FASRI Office Hours Securitizations Catherine Shakespeare

FASRI Office HoursSecuritizations

Catherine Shakespeare

How does a securitization work?

Assets

Account Receivables A

Account Receivables B

Account Receivables C

Pooled

AAA Tranche

Mezzanine A

Retained Interest

Mortgage-backed Securities

What is a CDO?Collateralized Debt Borrowing

Mortgage-backed SecuritiesAssets

Mezzanine C(From another securitization)

Mezzanine B(From another securitization) AAA

Tranche

Mezzanine D

Residual

Account Receivables A

Account Receivables B

Account Receivables C

Pooled Pooled ABC

AAA Tranche

Mezzanine A

Retained Interest

CDO2

AssetsMortgage-backed Securities (MBS)

AAA Tranche

Mezzanine G

Residual

Collateralized Debt Borrowing

Collateralized Debt Borrowing

Account Receivables A

Account Receivables B

Account Receivables C

PooledPooled

ABC

AAA Tranche

AAA Tranche

Pooled

DEF

AAA Tranche

Mezzanine A

AAA Tranche

MezzanineD

ResidualRetained Interest

MezzanineA

Mezzanine B(from another MBS)

Mezzanine C(from another MBS)

Mezzanine E(from another MBS)

Mezzanine F(from another MBS)

What happens on when the cash flows disappear?

Assets

Account Receivables C

Pooled

AAA Tranche

Mortgage-backed Securities

Account Receivables A

Account Receivables B Mezzanine A

Retained Interest

Note: Indicates the default portion

Extends into the CDO marketCollateralized Debt Borrowing

Mortgage-backed SecuritiesAssets

Pooled Pooled ABC

AAA Tranche

Account Receivables A

Account Receivables C

Account Receivables B

Mezzanine A

Mezzanine B(From another securitization)

Mezzanine C(From another securitization)

AAA Tranche

Mezzanine D

Residual

Note: Indicates the default portion

Retained Interest

House of cards start to fall….

AssetsMortgage-backed Securities (MBS)

Collateralized Debt Borrowing

Collateralized Debt Borrowing

Account Receivables C

PooledPooled

ABC

AAA Tranche

AAA Tranche

Pooled

DEF

Mezzanine A

Account Receivables A

Account Receivables B

MezzanineA

RetainedInterest

Mezzanine B(from another MBS)

Mezzanine C(from another MBS)

MezzanineD

AAA TrancheAAA

Tranche

Mezzanine E(from another MBS)

Mezzanine F(from another MBS)

Residual

AAA Tranche

Mezzanine G

Note: Indicates the default portion

Residual

Asset Derecognition

• Asset sold for cash, seller has no further involvement

• Asset sold for cash, seller has a call option to repurchase the asset, option way out of the money

• Asset sold for cash, seller has a call option to repurchase the asset, option way in the money

• Firm has a call option to purchase an option never owned

Asset Securitization: Conceptual Issues

• What are the basic conditions for removing an asset from the books?~ Is failure to meet the definition of an

asset sufficient?– If not, is there a flaw in the

definition?~ Implications of answer

– Income statement – gain/loss– Balance sheet – don’t remove asset

cash received is a loan

Asset Securitization: Conceptual Issues

• Does ownership history matter?• Can part of an asset be derecognized?• Modifications introduced as part of the

transfer~ Derivatives or guarantee

– Derivative offsets risks but introduces a new source of risk (counterparty performance)

– Cash flows may come from sources other than the asset

• Should these differences affect the accounting treatment?

Asset Securitization: Conceptual Issues

• Is legal isolation required?• Does the order of the transactions matter?

~ Fixed price call option to repurchase a previously owned asset, versus the same option on an asset never owned

• Can pieces of an asset be sold?~ Strict control might say no, strict components would

say yes~ How would you divide the asset?

– Cash flows, risk• How does derecognition interact with the choice

of measurement attributes?

Asset Securitization: Possible Approaches

• Risk and Rewards~ Compare transferor’s exposure before and after the

transfer– Should we look at max exposure or expected exposure?

• Control~ Assets are placed beyond reach of the transferor and

creditors~ Transferee must be able to pledge/exchange assets

– Should we really look to the transferee to determine the transferor’s accounting?

• Components Approach~ Focus on the contractual pieces

– Every call put etc would be separately valued