“PROCESS OF TRANSFORMING OTHERWISE FINANCIAL ASSETS INTO MARKETABLE CAPITAL MARKET SECURITIES” SECURITIZATION
EARLY TYPICAL SECURITES GNMA ‘PASS THROUGH’ AUTOMOBILE LOANS CREDIT CARD RECEIVABLES COMMERCIAL LEASES COMPUTER LEASES NOW: BUSINESS LOANS
EXAMPLE DAYTON HUDSON CREDIT CARD MASTER TRUST GO OVER
SECURITIZATION PROCESS LOAN ORIGINATON - SETS TERMS TRUST - BUYS LOANS FROM BANK AND ISSUES SECURITIES INVESTMENT BANKER - SELLS SECURITIES FROM TRUST GUARANTOR - INVESTORS
BUSINESS LOAN SECURITIZATION VERY SMALL SO FAR: –LOANS OUTSTANDING - $155 BILLION –SECURITIZED LOANS - <$900 MILLION
COMPARISON TRADITIONAL LENDING - originate, fund, service, monitor SECURITIZED LENDING - originate,sell, service
Asset(loan) Securitized Illiquid imprecise valuation lender monitoring high operating costs limited rates/terms local investor market Liquid efficient market val. Third party assesses low operating costs wide range of rates national/global market
REQUIREMENTS STANDARD CONTRACTS RISK RATING SYSTEM REPUTABLE CREDIT ENHANCERS STANDARDIZED LEGAL FRAMEWORK STANDARDIZED SERVICING QUALITY
LOW GROWTH=HIGH COST Specific borrower /local condition info. Needed for prediction of repayment Lack of standard loan term –line of business/credit quality –loan maturity –pricing/covenants/collateral –bank underwriting standards Lack of long term performance info.
SBA GUARANTEED LOANS GUARANTEED PORTION = SECURITIZED MONEY STORE INC. -$380 MILLION SBA LOANS FREMONT FINANCIAL - $330 MILLION IN LOANS SECURED BY A/R, INV. AND F/A
WHY THESE WORKED RIGOROUS UNDERWRITING STAND. SBA LOANS - VERY STANDARDIZED SIMILAR COLLATERAL/DOCUMENT. SBA CAN SUPPLY HISTORICAL LOSS EXPERIENCE DATA HIGH VOLUME LENDERS
BACKUP REQUIRED LOSS PROTECTION ON 11-20% OF THE LOAN POOLS OR PURCHASE PRIVATE BOND INSURANCE
MAIN BENEFITS TO LOAN ORIGINATOR LOANS SOLD/NO FUNDING NEEDED REDUCES MONITORING COSTS LOWER BORROWING COSTS DUE TO PREDICTABLE CASH FLOW FROM POOL OF ASSETS, NOT ONE
CONT. RELEASE BANK CAPITAL TO OTHER PURPOSES MANAGE CREDIT RISK DIVERSIFY LOAN PORTFOLIO
WHY FIRMS USE ASSET- BASED DEBT AVOID ASSET SUBSTITUTION COSTS “Mgmt. Often replaces low risk assets with high risk after debt financing. Only the stockholder get the higher return. Only securitized debt ties the bond to specific asset - thus, no substitution
Cont. Avoid underinvestment “Equity holders of stressed companies unwilling to make marginal investment as only bondholders get the return.” Use of asset-based security removes general company risk
Cont. Secured debt reduces information asymmetry problem of management not acting in bondholders’ interests
ISSUES FACED BY INVESTORS GUARANTEE ONLY PROVIDES LIMITED CREDIT PROTECTION INTEREST RATE RISK LIMITED BY BUYING “TRANCHES” IN DIFFERENT MATURITIES
CONT. LIQUDITY RISK NOT A PROBLEM PERFORMANCE RISK - EX. CREDIT CARD RECEIVABLES IN A RECESSSION
CONT. PREPAYMENT RISK - PARTICULARLY IN SECURITIES BACKED BY MORTGAGES GEOGRAPHIC CONCENTRATION
MAIN BARRIERS TO BANK LOAN SECURITIZATION SIZE CONSIDERATIONS –MIN. POOL FOR PRIVATE PLACE. -$50m –MIN. POOL FOR PUBLIC OFFER.-$100m RECOURSE - INVESTOR HAS CLAIM IF SECURITY DEFAULTS RISK EXPOSURE - POOLED ASSETS ARE DIFFICULT TO MONITOR
Cont. Lack of long term performance information