Alternatif finansman tekniği olarak menkul kıymetleştirme

Abstract

1970'li yıllarda ortaya çıkan menkul kıymetleştirmenin finansal piyasalara getirdiği ihtisaslaşma ve kurumsallaşma alternatif finansman tekniği sıfatıyla yakından ilgilidir. Globalleşen dünya düzeni neticesinde ülke ekonomileri arasında entegrasyonun artması dolayısıyla ürün transferi hız kazanmıştır. Özellikle gelişmiş ülke ekonomilerinde kurumların fonlama ihtiyaçlarını karşılayacak ürünlere yönelmesi, bir süre sonra diğer ülke ekonomilerinde model olarak işlev kazanmaktadır. VDMK arzlarının, yerleşik olduğu ekonomilerde yararlı olup olmadığı sorusu geride kalmıştır. Firmaların fonlama ihtiyaçlarını karşılama hususunda yabancı kaynak ile borçlanmanın getirdği maliyetten kaçınmak sebebinden yola çıkarak kendi varlıklarına (alacaklarına) dönmesi menkul kıymetleştirmenin sıçrama taşlarından en önemlisidir. Rakamsal verilere bakıldığında, 2000 yılı hacim USD 400 milyar civarında olup gelişmekte olan ülkelere olan kaynak transferinden daha fazladır. Dünya gayri safi milli hasılası ile karşılaştırıldığında 1,33% oranı görülmektedir. VDMK arzı ile ilgili son veri 2001 Eylül ayı itibariyle USD 295,5 milyar olup geçen senenin aynı dönemine oranla 21%'lik artış göstermiştir. Hacim olarak gelişme gösterilmesindeki itici gücün, ürünü icat eden Amerika'dan geldiği gözlenmektedir. Dikkat çeken rakamlarla beraber VDMK arzının gelişiminin dahada hızlanacağı açıktır. 1999 yılı verilerine bakıldığında gelişmiş ülkelerde verilen kredilerin GSYİH'a oranı 147% ve dünya ortalamasının ise 127% olduğundan yola çıkılırsa menkul kıymetleştirme hacminin gelişim hızının yüksek olduğu açıktır. Araştırmada bölümler arasında yoğunluk analizi yapıldığında, menkul kıymetleştirmenin getirdiği karmaşık yapılara ve bu yapılar neticesinde oluşan sofistike risk-kar döngülerine ağırlık verildiği gözükmektedir. Dünyadaki trendinde bu yönde olduğu açıktır. Gelişmiş ülkeler yasal düzenlemelerle ilgili sorunların üstesinden geldiğinden daha karmaşık yapılar ve uzmanlaşan kaynak firma, güvence mekanizması, derecelendirme kuruluşu profilinin yeni finansal sistemde yer alacağı açıktır. Menkul kıymetleştirme borçlanmanın yerine geçer mi sorusunun cevabı tüm bu gelişmelere rağmen mulak kalmaya devam etmektedir. Dünya ekonomisinin büyüyen görünüm alması için hem FED hem de ECB ardışık faiz indirimlerine gitmekte ve finansal piyasalardan borçlanmanın ucuzladığı dönem yaratmaktadır. VDMK arzında ise yapının oluşmasına ödenen masraflar caydırıcı etkide bulunmakta fakat yüksek rakamlı fonlama gereksinimi avantaj sağlayabilmektedir. Risk-kar döngüsünde ise yapılar çeşitlendikçe risk yönetim sistemleri de gelişmektedir. Yatırımcıların karşılaşabilecekleri riskleri minimize etmede yapılara dahil edilen güvence mekanizmaları, artan rekabet sebebiyle daha düşük maliyet getirmektedir. Dolayısıyla, VDMK arz eden için maliyet azaltılması yoluyla karlılık yaratmakta ve yatırımcıya ulaşmada emniyet subabı olmaktadır. Türkiye ayağına gelindiğinde ise VDMK arzında tüketici finansman şirketlerinin önemli rol oynadığı açıktır. 545 sayılı KHK'nin yasa gerekçelerinde 'Mali sektörümüzün dünya ile bütünleşme sürecinde sektörede bütünlük sağlanması, mali kesimimizin yeni müesseselerle çeşitlendirilmesi gereği, finansman ihtiyacı olanlara kredi sağlayan finansman şirketlerinin yasal çerçeveye oturtulması, finansman şirketlerinin faaliyete geçmesi ile ekonomik hayatın gerektiği gibi izlenmesine katkı sağlanacağı' ilkeleri vurgulanmıştır. 1992 yılında başayan VDMK arzı, ülke politik-ekonomik düzenin çalkantılı seyrinden dolayı dünyadaki trendin tersi yönünde hareket etmektedir. SPK'nın bankalarla olan rekabette tüketici finansman şirketleri lehine aldığı tutum gelişen koşullar itibariyle piyasalarda yer edememiştir. Devletin piyasalarda ana borçlanıcı olması, firmaların faaliyet dışında yarattıkları karların artış göstermesi ve 1998 yılının ikinci yarısından itibaren karşılaşılan global-lokal krizler kurumların VDMK arzından çıkmaları sonucunu getirmiştir. Finansman şirketlerinin kredi piyasasında etkinliğinin artmasının genel ekonomi üzerindeki etkileri; ·Kredili satışları arttırabilmek için fiyatlar genel seviyesinin yükselmesini engellemek ·Üretici firmaların asıl faaliyet alanlarında faaliyet göstererek gerçek karlılık seviyesinin saptanması ·Tüketicilerin ciddi kurumlarla muhatap olmasının sağlanarak bayilik sistemindeki çok farklı uygulamalar sebebiyle tüketici istismarının engellenmesi ·Kayıt dışı ekonominin küçülmesi ·Borçlanma piyasasının çeşitlenmesi olarak belirtilebilir. Ülkemizde yaşanan politik ve ekonomik istikrarsızlık VDMK arzının istenilen seviyelere gelmesini engelleyici niteliktedir. İstikrar ortamı sağlandığında bilançolarında alacak taşıyan kurumların borç sarmalından kurtulmak, sermaye tabanını yükseltmek ve sağlanan fon yoluyla tekrar kredi yaratmak için VDMK arzı üzerinde yoğunlaşacakları açıktır. Firmaların fonlama ihtiyacını spot veya vadeli fakat kurum dışı piyasadan sağlaması, sığ markette faiz oranları üzerinde yukarı doğru baskı yapmaktadır. Göreve gelen hükümetler tarafından uzun süre uygulanan portföy yatırımlarında reel faiz sağlama politikası firmalar için (yeterli kredibiliteye sahip) yabancı para borçlanması alternatifini de getirmiştir. İki unsur birleştiğinde, TRL ile borçlanmada artan faiz yükü ve reel getiri sağlamak güdüsüyle yaratılan açık pozisyon, özellikle 1994 ve 2001 krizlerinde reel sektöre ve finans kesimine önemli darbe vurmuştur. Dolayısıyla olası istikrarın firmalara daha sağlıklı bir aktif-pasif yapısı getireceği açıktır. SPK'nın mevzuatla ilgili düzenlemeleri şu an için yeterlidir fakat arz sonrası ikincil piyasayı yaratmada menkul kıymetlere işlerlik kazandırılması gelişimi hızlandıracaktır.

Because receivables' portfolio is used as the core element in ABS structure, attribute should be precise. Below mentioned is the list regarding the characteristics of receivables: 1.Should have a cash-flow 2.Unpaid and/ or late/ pre-payment data should be valid 3.Structure should be formed in line with the portfolio's maturity 4.Income from underlying portfolio should be greater than ABS income 5.Principal should be paid at the end of the maturity Credit card receivables (amounts are small but well diversified), car loans (maturity differs from 24 to 30 months), mortgages (the oldest sample in ABS structure), consumer and leasing loans could be subject to ABS structure. Gaining prosperity in an ABS structure, standartization comes as initial requirement. Contract, legal side, services and credit enhancer should be defined to ease the investors' attempt. Structure should also comprise statistical data to evaluate the risk. Computer system should be set to overcome complex calculations. In a simple ABS transaction, participant list commences with originator. Originator is the company which holds the receivables' portfolio. It then sells or transfers the portfolio to Special Purpose Vehicle (SPV). SPV changes the receivables to a security while investment banks sell those securities to the investors. During the process, structure needs a hike in credibility to meet the public interest. Hence, credit enhancer, rating agency attends to ABS issue. Reporting and some other task belongs to trustee. In addition, managing the portfolio via collecting the payment from the credit users and transferring the collection to the account under trustee for generating ABS's principal + interest payment is addressed to servicer. Credit enhancement could be procured internally (over - collateralize, fund account, senior/ junior) or externally (f.i. insurance). Rating agencies assist investors in making investment decisions. Through research, analysis and information the rating agencies protect investors against unknowingly taking credit risk. It says a particular instrument will pay interest and principal according to the terms of indenture. Rating agencies' approach to s structure precisely starts with loan-to-value ratio. 90% loan-to-value ratio is more risky than 50% loan-to-value. 50% loan holds a lot more equity, and the likelihood of recovering funds, even in catastrophic circumstances, is much greater. Seasoning is also important. For instance, if general trend for default in mortgage signals 4 years, a receivable portfolio that has the maturity longer than 4 years could require lower credit enhancement. Geographic diversification is another concern in eye-watch while evaluating portfolio stress tests comes as the final point. COMPARISON BETWEEN STRUCTURES The structures display two types. Originator removes the portfolio from its balance sheet in pass-through structure. Second type encompasses asset-backed bond & pay-through structures in which originator continues to hold the portfolio. PASS-THROUGH STRUCTURE Credit portfolio is sold to special purpose vehicle (SPV). Different from above-mentioned, trustee creates the security from the portfolio then investment banks are involved to sell to the investors. Proceeded from credit portfolio's removal, risk is decreased on balance sheet that paves the way to improvement of debt-shareholders' equity ratio. Also, the originator creates tax shelter. Disadvantageous part comes from creating one type product from the whole portfolio. ASSET-BACKED BOND Structure is similar to the bond issue with an exception that the collateral is the credit portfolio. Originators hold the portfolio on the balance sheet so no tax shelter and recovery in debt/ shareholders' equity ratio. Collateral requirement could also exceed the issuing level. PAY-THROUGH STRUCTURE Pay-through is the combination of pass-through and asset-backed bond. Portfolio remains on the balance sheet while originator has the flexibility of creating tranches from each cash flow. Disadvantageous part is the same as asset-backed bond while full use of cash-flow (many tranches) creates value added due to weighting & faces with investor need. RISKS IN SECURUTIZATION Before scrutiny on risk definition, securitization steps should be checked again. Initial action was selection of a convenient portfolio. Then structure should be established in line with legal status. Next step is the change of portfolio to a purchasable security. Final action is the SPV's management of ABS results. In ABS transaction, 4 risk types flash the eye. CREDIT RISK: Depends on the performance of receivables' portfolio that is subject to securitization. STRUCTURAL RISK: Probability over lack of consistency btw the structure and legislation. OPERATIONAL RISK: Probability over SPV's delinquency over the transaction. FINANCIAL RISK: Portfolio's behaviour under different conditions. Credit risk is relevant with the portfolio's itself. It comprises the risks of asset, servicer, credit enhancer, funds & account and trustee. Asset risk is the most important item in ABS structure while most of the time is spent on evaluating the portfolio. In general, assets can be sorted into three broad categories. Consumer, commercial and other assets. Consumer assets, both secured and unsecured, include auto loans and leases, credit card receivables, residential mortgages and home equity loans. These asset pools are typified by a large obligor base, homogenous origination and credit terms, and are usually enough to be analyzed using actuarial techniques. Commercial assets include equipment loans and leases, dealer inventor financing. Actuarial techniques should not cover the whole while single credit risk should also be involved. Other assets, student loans- special licensing agreement, are less securitized hence single credit risk should be used. Asset risk analysis encompasses monitoring portfolio's characteristics, probe over similarity between the selected and originator's whole portfolio, other indicators (consumer skills). Originator should have an eye-watch on the portfolio before applying to credit enhancer. Re-structuring the portfolio: After analyzing the historical data, the securitizer will decide not to get certain specific receivables, for example overdue, in the portfolio. Additionally, unwanted concentrations should be eliminated. For instance, securitizer will look for good sectoral distribution in the portfolio and will not let more than 10% for one sector. No matter, each simple credit has a loss probability in the portfolio. After weighting the average loss likelihood of the portfolio, securitizer should step more via cutting the credits have risk more than average. Setting reserves: Most transactions provide a mechanism whereby the originator absorbs some level of losses before any third party credit enhancer becomes affected. Setting termination triggers: Perhaps the most important protection mechanism used for transactions involving regular asset substitutions is to prevent the SPV from purchasing receivables form the originator if the default rate on the originator's overall portfolio exceeds a certain level. Setting the level of external credit enhancement: In several scenarios, internal reserve or recourse provisions may not be adequate. Such circumstances might arise because the originator suffered sudden bankruptcy before any termination trigger was reached because a deep recession caused portfolio losses to continue to mount rapidly even after an originator's ability had been terminated. Third party credit enhancement is often provided by a bank's providing an irrevocable letter of credit to the transaction. Alternatively, insurance companies may attend to the transaction via 100% or partial coverage. Improved recently, originators added senior/ junior structure to ABS structure. Credit enhancer risk starts due to originator's effort to add third party (f.i. insurance company) to the structure. Hence the investors should focus on the credit enhancer's trustworthiness. Banks, international insurance companies and monoline insurers dominate the enhancer market. Large commercial banks are typically provider of letters of credits. The letter giver's own rating is determined through comprehensive financial statement, capital structure and managerial and strategic analysis. Downgrade protection is afforded by through trigger mechanisms stated in the letter of credit agreement and the issuer's indenture provisions. Generally, if the LOC provider's rating falls below a bench mark, the provider must be replaced with a suitable, credit-worthy enhancer or some other enhancement immune to the added risk due to downgrade. International insurance companies give performance or 100% guarantee after first loss levels. First loss increased to 1-3% level from 0,5-1,5% due to hike in default rates & slow rise in home prices. Ratio-wise insurance mostly occurs between 5-15% after first loss. Most of these companies are only involved in carrying the pure credit risk through pool insurance policies while covering liquidity risk is rare. Downgrade of European insurers active in these lines of insurance has decreased the available high-rated risk carrying capacity provided by European multi-line insurers. Monoline insurance companies possess 7 major firms participating from US. They all have AAA ratings while none of them has been downgraded so far. These companies have the same scope with international insurance companies but they also have the chance of providing liquidity coverage. Performance or 100% guarantee are also valid in business plan while insurance ratio is 7,5-15%. If the receivables' portfolio displays heterogeneous origin, investors mostly look for 100% coverage hence they admit less profit. In case of homogeneous formation, investors are satisfied with legal and structural sides so ratio-wise insurance will be in use. Credit enhancers generate a complex scrutiny to reach a qualified portfolio while initial requirement form the originator is nominal collateral. Almost 70% of the portfolios have the rating greater than A & insurance agreement stipulates termination of all the reserves before process. Surety bonds, those provide principal + interest payment of defaulted receivables, are also in credit enhancement group. Servicer risk is soft point in ABS structure. Servicer's task covers controlling the cash flow in the receivables' portfolio and transfer to the accounts under trustee's sovereign. Even some companies belong to strong families, most of servicers are limited firms. Despite in most of the transactions cash transfer is on daily basis, in credit card receivables' day-gap extends to 70 days. Originator or its tie is usually the servicer not to jeopardise the structure's credibility. Trustee risk covers the default likelihood over reporting, eye-watch on the funds and account. Trustee should have a rating of BBB- minimum in long term. Additionally, if servicer goes bankruptcy, trustee should replace it. Funds and account risk commences with the cash transfer from servicer to the trustee. Money should be invested on certain and credible (determined by rating agencies) tools. SECURİTIZATION'S ANALYSIS Securitization's help on the originator is obvious on the recovery of risk-capital ratio. In the period form the end of 1987 to the middle of 1988, BIS Committee on banking regulations and supervisory practices-The Basle Committee- proposed and confirmed the structure of a regulatory framework. The framework is used upon the use of capital as a cushion against losses sustained from investment in assets of different level of risks. Assets are ' risk weighted ' in accordance with the following weightings: RISK WEIGHTING (%)ASSET TYPE 0-10Cash-short term loans to governments 20Long-term government securities Loans to OECD group banks, Loans to Building Societies 50Residential mortgage loans fully secured by property 100Everything else Calculation of risk weighted assets forces the holder to adjust 8% capital ratio. In other terms, if the originator holds 100 of asset (risk), 8% should be the capital on funding side. Removal of assets via securitization means freeing capital. During the process, maturity consistency could be procured & flexibility in managing other risks could be provided. Banks chose the way to fund credit portfolio by deposits or securitization. Deposit also brings expenses such as insurance fee (to gain the guarantee), operational expenditure to pull the deposit and after-deposit. Securitization's analysis comprises technical probe and economic analysis. In technical probe, analyst should focus on ROCE (Return on capital employed) and YOWRA (Yield on Weighted Risky Assets). In economic analysis, basic follow-up includes change in weighted average cost of funding, using securitization to improve the risk asset ratio, using securitization to improve profitability, break-even margin on incremental lending and equivalent cost of raising equity. ROCE exactly defines each investment's return on employed capital. For instance if the bank assumes to invest on 15% interest giver of a corporate bond, below mentioned is the calculation of ROCE tied to given data. Cost of Capital: 20%Risk-Capital Ratio: 8% Funding Cost: 10%Expected Return: 15% ROCE : 15% - (8% * 20% + 92% * 10%) = 53% 8% Corporate bond is 100% risky asset so 8% capital is compulsory. Capital employed brings 1,6% cost to the funding structure while rest of 92% would give 9,2% as the cost. Hence, net return is corporate bond return of 15% - 10,8% (net cost) = 4,2%. ROCE is ratio between net return & capital used. (53%) In YOWRA calculation, denominator is the risk adjusted investment amount. For instance, is the investment amount is 100 so net return is 4,2. Because corporate bond is 100% risky so YOWRA is 4,2%. In economic analysis, first step is to find out average funding cost on balance sheet. Capital requirement and funding need should be weighted while next step is the change of floating rate to fix fates by using swap equivalent on analysis date. If the originator uses securitization to improve asset-risk ratio, cash would be injected to close liability hence capital would increase on passive side. Analyst should reach free capital ration by using the formula of Asset Securitized * Risk Attribution * Risk - Capital Ratio. Income from the securitization, undertaken expense should be net then return from free capital should be added. Cash provided from securitization can be used to give new credits for paving to way to improve profitability. Because the risk-capital ratio should be in limit, cash is evaluated by the ratio to reach amount of new credits. Addition of new credits to the portfolio brings need of break-even calculation with external borrowing. Another alternative approach is capital increase. Soft point is after-tax capital. RISK MANAGEMENT IN SECURITIZATION Investor should be in mind of core risk group, credit - liquidity - junior, before an investment in ABS. Credit risk is actually an economic risk in other terms coverage of a defaulted receivable by collateral. Significant question comes as what type of credit enhancer should be hired. The structuror will consider on the extent to which an investor is exposed to risk, the consequence of this on the pricing of the security, any mechanism by which that risk can be ameliorated and whether the event risk is one that the investor might be prepared to incur because the chosen method of credit enhancement offers compensating benefits. Regulations play vital role in choosing credit enhancement. For example, in France an originator can invest in its own risk by purchasing the subordinated bonds which enhances the entire issue. But in UK, this would result in the entire issue being placed back on the issue. In each situation, local regulatory influences will suggest a choice of investment. The regulatory background therefore needs careful investigation before analysis of the credit enhancement choices can begin. With a new issuer, or in a country that is just starting to securitise, once the decision to proceed has been made and the structuring bank has been appointed, the study of credit enhancement choices need to follow rapidly. A long time needs to be spent educating potential credit enhancement parties about the new country or issuer. The originator should be aware of the considerations those are categorised in pricing and non-pricing. Below mentioned forms non-pricing part. ·What are the originator's objectives in the securitization ? ·How often is the originator planning to issue? ·What risks is the originator prepared to accept? ·How wide is the realistic choice of enhancement? ·Can the originator spend time educating and negotiating with the credit enhancement market to achieve the best possible price or is speed of issue the main objective? ·Which potential insurance companies have a license to issue a contract in the territory where the financing vehicle is located? ·If the credit risk is transferred to a third party, other than subordinated bond investors, what is the investor perception going to be of this party? At the same time, the originator must also draw up another list of issues that need to be determined in calculating the price of the various competing options. ·What is the schedule of premium payments, if an insurance format is used? ·What level of first protection will the credit enhancement party require form the originator and how is this going to be funded? ·How should the originator calculate the cost of funding this first loss position? ·When per annum payments are compared with upfront payments, what discount rate should the originator use to perform the calculation? Are they going to view this as a self-contained financing, and therefore use the funding rate of the asset-backed securitization as the relevant discount rate, or, because they are employing some of their own capital to pay the premium and to collateralise the first loss position, should they discount at their cost of capital ? Once an originator has received indications of pricing and conditions from potential credit enhancers, it may then proceed to examine the options. Subordinated 'mezzanine' bonds: For a new issuer it may be difficult to find buyers for the subordinated bond as that market was traditionally been thin and therefore illiquid. The originator may worry about future capacity of this market if it is going to be a frequent issuer. Letters of Credit: Limited market given the paucity of remaining AAA/ aaa banks. Letters of credit can be issued on a partial guarantee basis which makes them reasonably inexpensive. Letters of credit are sensitive to the rating of the bank and if the bank is down rated then the whole asset-backed structure may also be down rated. Cash collateral: This is a rare form of credit enhancement but has been employed by issuers of short-term securities. The cash can either be raised by the vehicle company through the securitization and retained by the vehicle, invested directly by the originator from his own sources or raised via a borrowing from other sources. Overcollateralization: Placing more assets than cash earned through securitization. It may be attractive when, for various reasons, enhancement is difficult to obtain but assets are plentiful. Monoline & multiline (international) insurance companies are also involved in options. In current ABS structures, originator looks for hybrid products. The most common hybrid is a combination of subordinated notes and insurance. Default risk: If a borrower falls to make the required payments on a loan promptly, the loan is classified as delinquent. In most cases, delinquency is cured promptly. If the delinquency is not cured, then after some period-typically 90 days in the case of home mortgage loans- the lender initiates steps to collect the loan balance and unpaid interest. The collection process is subject to legal restrictions that may affect the timing and amount of any recoveries. Ultimately, the lender may only be able to recover a fraction of the loan and unpaid interest. If lenders foreclose through a trustee's sale, they are limited to the proceeds from the sale of the real estate securing such loans net of transaction costs. Particularly, when real estate values decline, lenders may not recover the full amounts of their loans even though the loans were over collateralized at the time they were extended. Default risk depends on the principal factors of the general state of the economy, the state of particular industries that may be critical to different regions of the country, the overall level of consumer debt. For any particular mortgage loan, default risk will also depend on the loan-to-value ratio, the seasoning of the mortgage, the characteristics of the mortgage, and the state where the real estate is located. Liquidity risk: Asset securitization involves repackaging illiquid assets into liquid assets. Trading the underlying assets requires transferring the entire loan file. This can be a time consuming and hence expensive process. When secured loans are transferred, the purchaser of the loan must record its lien and perfect its security interest in the asset. As the value of collateral will affect the value of the loan, the seller will not be able to realize full value for the loan if the purchaser requires a discount to compensate for the risk that the value of the collateral may be impaired, for example due to falling real estate prices. A purchaser of loans must assess the default risks involved. This will entail making a judgement either about each borrower's ability to pay or about the seller's credit standarts. Interest rate risk: The degree of interest rate risk a financial institution faces depends on the extent of its asset-liability duration mismatch, that is, the difference between the duration, or interest rate sensitivity, of its assets and the duration of its liabilities. That also depends on the financial institution's condition of bearing a fixed or floating rate. STRUCTURES FOR ALLOCATING RISK Prepayment risk: Most multi-class mortgage backed securities, or CMOs, are designed to reallocate the prepayment risk on the underlying pool of mortgages. CMOs segment the stream of cash flows from a pool of mortgages into various classes and prioritize the classes with respect to their right to receive principal payments. Sequential pay securities comprises the procedure of making principal payments on the classes sequentially those were collected from underlying portfolio's receivables. Accordingly, no distributions of principal would be made on any classes until all prior classes have been repaid in full. Such a re-allocation is beneficial when it results in risk-return profiles that better suit investors' risk-return preferences. Money market mutual funds that did not wish to invest in the pool might be interested in investing the class that pays the principals quicker. Pension funds that might not want to invest in the pool might be interested in investing in the slowest-pay class. Planned / Targeted Amortization Classes and Companion classes is the method that reduces the investor's exposure to prepayment risk. PAC bonds (planned) are designed to make principal according a specified schedule so long as prepayments on the underlying mortgage pool remain within specified band. Such a CMO class thus gives investors a relatively stable cash flow over a wide range of interest rate scenarios. However, since prepayment risk needs to be reallocated among CMO classes, some of the other CMO classes- called companion classes - issued against the same mortgage pool function as prepayment shock absorbers in absorbing a disproportionate share of the overall prepayment risk. Investors in the companion classes need to understand the degree of prepayment risk to which they are exposed on account on the inclusion of PAC classes in the CMO structure. Prepayment Guarantees or Insurance is mostly used in truck loans where prepayment risk is much lower than in the case of mortgage loans. For example the Asset-backed Securities Corporation issued $ 1,4 billion of Asset-backed obligations Series 4 in July 1987 that included a Minimum Principal Payment Agreement, under which Morgan Guarantee agreed to purchase automobile receivables form the issuer when prepayment rates are to slow or invest funds on behalf of the issuer when prepayments are too fast, to maintain the sinking fund schedule specified in the prospectus. The elimination of prepayment risk reduced the required yield by approximately one-third of a percentage point. Interest only / Principal only securities are created by dividing cash flows from a pool of mortgages into two securities. The interest only strips (IO) get all the interest and the principal only strips (PO) get all the principal. IO and PO strips have differing exposures to prepayment risk. When prepayments accelerate, PO strips, which have large positive durations, increase in the value because principal is received sooner. IO strips, which have large negative durations, decrease in the value because the faster repayment of the mortgage principal means that the aggregate-flow on the interest payments is reduced. Default risk: Asset-backed securities, as their name implies, are backed by a diversified portfolio of assets. Forming a diversified portfolio reduces the exposure of the asset-backed securities purchasers to default risk through diversification. There are two basic methods for re-allocating default risk: 1) the issuer of the asset-backed security can purchase a guarantee, letter of credit, surety bond or similar promise of payment from a creditworthy third party 2) The issuer can assume a disproportionate share of the default risk by subordinating its right to receive payments from the underlying asset pool to the rights of other investors, by pledging a cash collateral account to cover the cost of defaults, or by undertaking to substitute replacement contracts for defaulted contracts. US Agency Guarantees Mortgage-Backed Securities Payments: In addition to re-allocating prepayment risk, the mortgage backed securities issued by FHLMC, FNMA and GNMA carry certain payment guarantees, which transfer much of the default risk to the agencies from the holders of the asset-backed securities. Agency guarantees eliminate entirely the investors' exposure to default risk only if the agency guarantees the timely payment of principal and interest, as FNMA and GNMA do. FHLMC guarantees only the timely payment of interest and the ultimate payment of principal. FHLMC may pay the amount due on account of its guarantee of ultimate collection of principal at any time after default of underlying mortgage, but no later than 30 days following the later of foreclosure sale & payment of the claim by a mortgage insurer. The payment delay represents a cost to the investor, which will be fully offset only if the interest rate on the PC is no less than the yield the investor could earn on the reinvestment of principal payment that are received in a timely fashion. Guarantee/ Insurance Security Structures: A mortgage, automobile, or credit card lender can retain the bulk of the default risk associated with specific pool of assets by providing a limited corporate guarantee or by collateralizing the asset-backed securities issue or by retaining a subordinated interest in the asset pool. The amount of credit enhancement is chosen so as to achieve a desired debt rating, typically AA in the case of mortgage-backed securities and AAA in the case of automobile loan-backed and credit card receivable-backed securities. Senior/ subordinated structure: That structure is used to bring default & prepayment risk to mimimum level. The uncertainty regarding the availability of satisfactory mortgage pool insurance and the highest cost of such enhancement led to the development of senior/ subordinated structure to eliminate the need for pool hazard or insurance. Senior/ subordinated mortgage backed securities are generally structured in either of two ways. A reserve fund structure or a shifting interest structure. Mostly used is reserve fund structure that involves fund to supplement ensuring the timely payment of principal and interest to senior certificate holders. The sponsoring financial institution establishes a reserve fund with a deposit between 0,1% and 0,5% of the initial pool balance at the time trust is formed. The subordinated certificate holder receives no cash flow until the reserve fund builds up to a pre-specified level, typically 1-2% of the pool in the case of mortgages, and up to 4-5% depending on actual loss experience, in the case of automobile loans. Once the reserve fund reaches the specified level, the senior certificate holders and subordinated certificate holders share pro rata in any payments of principal and interest made by the trust except to the extent. 1) principal and interest otherwise payable to subordinated certificate holders will be paid to senior certificate holders to cover payment shortfalls and 2) principal due to subordinated certificate holders will be used to replenish the reserve fund it falls below a specified level. The specified reserve level may increase or decrease over time depending on the loss experience of the collateral pool. Excess cash in the reserve fund reverts to the subordinated certificate holders. In shifting interest structure, the ownership percentage of the senior subordinated certificate holders shift in a way that will compensate senior certificate holders for any payment shortfalls they suffer. Liquidity risk: The asset-backed security is easier and cheaper to transfer between investors than the underlying assets. The loan files for the underlying assets reside with the pool servicer and never have to change hands during the entire life of the loan. Credit enhancement mechanisms coupled with either debt ratings obtained from nationally recognized rating agencies or a government agency guarantee serve to reduce the uncertainty as to the degree of default risk that the investor must bear and to eliminate the need for a lengthy and costly credit review of the underlying assets by the investor. The asset-backed securities are exempt from registration requirements. Securities are freely tradable among investors. Holders who wish to sell can contact the packager/ underwriter or any other securities firm that is making a market in the securities for a quotation. Asset-backed securities structures are designated to ensure, to the maximum extent practicable, that investors will receive payments of interest and principal on schedule. Temporary payment delinquencies often occur. Mortgage backed securities typically require the servicer to advance funds (or other structures) as required to meet the REMIC's temporary liquidity needs. Interest Rate risk: Securitization of assets can reduce a financial institution's exposure to interest rate risk. A bank that rolls over 5 year-certificates of deposit to fund a 30-year fixed rate mortgage loan is exposed to the risk that rising interest rates could cause the bank to lose money on the transaction. There are a variety of securitisation structures, such as IO/ PO strips and floating rate / inverse floating rate. CMO classes, that reallocate the sponsoring entity's interest rate risk among different classes of investors. Interest rate swaps have been employed in the form of fixed interest rate obligations and vice versa without exposing the issuing vehicle to unacceptable interest rate risk. For example let's assume a bank issues fixed rate sterling notes backed by a portfolio of variable rate UK mortgages. The nature of the assets and liabilities of the issuing vehicle created a duration mismatch. So the issuing vehicle enters a pay floating -receive fixed interest rate swaps in order to hedge the interest arte risk involved. RISK CONTROL MANAGEMENT An overall risk control framework comprises 1) high level management controls such as corporate planning and business strategy 2) operational controls over daily trading and support procedures. The controls overall internal procedures can be further classified as primary and secondary controls. Primary controls are concerned with the prevention of errors and irregularities before they occur and with the detection of errors and irregularities which have occurred. Secondary controls include management's regular review and control of budgets, management accounts and other information, transactions and balances and the use of analytical techniques. A good control framework should include consideration of corporate plans and market strategy, departmental plans and strategies and a well-defined, logical reporting structure. Additionally, market, economic, documentation, regulatory risks should be subject to scrutiny. S&P checks the risk control management through credit portfolio initially. Portfolio assets form the principal source of protection for the investors in all partially credit-enhanced structures, and an important secondary source of protection of in fully enhanced structures. The portfolio borrowers' payments should match the proceeds of asset-backed securities. Besides the portfolio, S&P also processes the surveillance of seller/ servicer of the assets, as well as a review of the specific business unit originating the assets. The overall credit worthiness of the seller is relevant for several reasons, predominantly relating to legal risk associated with asset transfers, the potential impact the seller's bankruptcy could have on the quality of its securitized assets, and the sizing of the credit support. S&P follows the rules based on event risk checklist. 1) Identify the weak links: Investors should know who the credit enhancer is and be aware of any providers of liquidity support. 2) Identify the trigger events: Investors should be aware of all trigger events in the structure of as well as the cash flow implications associated with each one. 3) Understand the implications of seller bankruptcy/ insolvency: The seller may be a weak link in the structure, or a seller bankruptcy/ insolvency may be a trigger event. Read the transaction documentation to understand the cash flow implications and consult legal counsel if necessary. 4) Understand S&P ratings criteria: Understand how dependent ratings may impact S&P's initial and ongoing rating assessment of an asset-backed transaction. Servicer is also under eye-watch in S&P process. Funds held by the servicer may be at risk in the event of the servicer's bankruptcy. This exposure is normally limited as most of the structures require that funds collected be remitted to the trustee on a daily basis where they are held in trust for benefit of certificate holders until disbursement. However some transactions allow for more periodic remittance, during which the collections on securitized receivables are commingled with the servicer's general operating funds. Some credit card-backed transactions provide for a commingling period of up to 70 days, during which time a substantial amount of collections may occur. The servicer also may provide a cash advance covering receivable delinquencies that it deems recoverable. The analysis of the assets supporting the transaction and the quality of the servicing of the assets focus on more fundamental risks. The assets supporting the transaction are reviewed within the context of firm specific, competitive and economic influences, beginning with a review of the business unit which is originating and servicing the assets to be securitized. The analysis, concentrates on projecting portfolio delinquency, default frequency and loss severity in period of severe economic stress. Credit enhancer's rating equals to the rating of the structure. Adequate credit support reflects the amount and timing of potential charges for losses against assets. Coverage under the credit support decreases when the support is drawn up. S&P tracks credit support levels against expected portfolio losses, and may upgrade or lower ratings over the life of a transaction if the level of credit support is determined to provide significantly greater or lesser protection against expected losses due to varying portfolio performance.