Prof. Ian Giddy New York University Asset-Backed Financing

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 2 Asset-Backed Securities: The Typical Structure FORD (SPONSOR) SPECIAL PURPOSE VEHICLE LOANS. ISSUES ASSET-BACKED CERTIFICATES SALE OR ASSIGNMENT LOANS. Servicing Agreement

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 3 Example: Ford Credit Owner Trust 1999-A

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 4 The Process Is the company ready? Is the company ready? Are the assets suitable? Are the assets suitable? What pool? What legal structure? What legal structure? What credit enhancement? What credit enhancement?

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 5 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?

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 6 Prerequisites to Successful Asset Securitization l Market imperfections are present  Investor information about the originators' operations is costly  Agency costs are high, or  Issuers are constrained by capital or other regulations, or where  Investors' choices are constrained  Government provides explicit or implicit backing for the issuer's debt.

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 7 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

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 8 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

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 9 Calculation

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 10 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.

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 11 Sears: Asset-Backed Financing? SEARS

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 12 Legal Aspects  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. LEGAL

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 13 Three conditions enable the separation of the assets and the originator  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 LEGAL

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 14 The Alternative: Synthetic ABS DB (Originator) SPECIAL PURPOSE VEHICLE REFERENCE POOL OF LOANS (Stay on balance sheet) ISSUES ASSET-BACKED CERTIFICATES CREDIT SWAP AGREEMENT TOP QUALITY INVESTMENTS

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 15 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 Credit Enhancement: Guarantee Method

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 16 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 Financial Guarantee Provider (if required) Guarantee Agreement

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 17 Atherton Capital (Seller) Atherton FLF 1998-A (Special Purpose Co.) Investors Servicing Agreement Proceeds Sale of Assets Proceeds Asset-Backed Securities Mellon Mortgage (Servicer) Franchisees (Borrowers) Loan Agreement Example: Franchise Loan Securitization Servicing Advisor Loan Payments

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 18 Deal documentation List information requirements Due diligence & Meeting with management Issuer/Banker Requests rating Pool credit analysis Legal analysis Stress testing Credit enhancement negotiation Rating committee Presale report Final report Rating Process Surveillance “Rating CLOs” (Fitch) on Workshop Website giddy.org/abs-hypo.htm “Rating CLOs” (Fitch) on Workshop Website giddy.org/abs-hypo.htm

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 19 Trade Receivable Backed CP l Over $500 billion outstanding in US alone l Key feature is pooling of different companies’ trade receivables, allowing smaller companies to take advantage of ABS market l Need two-tier legal structure – SPV at level of each company’s receivables pool, and at multi-company program (the “conduit”)

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 20 Corporation A Corporation B Corporation C SPECIAL PURPOSE VEHICLE “CONDUIT” Credit enhancement facility provider Liquidity facility provider Sponsor/ administrator Legal owner INVESTORS Trade receivables Payments on maturing ABCP Fees Nominal dividends Trade Receivable-Backed Commercial Paper (ABCP) Pool A Pool B Pool C

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 21 Example: Ford Credit Owner Trust 1999-A

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 22 Ford l What is the nature and value of the assets? l How strong is the legal structure? l Is the collateral sufficient? Would you recommend purchasing the subordinated tranche? l What could go wrong with this deal? What could go right?

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 23 Ford Structure FordFord Motor Credit Ford Credit Auto Rec. Two LP Ford Credit Auto Owner Trust Receivables Class A-1 to A6 Class B Class C Class D Class A-5 and A-6 Class D Sale

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 24 Ford Credit Auto Owner Trust l What are the economic benefits and costs to Ford in this ABS deal? l What do the underlying assets earn? l What rates do the securities pay? l Other costs? l Who gets the excess spread?

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 25 Ford Credit Auto Owner Trust l Interest cost l Underwriting fees l Rating agency and other securitization costs l Servicing fees l Other costs l Default losses ….compare with Ford Credit’s alternative

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 26 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

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 27 Ford Structure: Default or Loss? Receivables Class A-1 to A6 Class B Class C Class D

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 28 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.

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 29 Ford Structure: Waterfall Receivables Class A-1 to A6 Class B Class C Class D

Ford Structure: Waterfall

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 32 Other Deals – Check the Paydown Structure l DVI Receivables l Stratford ABSresearch.com

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 33 Paydown: Waterfall vs Soft Bullet Structure

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 34 Implications of Waterfall Upgrades l 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. l 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. l An ABS portfolio should be traded much more actively than a corporate loan portfolio to take advantage of its inherent rating volatility.

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 38 Contact Info Ian H. Giddy NYU Stern School of Business Tel ; Fax