Securitization Of Financial Assets
GENERAL BACKGROUND
Mortgage backed (MBS) and asset backed (ABS) securitizations,
or more generally, the securitization of financial assets (for purposes of this
outline, Securitizations), is a form of structured finance initially
developed in the early 1980s in MBS format. It matured in the late 1980's in
both MBS and ABS formats and is now a $400 billion industry in the U.S. alone.
In recent years, it has spread to Europe (the largest market outside the U.S.),
Latin America and Southeast Asia (primarily Japan).
Virtually all forms of debt obligations and receivables (Receivables)
have been securitized in the U.S.: residential mortgages; home equity loans;
manufactured housing loans; timeshare loans; auto, truck, RV, aircraft and boat
loans and leases; credit card receivables; equipment loans and leases; small
business loans; student loans; trade receivables (just about any type, i.e.,
airline tickets, telecommunications receivables, toll road receipts); lottery
winnings; and record album receivables (David Bowie and Pavarotti). Although the
basic concepts, many based upon tax and accounting effects and desired results,
are essentially the same, each asset class presents unique structuring
considerations, and the players are constantly looking for ways to improve
structures to achieve higher ratings (and thus lower costs) and reduced
expenses. Securitizations outside the U.S. have been more limited because of
certain impediments (discussed below). In Latin America the principal asset
class securitized has been trade receivables (primarily the "future flow" from trade receivables, discussed in more detail below).
BASIC STRUCTURE
In its simplest form a Securitization involves (1) the sale of a large pool
of Receivables by an entity (Originator) that creates such Receivables
(or purchases the Receivables from entities that create them) in the course of
its business to a "bankruptcy-remote," special purpose entity (SPE)
in a manner that qualifies as a "true sale" (vs. a secured loan) and is intended to achieve certain results for
accounting purposes, as well as protecting the Receivables from the claims of
creditors of the Originator, and (2) the issuance and sale by the SPE (Issuer),
in either a private placement or public offering, of debt securities (Securities)
that are subsequently satisfied from the proceeds of and secured by the
Receivables. When the Securitization is "closed,"
funds flow from the purchasers of the Securities (Investors - usually
banks, insurance companies and pension funds) to the Issuer and from the Issuer
to the Originator. All of these transactions occur virtually simultaneously.
In the United States, the Issuer in the basic structure is normally a trust
(grantor, owner or business, depending upon the Originator's objectives and the
structure), which issues Securities consisting of notes or other forms of
commercial paper (Notes) and certificates evidencing an undivided
ownership in the Issuer (Certificates). Frequently, there is also created
a residual interest in the Issuer that entitles the holder (usually the
Originator) to funds remaining after all obligations to the holders of the Notes
and Certificates (Securityholders) have been satisfied. During the term
of the Securitization, payments on the Receivables are collected by a servicing
entity, usually the Originator (Servicer), deposited and invested (in
"eligible
securities") in various accounts under the control of a trustee (Trustee),
and disbursed by the Trustee to the Securityholders in payment of the
Securities.
In many instances a "two step" structure has been used whereby the Receivables are first transferred by the
Originator to an intermediate SPE (Intermediate SPE) that is a wholly
owned subsidiary of the Originator, but which is only permitted to engage in the
business of acquiring, owning and selling the Receivables, has at least one
independent director and is restricted in various ways from entering into
voluntary bankruptcy and other prohibited acts. Frequently, this transfer is, at
least in part, a contribution of capital by the Originator to the Intermediate
SPE. In the second of the "two steps," the Intermediate SPE sells the Receivables to the Issuer. This structure is
intended to enhance the "true sale" and "bankruptcy remote" characteristics of the transaction. That is, the transaction is structured to
insure that the sale of Receivables to the Intermediate SPE is a "true sale" rather than a financing device, which is necessary for the Originator to get the
Receivables off its balance sheet and book a profit or loss for accounting
purposes and, combined with the second transfer by the Intermediate SPE to the
Issuer, an essential part of the required protection from the claims of
creditors, including by avoiding consolidation of the Receivables with the
assets of the Originator in the event of the bankruptcy of the Originator.
Beginning in 1997, a change in accounting rules in the U.S. pursuant to FASB 125 (replaced by FASB 140)
has virtually mandated the use of the two step structure to obtain an
"isolation
of assets" and, therefore, a "true sale," whenever the Originator retains an interest in the Securities issued by the
Issuer (usually for credit enhancement purposes, as discussed below). However,
it should be noted that in some cases the Originator does not want a true sale
to occur (and book a gain or loss) and deliberately structures the transaction
as a secured loan.
The above description of the Securitization structure is very basic. Actual
structures involve many more elements and participants. The classes of assets
also result in different and, in many cases, more complex structures. For
example, in securitizing motor vehicle leases, to avoid the very high costs of
multiple transfers of titles to the vehicles, a new structure was developed
several years ago (in which the...
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