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FASRI Office Hours Securitizations

FASRI Office Hours Securitizations. Catherine Shakespeare. How does a securitization work?. Mortgage-backed Securities. Assets. Account Receivables A. AAA Tranche. Pooled. Account Receivables B. Mezzanine A. Account Receivables C. Retained Interest. What is a CDO?.

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FASRI Office Hours Securitizations

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  1. FASRI Office HoursSecuritizations Catherine Shakespeare

  2. How does a securitization work? Mortgage-backed Securities Assets Account Receivables A AAA Tranche Pooled Account Receivables B Mezzanine A Account Receivables C Retained Interest

  3. What is a CDO? Mortgage-backed Securities Collateralized Debt Borrowing Assets Mezzanine B (From another securitization) AAA Tranche Account Receivables A AAA Tranche Mezzanine A Pooled ABC Account Receivables B Pooled Mezzanine D Account Receivables C Retained Interest Mezzanine C (From another securitization) Residual

  4. CDO2 Mortgage-backed Securities (MBS) Collateralized Debt Borrowing Collateralized Debt Borrowing Assets Mezzanine B (from another MBS) Mezzanine E (from another MBS) AAA Tranche AAA Tranche AAA Tranche AAA Tranche AAA Tranche Account Receivables A Pooled Pooled ABC Pooled DEF Mezzanine A Account Receivables B MezzanineA MezzanineD Mezzanine G Account Receivables C Retained Interest Residual Residual Mezzanine C (from another MBS) Mezzanine F (from another MBS)

  5. What happens on when the cash flows disappear? Mortgage-backed Securities Assets Account Receivables A AAA Tranche Pooled Account Receivables B Mezzanine A Account Receivables C Retained Interest Note: Indicates the default portion

  6. Extends into the CDO market Mortgage-backed Securities Collateralized Debt Borrowing Assets Mezzanine B (From another securitization) AAA Tranche AAA Tranche Account Receivables A Pooled ABC Account Receivables B Pooled Mezzanine A Mezzanine D Account Receivables C Retained Interest Mezzanine C (From another securitization) Residual Note: Indicates the default portion

  7. House of cards start to fall…. Mortgage-backed Securities (MBS) Collateralized Debt Borrowing Collateralized Debt Borrowing Assets Mezzanine E (from another MBS) Mezzanine B (from another MBS) AAA Tranche AAA Tranche AAA Tranche AAA Tranche Account Receivables A AAATranche Pooled Pooled ABC Pooled DEF Mezzanine A Account Receivables B MezzanineA MezzanineD Mezzanine G Account Receivables C RetainedInterest Residual Residual Mezzanine C (from another MBS) Mezzanine F (from another MBS) Note: Indicates the default portion

  8. 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

  9. 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

  10. 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?

  11. 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?

  12. 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

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