. Copyright ©2001 Ian H. Giddy Asset Securitization 5 giddy.org SPONSORING COMPANY SPECIAL PURPOSE VEHICLE ACCOUNTS RECEIVABLE ACCOUNTS RECEIVABLE ISSUES ASSET-BACKED CERTIFICATES SALE OR ASSIGNMENT Securitization: The Basic Structure

6. Copyright ©2001 Ian H. Giddy Asset Securitization 6 giddy.org 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. IMPLEMENTATION

7. Finance Company Limited

8. Copyright ©2001 Ian H. Giddy Asset Securitization 8 giddy.org Case Study: The Company (Finance Company Limited) l Finance company whose growth is constrained l Has pool of automobile receivables l Has track record l Plans to use this as an ongoing source of financing

9. Copyright ©2001 Ian H. Giddy Asset Securitization 9 giddy.org Securitize the assets Form of transfer of asset Form of credit enhancement Form of transformation of cash flows Form of cash flow allocation Decisions Form of special purpose vehicle Key Decisions

10. Copyright ©2001 Ian H. Giddy Asset Securitization 10 giddy.org Finance Co. Ltd (Seller) Finance Co.’s Customers Hire-Purchase Agreement Case Study: Initial Exchanges

11. Copyright ©2001 Ian H. Giddy Asset Securitization 11 giddy.org Finance Co. Ltd (Seller) FCL 1997-A (Special Purpose Co.) Investors Proceeds Finance Co.’s Customers Hire-Purchase Agreement Case Study: Initial Exchanges

12. Copyright ©2001 Ian H. Giddy Asset Securitization 12 giddy.org Finance Co. Ltd (Seller) FCL 1997-A (Special Purpose Co.) Investors Servicing Agreement Proceeds Sale of Assets Proceeds Asset-Backed Securities Trustee Trust Agreement Finance Co.’s Customers Hire-Purchase Agreement Case Study: Initial Exchanges

13. Copyright ©2001 Ian H. Giddy Asset Securitization 13 giddy.org Finance Co. Ltd (Seller) FCL 1997-A (Special Purpose Co.) Investors Servicing Agreement Proceeds Sale of Assets Proceeds Asset-Backed Securities Rating Agency Top Rating Trustee Trust Agreement Finance Co.’s Customers Hire-Purchase Agreement Case Study: Initial Exchanges

14. Copyright ©2001 Ian H. Giddy Asset Securitization 14 giddy.org Finance Co. Ltd (Seller) FCL 1997-A (Special Purpose Co.) Investors Financial Guarantee Provider (if required) Servicing Agreement Proceeds Sale of Assets Proceeds Asset-Backed Securities Guarantee Agreement Rating Agency Top Rating Trustee Trust Agreement Finance Co.’s Customers Hire-Purchase Agreement Case Study: Initial Exchanges

15. Copyright ©2001 Ian H. Giddy Asset Securitization 15 giddy.org Finance Co. Ltd (Seller) FCL 1997-A (Special Purpose Co.) Investors Financial Guarantee Provider Monthly HP Payments Guarantee Responsibilities Trustee Responsibilities Monthly ABS Payments Servicing Fees Finance Co.’s Customers Hire-Purchase Payments Case Study: Ongoing Payments

16. Copyright ©2001 Ian H. Giddy Asset Securitization 16 giddy.org Getting a Rating: The Risks l Credit risks l Liquidity risk l Servicer performance risk l Swap counterparty risk l Guarantor risk l Legal risks l Sovereign risk l Interest rate and currency risks l Prepayment risks

17. Copyright ©2001 Ian H. Giddy Asset Securitization 17 giddy.org SPONSORING COMPANY SPECIAL PURPOSE VEHICLE ACCOUNTS RECEIVABLE ACCOUNTS RECEIVABLE ISSUES ASSET-BACKED CERTIFICATES SALE OR ASSIGNMENT CREDIT ENHANCEMENT CREDIT ENHANCEMENT SOVEREIGN PROTECTIONS SOVEREIGN PROTECTIONS INTEREST RATE/ CURRENCY HEDGES INTEREST RATE/ CURRENCY HEDGES CASH FLOW REALLOCATION CASH FLOW REALLOCATION Risk-Management Techniques in ABS

18. Copyright ©2001 Ian H. Giddy Asset Securitization 18 giddy.org Finance Co. Ltd (Seller) FCL 1997-A (Special Purpose Co.) Senior Proceeds Sale of Assets Rating Agency Top Rating Credit Enhancement: An Alternative Approach Subordinated More Subordinated Lower Rating No Rating

19. Copyright ©2001 Ian H. Giddy Asset Securitization 19 giddy.org Choose a Structure to Suit the Type of Assets to be Securitized l Mortgage Securitization l Non-Mortgage ABS l Intangibles l Infrastructure and Project Financing

20. Copyright ©2001 Ian H. Giddy Asset Securitization 20 giddy.org Asset-Backed Securities: Legal and Regulatory Aspects l Legal  The Transfer  The Special-Purpose Vehicle l Taxation l Accounting Treatment l Bank Regulatory Treatment

21. Copyright ©2001 Ian H. Giddy Asset Securitization 21 giddy.org Legal Aspects l 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 l 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. LEGAL

22. Copyright ©2001 Ian H. Giddy Asset Securitization 22 giddy.org Three conditions enable the separation of the assets and the originator l 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. l The assets must be owned by a special- purpose corporation, whose ownership of the sold assets is likely to survive bankruptcy of the seller. l The special-purpose vehicle that owns the assets must be independent LEGAL

23. Copyright ©2001 Ian H. Giddy Asset Securitization 23 giddy.org What Makes it a Sale? l The form and treatment of the transaction l The nature and extent of the benefits transferred l The irrevocability of the transfer l The level and timing of the purchase price, l Who possesses the documents l Notification when the assets are sold LEGAL

24. Copyright ©2001 Ian H. Giddy Asset Securitization 24 giddy.org What Makes it Likely to be Consolidated? l The difficulty of segregating and ascertaining individual assets and liabilities l The presence or absence of consolidated financial statements l The comingling of assets and business functions l The existence of parent and intercorporate guarantees and loans l The transfer of assets without strict observance of corporate formalities. LEGAL

25. Copyright ©2001 Ian H. Giddy Asset Securitization 25 giddy.org Taxation Aspects l 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 l Seller/servicer l Trust or special-purpose corporation l Investors TAX

26. Copyright ©2001 Ian H. Giddy Asset Securitization 26 giddy.org Accounting Treatment l Sale versus financing l Consolidation l Accounting for loan servicing ACCOUNTING

27. Copyright ©2001 Ian H. Giddy Asset Securitization 27 giddy.org FASB Sale Treatment l The transferor relinquishes control of the future economic benefits embodied in the assets being transferred l The SPV cannot require the transferor to repurchase the assets except pusuant to certain recourse provisions l The transferor's obligation under any recourse provision are confined and can be reasonably estimated ACCOUNTING

28. Copyright ©2001 Ian H. Giddy Asset Securitization 28 giddy.org Consolidation Treatment l International accounting standards hold that consolidated financial statements are more meaningful than separate ones l "Nonhomogeneous operation" exception l Finance, insurance, real estate and leasing subsidiaries can generally be left apart ACCOUNTING

29. Copyright ©2001 Ian H. Giddy Asset Securitization 29 giddy.org Fees l Loan-origination fees. These are deferred and recognized over the life of the loan as an adjustment of yield. l Commitment fees. These are to be deferred. l Syndication fees. These should be recognized when the syndication is complete unless the originator retains a portion of the syndicated loan. ACCOUNTING

30. Copyright ©2001 Ian H. Giddy Asset Securitization 30 giddy.org Bank Regulation and Capital Requirements l Goal: Ensure that the substance and not the form of the asset transfer is what governs capital requirements. The regulatory authorities may assess capital or reserve requirements as if the financing was a secured borrowing:

31. Copyright ©2001 Ian H. Giddy Asset Securitization 31 giddy.org Bank Regulation: Issues in Asia l Avoid excessive bank risk-taking l Discourage speculative investments l Prevent financial market scandals l Prevent circumvention of deposit regs l Encourage financing of capital investment l Discourage financing of consumption l Promote development of capital markets

32. Asset Securitization: Cost-Benefit Analysis

33. Copyright ©2001 Ian H. Giddy Asset Securitization 33 giddy.org Separation of Two Businesses: Origination and Lending

34. Copyright ©2001 Ian H. Giddy Asset Securitization 34 giddy.org Separation of Two Businesses: Origination and Lending Asset securitization makes sense when the assets are worth more outside the company than within But what makes them worth more outside?

35. Copyright ©2001 Ian H. Giddy Asset Securitization 35 giddy.org For Banks: Capital Requirements l In a perfect world, adding good assets would require little additional capital, since creditors would not see any increase in the bank's risk l But if regulatory capital requirements penalize banks for holding such assets, they should:  securitize the good assets  profit from origination and servicing l In general, regulatory costs or rigidities create an incentive for banks to shrink their balance sheets by securitizing loans

36. Copyright ©2001 Ian H. Giddy Asset Securitization 36 giddy.org A Bank’s Capital Savings Securitization Cost-Benefit Analysis (for a regulated financial institution) Gain/cost ($ millions) Funding cost savings  Two-year bank notes vs pass- though rate 1.1 Upfront costs  Underwriting  SEC filing, legal fees, etc (2.6) Ongoing costs  Letter-of-credit fee(0.5) Capital charge  Cost of capital at 25% (15% after tax) 7.7 Net benefit5.7

37. Copyright ©2001 Ian H. Giddy Asset Securitization 37 giddy.org For Corporations: “Pure Play” Argument Separate the credit of the assets from the credit of the originator: l Identify and isolate good assets from a company or financial institution l Use those assets as backing for high-quality securities to appeal to investors. l Such separation makes the quality of the asset-backed security independent of the creditworthiness of the originator.

38. Copyright ©2001 Ian H. Giddy Asset Securitization 38 giddy.org Sears: Asset-Backed Financing? SEARS

39. Copyright ©2001 Ian H. Giddy Asset Securitization 39 giddy.org Why Did Chrysler Use ABS in 1992? l Downgraded to B+ in early 1992 l Lost access to its normal funding sources l Needed to continue to fund its car loans l Only way to do this was to securitize the loans l “Firms that securitize tend to have considerably weaker credit quality than other firms.”

40. Copyright ©2001 Ian H. Giddy Asset Securitization 40 giddy.org Costs Associated with Securitization l Interest cost of the debt l Issuance expenses of the debt l Also:  Credit enchancement and liquidity support for the assets  Structuring fees payable to bankers  Legal, accounting and tax advice fees  Rating agencies' fees  Systems modifications  Management time

41. Copyright ©2001 Ian H. Giddy Asset Securitization 41 giddy.org Costs Needed to Measure the Annual Pre-Tax Impact of Securitization l The interest on the securitized funding l The annual costs of credit enhancement/liquidity lines l Any guarantees to enhance the credit rating of any interest rate or foreign exchange swap counterparty l Amortized front-end fees (debt issuance, credit enhancement, liquidity lines) l Amortized transaction costs (legal, accounting, structuring, rating, etc.) l Opportunity costs relating to any temporary cash retention in any guaranteed investment contract (GIC) l Annual systems/accounting/rating agency costs etc.

42. Copyright ©2001 Ian H. Giddy Asset Securitization 42 giddy.org Sample Cost/Benefit Analysis

43. Copyright ©2001 Ian H. Giddy Asset Securitization 43 giddy.org Corporation or Financial Institution requires additional funds to give customers financing or to finance a future revenue stream. Are funds freely available from banks ? Does the firm/FI have good, self-liquidating assets ? Do the assets have a sufficiently high yield to 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 from banks Issue equity or mezzanine capital Get out of the financing business Use assets as collateral for on-balance sheet debt No Yes No The Decision Process

44. Project Financing Prof. Ian Giddy Stern School of Business New York University Asset-Backed Securities

45. Copyright ©2001 Ian H. Giddy Asset Securitization 45 giddy.org Asset-Backed and Project Financing l Collateralized debt l Securitized loans l Non-recourse project debt l Basic question: Why should a company segregate the cash flows from a particular business, and make it self- financing?

46. Copyright ©2001 Ian H. Giddy Asset Securitization 46 giddy.org Project Financing l Stand-alone, non-recourse, multi-stake, "production payment financing " l Structure? l Participants? l Funding sources? l Risks?

47. Copyright ©2001 Ian H. Giddy Asset Securitization 47 giddy.org Project Financing (Summary) l Stand-alone, non-recourse "production payment financing" l Sponsor's vehicle company structures multi-stake finance l Sources: govt development financing, IBRD/IFC, sponsor loans, supplier credits, customer credits, institutional investors, banks, lease financing, equity l Risks: resource quantity, input costs, technical, timing, pre-completion, demand, operating, force majeure, political l Risk sharing and mitigation

48. Copyright ©2001 Ian H. Giddy Asset Securitization 48 giddy.org Project Financing Definition l Lending to a single purpose entity for the acquisition and /or construction of a revenue- generating asset with limited or no recourse to the sponser l Repayment of the loan is solely from the revenues generated from operation of the asset owned by the entity l Security for the loan u the revenue generating asset u all shares and interests in the entity u real property u all contacts, permits u authorizations, etc.; and, u all other instruments necessary for continuing project operations

49. Copyright ©2001 Ian H. Giddy Asset Securitization 49 giddy.org Project Financing Definition l Lending to a single purpose entity for the acquisition and /or construction of a revenue- generating asset with limited or no recourse to the sponser l Repayment of the loan is solely from the revenues generated from operation of the asset owned by the entity l Security for the loan u the revenue generating asset u all shares and interests in the entity u real property u all contacts, permits u authorizations, etc.; and, u all other instruments necessary for continuing project operations Steps Project Identification & Resource Allocation Risk Allocation & Project Structuring Bidding & Mandating Contracts Due Diligence & Documentation Execution & Monitoring Construction Monitoring Term Loan Conversion & Ongoing Monitoring

50. Copyright ©2001 Ian H. Giddy Asset Securitization 50 giddy.org Benefits of Project Financing l Limitation of Equity Investment to Project’s Economic Requirement - Enhanced Returns l Risk Sharing and Diversification l Accounting Treatment Preserves Corporate Borrowing Capacity l Access to Long Term Financing l Tax Benefits l Political Risk Mitigation

51. Copyright ©2001 Ian H. Giddy Asset Securitization 51 giddy.org The Risks l Political l Resource & input l Technical l Construction l Legal l Economic n Cost overruns n Completion delays n Mounting interest expenses

52. Copyright ©2001 Ian H. Giddy Asset Securitization 52 giddy.org Eurotunnel: The Risks and the Remedies

53. Copyright ©2001 Ian H. Giddy Asset Securitization 53 giddy.org Sample Structure Sponsors / Shareholders SINGLE PURPOSE PROJECT COMPANY Equipment Supplier Contractor Feed Stock (e.g., fuel) Supplier Warranties and Supply Agents Operator Turnkey Construction Long Term Agreement Operations & Maintenance Mgmt Purchaser Syndicate Banks Other Project Participants: Currency and Interest Rate Hedge Providers Multilaterals and EDA’s Legal Counsel Technical Consultants Offtake (e.g, power purchase) Agreement Arranging Bank

54. Copyright ©2001 Ian H. Giddy Asset Securitization 54 giddy.org Ras Laffan l Who is the issuer?  Ras Laffan LNG Co. Ltd. (Qatar)  But Security Trustee (IBJ) plays unusually major role l What assets does it have?  Natural gas reserves;  LNG take-or-pay Sale and Purchase Agreement with Korea Gas;  Security Trust Agreement; Project Coordination Agreement; loan refund agreement, etc.

55. Copyright ©2001 Ian H. Giddy Asset Securitization 55 giddy.org Ras Laffan l What are the risks, and how are they handled?  Qatar/regional interference  Qatar legal system  Default on Agreements  Completion/timing  Operating  Economic (LNG market)

56. Copyright ©2001 Ian H. Giddy Asset Securitization 56 giddy.org Ras Laffan: Natural Gas Project Finance Ras Laffan Liquified Natural Gas Korea Gas Security Trustee LNG payments Debt service payments

57. Ras Laffan Liquified Natural Gas Korea Gas Security Trustee (New York) Bondholders Mobil QM (Mobil Corp.) Qatargas (State of Qatar) Joint venture agreement 30%70% Contractors LNG payments Debt service payments Residual payments Contract payments Banks Export Credit Agencies Debt service payments Ras Laffan

58. Copyright ©2001 Ian H. Giddy Asset Securitization 58 giddy.org n asiansecuritization.com

59. Copyright ©2001 Ian H. Giddy Asset Securitization 59 giddy.org Ian H. Giddy Stern School of Business New York University 44 West 4th Street, New York, NY 10012, USA Tel 212-998-0332 Fax 917-463-7629 ian.giddy@nyu.edu http://giddy.org