Securitization: Past, Present and Future (eBook)

Solomon Y Deku is a Lecturer in Accounting and Finance at Nottingham Trent University, UK. He holds a BSc in Administration (Banking & Finance) from the University of Ghana and an MSc Financial Management from the University of Hull, UK. Solomon started his career as a junior accountant in Accra, Ghana, before becoming a Billings Analyst for the Economist Group, UK. He became a Chartered Accountant in 2013 and was awarded a scholarship for his PhD program by the Hull University Business School, UK. His research interests include securitization and financial exclusion. Alper Kara, PhD, is a Senior Lecturer in Finance at the Loughborough University’s School of Business and Economics, UK. Previously, Dr Kara worked in various capacities at the Hull, Leicester, Robert Gordon and Bangor Universities, UK. Dr Kara’s research interests and publication record cover a range of topics, including securitization, syndicated bank lending, bank governance and households’ access to finance and financial exclusion. Preceding his academic career, Dr Kara worked in the banking industry as a trader in the international bond and foreign exchange markets. 

Preface 6
Contents 8
List of Abbreviations 9
About the Authors 12
List of Figures 13
List of Tables 16
1: Introduction 17
2: Mechanics of Securitization 22
Introduction 22
What Is Securitization? 23
From Originate-to-Hold to Originate-to-Distribute 24
The Securitization Process 25
Originator 26
Servicer 26
Trustee 26
Underwriter 27
SPV Types 27
Amortising Structures (Pass Through) 27
Revolving Structures 28
Master Trusts 29
Tranching 29
Methods of Tranching 30
Credit Enhancement (Credit Support) 31
Internal Credit Enhancement 32
Subordination 32
Excess Spread 32
Over-Collateralisation 33
External Credit Enhancement 33
Surety Bonds (Insurance) 33
Third Party (Related Party) Guarantees 33
Letter of Credit 33
Cash Collateral Account 34
Collateral Invested Amount 34
Retained Interest 34
The Credit Ratings Process 36
Asset Risks/Credit Risk Modelling 36
Legal and Regulatory Risks 37
Structural Analysis 37
Operational and Administrative Risks 37
Counterparty Risk 38
Underwriting and Issuance 38
A Comparison of the US and European Market 38
Government Support 40
Mortgage Contracts 41
Insolvency and Foreclosure Procedures 42
Demand for Securitization 43
Conclusion 44
References 44
3: Securitization Structures 46
Introduction 46
Securitization Structures 46
Risk Transfer 47
Cash Securitization 47
Synthetic Securitization 47
Ownership of Reference Assets 48
Pass Through Structures 48
Pay Through Structures 49
Securitization Instruments 49
Asset Backed Commercial Paper (ABCP) 51
ABCP Market Background 51
The Basics of How an ABCP Program Works 53
ABCP Versus Term Securitizations 53
Types of ABCP Conduit Structures 54
Single Seller Conduits 54
Multi Seller Conduits 54
Securities Backed (Arbitrage) Conduits 55
Hybrid Programme 55
Collateralized Commercial Paper (CCP) Programme 55
Structured Investment Vehicle (SIV) 55
ABCP Conduit Credit Variations 56
Credit Enhancement of ABCP Conduits 56
Liquidity Support 57
Mortgage Backed Securities (MBS) 57
Mortgage Pass-Through Securities/Participating Certificates 58
Collateralised Mortgage Obligations (CMOs) 58
Types of CMO Bonds 59
Sequential Pay (Plain Vanilla) 59
Planned Amortization Class (PAC) Bonds 59
Target Amortization Class (TAC) Bonds 60
Z-Bonds (Accretion/Accrual Bonds) 60
Floating-Rate Bonds 60
Stripped Mortgage-Backed Securities 61
Maturity Measures in MBS 61
Return Measures in MBS 62
Constant (Conditional) Prepayment Rate (CPR) 62
Commercial Mortgage Backed Securities (CMBS) 62
Background of CMBS 63
Asset Backed Securities (ABS) 63
Collateralized Debt Obligations (CDOs) 64
Motivation and Purpose for CDOs 65
Funding of CDOs 66
Underlying Assets in CDOs 66
Credit Structures in CDOs 67
P2P Securitization 68
Conclusion 69
Notes 69
References 70
4: A Historical and Regional Overview of Securitization 72
Introduction 72
Origins of the Market in the 1970s 73
Invention of CMOs 74
Real Estate Mortgage Investment Conduit (REMICs) 76
Savings and Loans Crisis of the 1980s 77
Private Enterprises Entering the Market 77
Basel I and Securitization for Regulatory Capital Arbitrage in the 1990s 79
Weaknesses of Basel I 80
European Market in the 1990s 81
Growth in the 2000s Prior to the 2007–2009 Financial Crisis 82
Poor Underwriting Standards 84
Beginning of the Crisis 84
Regulation of the Securitization Market 86
Disclosure 87
Risk Retention 88
Reforming the Rating Agencies 89
Capital Requirements 89
Due Diligence 90
Covered Bond Markets in Europe: An Alternative 90
Dual Recourse 91
Asset Segregation and Dynamic Cover Pool 92
Special Legislation and Supervisory Frameworks of Covered Bonds 92
Developments in the UK 93
US Versus European Market 98
Conclusion 104
Notes 104
References 105
5: Effects of Securitization on Banks and the Financial System 107
Introduction 107
What Drives Bank Securitization? 108
Cost of Funding 108
Risk Management 109
Regulatory Capital Arbitrage 110
Liquidity 111
Profitability 111
Benefits of Securitization to the Overall Financial System 112
Securitization and Banking Risks 113
Relaxing Lending Standards 114
Weakened Monitoring Incentives 114
Increasing Risk Appetite 115
Keeping Riskier Loans 116
Securitization and Financial Stability 118
Market Perception and Reaction 119
Weakening Effect on Monetary Policy 120
Conclusion 120
References 121
6: Valuation of ABS Under Asymmetric Information 126
Introduction 126
Benefits of Securitization to Investors 127
Information Asymmetries Faced by Investors in ABS Deals 128
Asset Misreporting and Fraud 128
Securitization Chain and Performance 129
Reliance on Credit Ratings 129
Mechanism to Reduce Information Asymmetries 130
Issuer Reputation 130
Equity Retention 131
Issuer and Rating Agency Interaction 132
Trustees and Their Reputation 133
Issuer and Trustee Relationship 134
Foreign Banks as Issuers 135
Excessive Loan Growth 136
Issuer Moral Hazard 137
The Role of the Credit Cycle in Valuation of ABS 137
Conclusion 138
References 138
7: The Role of Securitization in the 2007–2009 Crisis 143
Introduction 143
Prelude to the Crisis: Sub-prime Mortgage Securitization in the US 144
Decline in Credit Quality 145
Lower Denial Rates in Mortgage Applications 146
Reduced Screening of Borrowers 147
Selling Ex-ante Riskiest Mortgages 147
Were Corporate Loans Also Risky? 148
Evidence from Ex-ante Pricing 149
Failure of Credit Rating Agencies 150
Unsuitable Rating Methodologies 150
Negotiable Nature of ABS Ratings 151
Dubious Relationship Between Issuers and Rating Agencies 151
Inadequacy of Regulation 152
Conclusion 153
References 153
8: Securitization: Key Trends Since the Crisis 156
Introduction 156
Trend 1: Regulatory Tightening 157
Overview 157
Capital Requirements 157
Risk Retention and Due Diligence 161
Reduced Reliance on External Ratings 162
Transparency/Pillar III Disclosures 163
Solvency 2 164
Trend 2: Market Adjustment 164
Overview 164
Focus on Repricing of European Corporate Credit Risk 168
Trend 3: Increased Role of Public Sector 169
Trend 4: Increased Role of Synthetic ABS 171
Conclusions 174
Notes 175
References 176
9: Concluding Remarks 179
Index 182