Part I: Securitisation: Concept and Markets

CHAPTER 1: SECURITISATION AND STRUCTURED FINANCE... .29

Asset securitisation:

What is an asset-backed security?.................................................................. 32

Legal preference by isolation:............................................................................ 34

Capital market window:...................................................................................... 35

Use of special purpose vehicles:....................................................................... 35

Some definitions of securitisation:...................................................... 36

Securitisation of receivables:........................................................................ 37

Quick guide to jargon:................................................................................. 37

Securitisation and structured finance:............................................................ 40

Some quick features of securitisation:........................................................... 40

What receivables are securitisable:.................................................... 40

Creation of security:.......................................................................... 41

Special purpose vehicle:.................................................................... 42

Re-distribution of risks:..................................................................... 43

Rating.............................................................................................. 43

The Big picture of securitisation of finance:................................................... 44

Changing structure of financial markets:............................................. 44

Institutionalisation of savings:............................................................................. 44

Changes in corporate borrowing:..................................................................... 45

Securitisation and disintermediation:................................................................ 46

Changes in bank liability structure.................................................................... 47

Securitisation: changing  the face of banking:............................................... 47

Capital markets fuelled securitisation:............................................................. 48

Securitisation and financial disintermediation:..................................... 49

Utilities added by financial intermediaries:..................................................... 49

Securitisation: changes the function of intermediation:.............................. 50

Securitisation as a tool of risk management:.................................................. 51

Securitisation and credit derivatives:............................................................... 52

Synthetic securitisation:......................................................................................... 52

Economic impact of securitisation:................................................................ 53

1. Facilitates creation of markets in financial claims:........................... 53

2. Disperses holding of financial assets:.............................................. 53

3. Promotes savings:......................................................................... 54

4. Reduces costs:............................................................................. 54

5. Diversifies risks:............................................................................ 54

6. Focuses on use of resources, and not their ownership:................... 55

7. Smoothens impact of recession:.................................................... 55

The alchemy of securitisation:  is the sum of parts more than the whole?........ 55

The alchemy of structured finance:..................................................... 56

Structured finance:.................................................................................................. 56

Lower costs due to higher leverage................................................................. 57

Capturing scale and volume efficiencies......................................................... 58

Risks and benefits of securitisation:............................................................... 58

Abdication of credit: Subprime lending created and sold:...................... 60

Trading on thin capital:.......................................................................................... 61

Off  balance sheet financing:............................................................................... 62

Increases opacity of banks:................................................................................ 63

The case of Superior Bank................................................................................. 64

Cross-sector risk transfers:................................................................................. 65

Monetary policy sterilised:.................................................................................. 65

chapter 2: SECURITISATION : METHODOLOY AND STRUCTURES        67

Modus-operandi of securitisation briefly explained....................................... 68

Features of securitisation of receivables:....................................................... 71

1. Mode of asset-based financing:..................................................... 71

2. Mode of structured financing:........................................................ 72

3. Securitisation of claims against third parties:................................... 73

4. Limited Recourse:......................................................................... 73

5 Asset features:............................................................................... 74

1. Asset should represent cashflows:.............................................................. 75

2. Quality of the receivables:.............................................................................. 75

3. Diversification of the portfolio:..................................................................... 76

4. Size of individual receivable:......................................................................... 76

5. Maturity composition of the receivables:.................................................. 77

6. Periodicity of payments:.................................................................................. 77

7. Homogeneity of the assets:............................................................................ 77

8. No executory clauses:..................................................................................... 77

9. Capacity to assign:............................................................................................ 78

10. Independence from the originator:........................................................... 78

11. Assets should be free of withholding taxes/ pre-paid taxes:.......... 78

6 Originator features:........................................................................ 78

1. Receivables as major assets:......................................................................... 78

2. Financial and organisational strength:......................................................... 80

7 Issuer/ SPV features:..................................................................... 80

8 Investor features............................................................................ 81

Securitisation and factoring:.......................................................................... 82

Securitisation and ring fencing:...................................................................... 82

Asset classes:.............................................................................................. 83

Broad types of securitisation structures:........................................................ 85

Cash versus synthetic structures:....................................................... 87

True sale versus secured loan structures:........................................... 87

Pass-through versus collateral structure:............................................ 88

Discrete trust versus master trust:...................................................... 88

Direct portfolio transfers:............................................................................. 89

Pass-through structure................................................................................. 91

Steps in a pass through transaction.................................................................. 91

Nature of pass through certificates:................................................................. 92

Difficulties in the pass through structure:........................................................ 93

Refinements in the pass through structure:.................................................... 94

Pay-through structure:....................................................................... 95

Collateralised mortgage obligation bonds:.......................................... 99

Refinements in CMO structure:....................................................................... 101

Revolving assets securitisation:........................................................ 103

Future flows securitisation:.............................................................. 104

Advantages of securitisation for the issuer................................................... 112

Lower cost............................................................................................................. 112

Alternative investor base.................................................................................... 113

Perfect matching of assets and liabilities...................................................... 113

Makes the issuer-rating irrelevant.................................................................. 113

Multiplies asset creation ability:....................................................................... 114

Allows higher funding:......................................................................................... 114

Off-balance sheet financing:.............................................................................. 114

Helps in capital adequacy requirements:...................................................... 115

Improves capital structure................................................................................. 115

Better opportunity of trading on equity with no increased risk:.......... 115

Extends credit pool:............................................................................................. 116

Not regulated as a loan:..................................................................................... 116

Reduces credit concentration:.......................................................................... 116

Avoids interest rate risk:.................................................................................... 116

Arbitraging by repackaging:.............................................................................. 116

Arbitraging on liquidity and term structure:................................................. 117

Improves accounting profits.......................................................... 117

Advantages to the investors:....................................................................... 117

1.    Better Security:............................................................................................ 118

2.    Good ratings:................................................................................................ 118

3.    Rating resilience:.......................................................................................... 118

4.    Better matching with investment objectives:..................................... 118

5.    Good spreads:.............................................................................................. 119

6.    Few instances of default:.......................................................................... 119

7.    Moral responsibility:................................................................................... 119

8.    Better matching with investment objectives:..................................... 119

Threats in securitisation:............................................................................. 119

1. Costly source:................................................................................................... 120

2. Uneconomical for lower requirements:................................................... 120

3. Passes on database to investors:............................................................... 120

4. Leaves the entity with junk assets:............................................................ 120

5. Poses liquidity threats:................................................................................... 121

6. Bad in bad days:.............................................................................................. 121

7. Makes profit accounting volatile................................................................ 121

Appendix Securitisation terminology............................. 123

chapter 3: The World of Securitisation.......................... 147

History of securitisation:............................................................................. 148

Deeper in history............................................................................ 149

The US mortgage market:............................................................... 149

Ginnie Mae's first securitisation initiative:..................................................... 150

Fannie Mae's securitisation deals:.................................................................. 150

The Freddie Mac:................................................................................................. 150

Spreads over to non-mortgage assets:............................................. 150

Securitisation through recession:...................................................... 151

The life cycle of securitisation:.................................................................... 151

Present state of securitisation:..................................................................... 152

North America.......................................................................................... 152

United States:................................................................................. 152

Canada:......................................................................................... 155

Europe:..................................................................................................... 155

Origins of European securitisation:................................................................. 156

Growth of securitisation in Europe:................................................................ 156

United Kingdom:............................................................................ 157

Legal Systems and initiatives:......................................................................... 158

Taxation:................................................................................................................. 158

Originator taxation:.................................................................. 159

Investors' taxation:................................................................... 159

SPV taxation:.......................................................................... 159

Accounting and regulatory treatment:........................................................... 160

SPV structures:...................................................................................................... 160

Germany:....................................................................................... 160

Pfandbriefe: The traditional German instrument:..................................... 160

Modern securitisation market.......................................................................... 161

German regulations on securitisations:.......................................................... 162

ABS definition......................................................................... 162

Capital requirements................................................................ 162

No cherry-picking of receivables............................................. 164

Notification to the debtor:........................................................ 164

Not applicable to revolving assets:........................................... 165

Tax aspects:............................................................................................................ 165

Accounting Aspects............................................................................................. 165

Italy:............................................................................................... 166

State of the market and developments:........................................................ 166

Legal initiatives to promote securitisation:................................................... 166

Taxation of securitisation:.................................................................................. 168

Denmark:....................................................................................... 168

The birthplace of securitisation:....................................................................... 168

Present state of the market:.............................................................................. 169

Legal initiatives to promote securitisation:................................................... 169

Netherlands:................................................................................... 169

General legal system:........................................................................................... 169

Exemption regulation for SPVs.................................................... 170

Taxation:................................................................................................................... 172

France:........................................................................................... 172

Legal initiatives:...................................................................................................... 172

The French FCC:................................................................................................. 173

Taxation issues:...................................................................................................... 174

Synthetic securitisation........................................................................................ 174

Belgium:......................................................................................... 174

Development and state of the Market:......................................................... 174

Legal initiatives:...................................................................................................... 175

General law on assignment of receivables:.................................................. 175

Basic conditions concerning the receivables.............................................. 176

Regulatory framework........................................................................................ 177

Prudential regulation............................................................................................ 178

Taxation:................................................................................................................... 178

Portugal:......................................................................................... 179

Spain:............................................................................................. 180

State of the Market:............................................................................................. 180

Legal initiatives:...................................................................................................... 181

Regulatory and accounting issues:.................................................................. 182

Sweden:......................................................................................... 183

Legal and regulatory framework:.................................................................... 183

Finland:.......................................................................................... 183

Legal system:.......................................................................................................... 184

Switzerland:.................................................................................... 184

Luxembourg................................................................................... 185

Turkey........................................................................................... 186

Latvia............................................................................................. 187

Poland........................................................................................... 188

Austria........................................................................................... 189

Czech Republic.............................................................................. 189

Hungary......................................................................................... 190

Central and South America:....................................................................... 190

Origins of securitisation in Latin America:........................................ 191

Mexico:.......................................................................................... 191

State of the Market:............................................................................................. 191

Legal initiatives:...................................................................................................... 192

Tax issues................................................................................... 193

Brazil:............................................................................................. 193

State of the Market:............................................................................................. 193

Legal initiatives to promote securitisation:................................................... 194

Taxation of securitisation:.................................................................................. 195

Future flows and Brazilian bankruptcy laws:.............................................. 195

Asia:......................................................................................................... 196

Japan:............................................................................................ 197

General Overview................................................................................................ 197

Recent Developments......................................................................................... 198

Legal Aspects........................................................................................................ 198

Mortgage Backed Loans................................................................................... 199

Aspects of Taxation............................................................................................. 199

Accounting Aspects............................................................................................. 199

Others....................................................................................................................... 200

Singapore....................................................................................... 200

General Overview................................................................................................ 200

Legal Aspects........................................................................................................ 201

Taxation Aspects.................................................................................................. 202

Mortgage Backed Securities............................................................................ 202

Hong Kong.................................................................................... 203

General Overview................................................................................................ 203

Legal Aspects........................................................................................................ 203

Accounting Aspects............................................................................................. 203

Taxation Aspects.................................................................................................. 204

Mortgage Backed Securities............................................................................ 204

Thailand......................................................................................... 205

General Overview................................................................................................ 205

Legal Aspects........................................................................................................ 205

Taxation Aspects.................................................................................................. 208

Mortgage Backed Securities............................................................................ 209

Indonesia....................................................................................... 210

General Overview................................................................................................ 210

Recent Development........................................................................................... 210

Legal Aspects........................................................................................................ 210

Taxation Aspects.................................................................................................. 211

Korea............................................................................................ 212

General Overview................................................................................................ 212

Legal Aspects........................................................................................................ 213

Peoples' Republic of China:............................................................ 214

General Overview................................................................................................ 214

Recent Developments......................................................................................... 215

Legal Aspects........................................................................................................ 215

Taiwan........................................................................................... 216

General Overview................................................................................................ 216

Legal Aspects........................................................................................................ 216

Taxation Aspects.................................................................................................. 217

Pakistan......................................................................................... 218

General Overview................................................................................................ 218

Recent Development........................................................................................... 218

Legal Aspects........................................................................................................ 219

Taxation Aspects.................................................................................................. 220

The Pacific:............................................................................................... 221

Australia......................................................................................... 221

General Overview....................................................................... 221

Recent developments.................................................................. 221

Legal aspects.............................................................................. 222

Mortgage backed market............................................................ 222

Aspects of taxation..................................................................... 222

Accounting aspects..................................................................... 223

New Zealand................................................................................. 223

General Overview................................................................................................ 223

Recent Developments......................................................................................... 223

Legal Aspects........................................................................................................ 224

Aspects of Taxation............................................................................................. 225

Accounting Aspects............................................................................................. 225

Securitisation in India................................................................................. 226

Trends in global securitisation:.................................................................... 226

1. Blurring distinction between structured finance and corporate finance:…………………        227

2. Increasing use of derivatives in securitisations:..................................... 227

3. Increasing risk securitisations...................................................................... 228

4. Equity into debt, and debt into equity:..................................................... 228

chapter 4: Structuring, credit enhancing and evaluating securitisation transactions          

Parties involved:........................................................................................ 229

Primary parties:.............................................................................. 230

Supportive agencies:....................................................................... 230

Steps in a securitisation transaction:............................................................ 231

Initial feasibility study:..................................................................... 231

Objective of the originator:............................................................................... 231

Legal feasibility:..................................................................................................... 232

Financial feasibility:............................................................................................... 233

Systems feasibility:................................................................................................ 233

Key appointments:.......................................................................... 233

Asset analysis and selection:............................................................ 233

Due diligence audit:......................................................................... 234

Determination of the structure:......................................................... 235

Credit enhancements:...................................................................... 236

Intervening reinvestments:............................................................... 236

Guaranteed reinvestment contracts:............................................................... 237

Reinvestments in buying fresh receivables:.................................................. 237

Reinvestment in other permissible collateral:.............................................. 237

Fixing the legal structure:................................................................. 237

Legal opinions................................................................................ 238

Rating............................................................................................ 238

Offer.............................................................................................. 239

Appointment of servicer/ administrator:........................................... 239

Servicer capabilities............................................................................................. 239

Post completion routines................................................................. 239

Ongoing reporting:.......................................................................... 239

Clean up call:.................................................................................. 240

Credit enhancements:................................................................................. 240

First loss, second and subsequent loss:............................................ 241

Internal and external credit enhancements:....................................... 242

Originator credit enhancements:...................................................... 242

Excess spread or profit:..................................................................................... 242

Cash collateral:...................................................................................................... 243

Overcollateralisation:........................................................................................... 244

Early amortisation triggers:................................................................................ 244

Structural credit enhancements:....................................................... 245

Junior / senior structure or tranched securitisation:.................................. 245

Third party credit enhancements:..................................................... 246

Letters of credit:.................................................................................................... 246

Related party guarantee:.................................................................................... 246

Monoline insurance:............................................................................................. 246

Pool insurance:....................................................................................................... 246

Liquidity enhancement .............................................................................. 246

Pay-down structure................................................................................... 247

Cashflow waterfall:......................................................................... 247

Sequential paydown:........................................................................................... 247

Pro-rata paydown:............................................................................................... 248

Fast-pay/ slow-pay structure:.......................................................................... 248

Financial evaluation of securitisation transactions:........................................ 249

Basic cash flows in securitisation:.................................................... 249

Weighted average maturity of securitisation:..................................... 250

Securitisation and borrowing options:.............................................. 251

IRR or NPV:.................................................................................. 252

Weighted average cost method:...................................................... 255

chapter 5: Rating of securitisation transactions... 259

Rating agency concerns............................................................................. 260

Asset quality:.......................................................................................................... 260

Solvency of the issuer:........................................................................................ 261

Perfection of legal structure.............................................................................. 261

Tax risks................................................................................................................... 261

Clean and prior title to the securitised portfolio:....................................... 262

Risk of set-off........................................................................................................ 262

Risk of prepayment.............................................................................................. 262

Executory contractual clauses:......................................................................... 263

Ratings of connected parties:........................................................................... 263

Servicer or administrator rating:...................................................................... 263

Sovereign risks:..................................................................................................... 263

The rating process:.................................................................................... 264

Review / presentation.......................................................................................... 264

Asset analysis......................................................................................................... 264

Transaction analysis............................................................................................. 264

Legal and tax.......................................................................................................... 265

Rating models............................................................................................ 265

Part II: Securitisation asset classes

chapter 6: Residential mortgage-backed securitisation       269

Mortgage funding systems:......................................................................... 270

Government support to housing finance:..................................................... 271

Why secondary mortgage markets:............................................................ 271

Origin of the secondary mortgage markets:................................................. 273

The secondary mortgage market in the USA:................................... 273

Agency market:..................................................................................................... 273

The non-agency market..................................................................................... 274

Current size of the US RMBS market:............................................ 277

Conforming and non-conforming market:................................................... 278

Secondary mortgage market in other countries:................................ 279

Current size of the RMBS market in Europe:............................................ 280

RMBS in UK......................................................................................................... 281

Structuring of RMBS transactions:............................................................. 281

Structure of agency-backed securitisation:....................................... 281

Illustration of Fannie Mae MBS structure:.................................................. 281

Secondary market in agency MBS................................................................ 284

Structure of non-agency pass-throughs:........................................... 284

Structure of CMOs:........................................................................ 284

UK RMBS:.................................................................................... 285

Case study: Abbey National's Holmes Financing............................. 286

Special purpose vehicles:................................................................................... 288

The loan portfolio:................................................................................................ 288

Master trust and the transfer of assets:......................................................... 289

Home equity loans securitisation:................................................................ 291

Manufactured home loans:......................................................................... 292

European Mortgage bonds or Pfandbriefes:................................................ 293

Investing in the MBS market:..................................................................... 294

Who invests in MBS....................................................................... 294

Risks in investing in MBS:............................................................... 295

Orange County's bankruptcy:.......................................................................... 295

Askin Capital Management.............................................................................. 296

Beacon Hill Hedge fund:.................................................................................... 296

MBS  versus fixed income investments:....................................................... 296

MBS and interest rates:...................................................................................... 298

Prepayment modeling in RMBS:..................................................... 298

Why do mortgagors prepay?........................................................................... 298

Relevance of prepayment modeling to investors:..................................... 299

Conditional prepayment rate:........................................................................... 300

How is the SMM information used to project yield:............................... 300

Need for a prepayment model:....................................................................... 300

The PSA prepayment model............................................................................ 301

Illustrations.............................................................................................................. 301

Projected speeds based on PSA:.................................................................. 301

Negative convexity of MBS:........................................................... 302

Illustration................................................................................................................ 302

Option-adjusted spread:.................................................................................... 305

chapter 7: Commercial mortgage-backed securitisation     307

What is CMBS......................................................................................... 308

Differences between RMBS and CMBS:........................................ 308

Typical features:............................................................................. 309

CMBS and REITs:......................................................................... 310

CMBS market:.......................................................................................... 311

Development of the CMBS market:................................................ 311

USA........................................................................................................................... 311

Late Development of CMBS market:.......................................................... 312

Reasons for decline post 1998 in the US market:................................... 312

Europe:..................................................................................................................... 314

Structure of a CMBS transaction:.............................................................. 314

Balance sheet and conduit activity:.................................................. 315

Trophy asset versus portfolio of assets:........................................... 315

By property sectors:....................................................................... 315

Balloon loans:................................................................................. 315

Diversification:................................................................................ 316

Spatial diversification:.......................................................................................... 316

Property-type diversification:........................................................................... 316

Servicers:....................................................................................... 316

Case study: GMAC's 2001-WTC transaction............................................ 316

Collateral:....................................................................................... 317

The loan:........................................................................................ 318

Prepayment protection....................................................................................... 320

The certificates:.............................................................................. 320

Retention of interests by the originator:........................................................ 321

Liquidity and credit enhancements:.................................................. 321

The aftermath:................................................................................ 321

Case study: Canary Wharf - A TYPICAL UK CMBS:.............................. 322

Introduction to the transaction:........................................................ 323

Transaction structure...................................................................... 323

The properties:............................................................................... 325

Cashflows...................................................................................... 326

Investing in CMBS.................................................................................... 326

Prepayment protection in CRE loans:.............................................. 327

Delinquency in CMBS:................................................................... 327

chapter 8: Credit cards securitisation:......................... 329

Nature of credit card debt......................................................................... 330

An overview of the market......................................................................... 331

Transaction structure................................................................................. 332

Revolving asset structure:................................................................ 333

Seller’s interest:.............................................................................. 333

Discrete and master trust structure:.................................................. 334

Allocation of interest:........................................................................................... 334

Allocation of principal and prepayments:.................................................... 334

Components of a credit card structure........................................................ 335

Portfolio yield:................................................................................ 335

Charge offs:.................................................................................... 337

Credit scores and the charge off rate:........................................................... 339

Payment rate:................................................................................. 339

Servicing fee and Base rate:............................................................ 339

Early amortization triggers:.............................................................. 340

Subordination structure in credit card ABS:..................................... 340

Investor experience in credit cards:............................................................ 341

Commercial Financial Services:....................................................... 341

NextCard:...................................................................................... 341

chapter 9: Auto loan securitisation................................ 343

Forms of car funding:................................................................................. 344

Auto loans securitisation market:................................................................ 344

The US market:.............................................................................. 345

Other countries:.............................................................................. 345

Collateral quality........................................................................................ 345

Typical structures:...................................................................................... 346

Credit enhancements:...................................................................... 346

Specific issues in auto loan securitisation..................................................... 347

Case study: Daimler-Chrysler Auto Trust:.................................................. 348

The collateral:................................................................................. 348

Transaction structure:...................................................................... 350

Issuer:........................................................................................................................ 351

Pay-down structure:............................................................................................ 351

Clean up call:.......................................................................................................... 351

Credit enhancements:...................................................................... 351

Over-collateralisation:......................................................................................... 351

Reserve fund:.......................................................................................................... 352

Yield supplement:................................................................................................. 352

Excess interest:...................................................................................................... 352

Certificates:............................................................................................................. 352

Cashflow waterfall:......................................................................... 352

chapter 10: Equipment Lease securitisation................. 355

Equipment leasing market:............................................................... 356

Equipment lease securitisation market:............................................. 356

Product structure............................................................................ 356

Rating of equipment lease securitisations:......................................... 357

Residual value risk in equipment lease securitisations:....................... 357

Investing in equipment lease securitisations:................................................. 358

chapter 11: Collateralised Debt Obligations............ 359

What is a CDO:........................................................................................ 360

Differences between CLOs and CBOs:........................................... 360

Typical structure of a CDO:............................................................ 361

Types of CDOs:........................................................................................ 361

Cash and synthetic CDOs:.............................................................. 362

CDO types based on collateral:...................................................... 362

Balance sheet and arbitrage CDOs:................................................. 363

Par value and market value based structures:................................... 363

Growth of the CDO market:...................................................................... 363

European CDO market.................................................................. 365

Balance sheet CDOs:................................................................................ 365

Traditional, cash CDOs:................................................................. 365

Type of SPV:......................................................................................................... 365

Underlying assets:................................................................................................. 365

Diversity score:...................................................................................................... 366

Reinvestment period:........................................................................................... 367

Typical stratification:............................................................................................ 367

Early amortisation triggers:................................................................................ 367

Structural tests:...................................................................................................... 368

Cashflow waterfall:............................................................................................... 368

Synthetic CDOs:............................................................................ 368

Arbitrage CDOs:....................................................................................... 368

Meaning of an arbitrage CDO:........................................................ 368

Illustration of arbitraging:................................................................. 369

Typical funding structure:................................................................................... 369

How and why arbitrage exists:........................................................................ 369

Emergence of arbitrage CDOs:....................................................... 370

Difference between arbitrage CDOs and balance sheet CDOs:........ 371

Revolving period:............................................................................ 372

Market value CDOs:................................................................................. 372

Structure of a market value CDO:................................................... 372

Liabilities of cashflow and market value CDOs:............................... 373

Ramp up period:........................................................................................ 374

The CDO manager:................................................................................... 374

Qualities of the CDO manager:....................................................... 375

Experience:.............................................................................................................. 375

Staffing:..................................................................................................................... 376

Strong internal controls:...................................................................................... 376

Technological investments:................................................................................ 376

Financial resources:.............................................................................................. 376

Balancing between equity  investors and debt investors:....................... 379

The CDO manager’s fees:.............................................................. 380

The CDO investors:................................................................................... 380

The CDO trustee:...................................................................................... 381

Authorisation of trades:................................................................... 381

Credit enhancer and swap counterparty:..................................................... 381

Typical Credit enhancements in CDOs:........................................... 382

Subordination:........................................................................................................ 382

Cash collateral:...................................................................................................... 382

Excess spread:....................................................................................................... 383

Bond insurance or financial guarantee:......................................................... 383

Managing the assets of CDOs:................................................................... 383

Asset quality tests:..................................................................................... 384

Minimum average rating test:............................................................................ 384

Minimum recovery rate test:............................................................................. 384

Industry and obligor concentration tests:..................................................... 384

Minimum weighted average coupon:............................................................. 384

Cashflow coverage tests:........................................................................... 384

Over-collateralisation and interest coverage ratios:........................... 384

What happens when the tests are not met:....................................... 387

Cashflow waterfall:......................................................................... 387

Resecuritisation or structured finance cdos:................................................. 390

Growth of structured product CDOs:.............................................. 391

Distressed debt CDOs:.............................................................................. 392

What is distressed debt:.................................................................. 393

Distressed debt CDOs and securitisation of non-performing loans:... 393

Motivations:................................................................................... 394

Credit enhancement levels............................................................... 394

Typical issues in distressed debt CDOs:.......................................... 394

Evaluation of distressed debt CDO manager:................................... 395

Hedge fund CDOs or fund of funds............................................................ 396

Investing in CDOs:.................................................................................... 396

Investor motivations:....................................................................... 396

1. Strength and Stability..................................................................................... 397

2. Diversification................................................................................................... 397

3. Standardisation................................................................................................. 397

4. Deep market..................................................................................................... 397

5. Yield..................................................................................................................... 397

6. Transparency.................................................................................................... 397

Risks in CDO investment - structure and collateral risks:............................. 398

Interest rate and basis mismatch:..................................................... 398

Cross currency risk:........................................................................ 398

Liquidity risk:.................................................................................. 398

Ramp up risks:............................................................................... 399

Reinvestment risks during the revolving period:................................ 399

Asset risks:..................................................................................... 400

Taxation of CDOs:.................................................................................... 400

Legal issues specific to CDOs:................................................................... 401

Bankruptcy remoteness:.................................................................. 401

True sale opinion:........................................................................... 401

Transfer of loans and perfection:..................................................... 401

Right of set off:............................................................................... 403

Lender liability:............................................................................... 403

Current problems facing the CDO sector:................................................... 402

Increasing downgrades and defaults................................................ 403

Accounting worries:........................................................................ 404

De-leveraging:................................................................................ 404

chapter 12: Asset backed commercial paper............... 405

Genesis of asset backed commercial paper................................................ 406

The ABCP market.................................................................................... 407

Types of ABCP conduits:.......................................................................... 408

ABCP collateral:....................................................................................... 409

Structure of ABCP programs:.................................................................... 410

The role of the sponsor:.................................................................. 412

chapter 13: Future flows securitisation........................ 413

What future flows are securitisable:............................................................ 414

Some key features of future flows deals:.......................................... 414

Uncertain receivables:......................................................................................... 414

Cashflow trapping:............................................................................................... 414

Prioritisation of the transferee:......................................................................... 415

High extent of over-collateralisation:............................................................. 415

Restrictions on the borrower’s business:..................................................... 415

No originator independence:............................................................................ 415

Why future flow securitisation?................................................................... 416

Types of future flow deals :........................................................................ 417

Based on exports of goods or services........................................................ 417

Based on sales of goods or services............................................................. 418

Financial future flows........................................................................................... 418

Other future flows................................................................................................. 418

Structural features:..................................................................................... 418

Early amortization triggers:.............................................................. 418

Reps and warranties of the seller:.................................................... 419

The future flows market:............................................................................ 419

Legal taxation and accounting issues:.......................................................... 420

Experience with future flows:...................................................................... 421

chapter 14: Whole business and operating revenues securitisation         423

Market development................................................................................. 424

Methodology............................................................................................. 425

Secured loan structure.................................................................... 425

Bankruptcy protection:................................................................... 425

The legal basis:.......................................................................................... 427

Administrative receivership............................................................. 427

Law of receivership........................................................................ 428

Fixed and floating charges:.............................................................. 429

Challenge to floating charges: the ruling in Brumark's case:................ 429

UK Insolvency law amendment and whole business transactions:..... 430

Is a secured loan structure as safe as true sales?.............................. 431

Businesses where whole business securitisation is possible:......................... 431

Why SPV in a whole business structure:..................................................... 432

Inventory securitisation.............................................................................. 433

Case study: Rosey Blue diamond inventory securitisation................. 433

Potential products for inventory securitisation............................................. 434

chapter 15: Other miscellaneous asset classes......... 437

Securitisation of intellectual property:.......................................................... 437

Intellectual properties revenues securitisation market........................ 437

Music royalties:.............................................................................. 438

Bowie Bonds:......................................................................................................... 438

More instances of music securitisation:........................................................ 438

Transaction structure:.......................................................................................... 439

Film financing................................................................................. 440

Bond bonds................................................................................ 440

Dreamworks........................................................................................................... 440

Others:........................................................................................... 441

Securitization of non-performing loans........................................................ 441

The massive problem of bad loans:.................................................. 441

Resolution Trust Corp:.................................................................... 441

Models in other countries:............................................................... 442

Japan:........................................................................................................................ 442

MSDW’s securitization in Japan:................................................................... 442

Resolution and Collection Corp., Japan:..................................................... 443

Kamco’s Korean NPL securitisation............................................... 444

The NPL problem in Korea and initiatives to clean up:......................... 444

Kamco’s NPL sales and securitisation:....................................................... 445

The portfolio:.......................................................................................................... 445

The SPV structure................................................................................................ 446

The senior notes:................................................................................................... 446

Credit enhancements:.......................................................................................... 446

How does it actually happen:.......................................................... 446

Government receivables............................................................................. 447

Italian securitisations:...................................................................... 447

US tobacco settlement receivables:................................................. 448

chapter 16: Synthetic Securitisation and Other Risk Transfer Devices  451

Cash versus synthetic securitisation:............................................................ 452

Modus operandi:............................................................................ 453

Structured credit risk transfer:......................................................... 454

Leveraged risk transfer:.................................................................. 456

Super-senior swap............................................................................................... 457

Advantages of synthetic securitisation over cash transfers:........................... 458

Minimizes funding and reinvestment problems:......................................... 459

Splits the funding and the risk transfers........................................................ 459

Alleviates transfer-related problems:............................................................. 459

Does not require artificial separation of origination and servicing functions:         461

Lesser legal costs:................................................................................................. 462

No upfront taxation:............................................................................................. 462

Avoids double taxation of residual profits:.................................................. 463

No accounting volatility:..................................................................................... 463

Does not reduce book size:.............................................................................. 465

Retains flexibility in customer service:........................................................... 465

Distinction between cash-funded and synthetic securitisation:...................... 466

Elements of synthetic securitisation............................................................. 467

Originator:...................................................................................... 467

Obligor portfolio:............................................................................ 467

Type of Credit derivative:............................................................... 468

Credit events and loss computation:................................................ 468

Special purpose vehicle:.................................................................. 469

Assets of the SPV:......................................................................... 470

Liabilities of the SPV:..................................................................... 471

Non-SPV structures:...................................................................... 471

Sizing of the credit enhancement:..................................................... 472

Swap calculation agent:................................................................... 474

Trustees:........................................................................................ 474

Super senior swap provider:........................................................... 475

Other swap counterparties:............................................................. 475

Arbitrage synthetic CDOs:......................................................................... 475

Difference between arbitrage synthetic CDOs and balance sheet synthetic CDOs:…………….. 478

Collateral manager:......................................................................... 479

OC and IC triggers in case of synthetic CDOs:........................................... 479

Application of OC and IC triggers to synthetic CDOs:..................... 479

Paydown structure:.................................................................................... 480

Sequential paydown:....................................................................... 480

Pro-rata paydown:......................................................................... 480

Fast-pay/ slow-pay structure:.......................................................... 481

Evolution and growth of synthetic CDOs.................................................... 481

Investing in synthetic CDOs:...................................................................... 483

Insurance risk securitisation:....................................................................... 485

Alternative risk transfer:.................................................................. 486

Insurance securitisation:.................................................................. 486

Catastrophe bonds:.............................................................................................. 486

Not catastrophe risk securitisation................................................................. 486

Risk transfer by the insured.............................................................................. 487

The cat bonds market:.................................................................... 487

Illustration of the cat bonds technology:........................................... 489

Equity call option:........................................................................... 490

Insurance securitisation by non-insurance companies:....................... 490

Part III Technical Issues

chaper 17: LEGAL ISSUES IN SECURITISATION........................ 495

The significance of legal issues in securitisation:........................................... 496

Why are securitisation legal issues complicated?......................................... 497

What are the main legal issues?.................................................................. 498

Securitisation and loan obligations:............................................................. 498

The true sale question................................................................................ 501

Background of the true sale question:.............................................. 501

Why should we ask a true sale question?................................................... 501

Who can question the true sale?..................................................................... 501

What if it is not a true sale?............................................................................... 502

The question of substantive transfer or financing arrangement:.......... 502

Case law on true sale................................................................................. 502

US Cases....................................................................................... 504

Major's Furniture Mart:...................................................................................... 504

Evergreen Valley Resort:................................................................................... 506

Endico Potatoes:................................................................................................... 506

Octagon Gas:......................................................................................................... 507

LTV Steel:............................................................................................................... 508

Avianca future flow transaction:...................................................................... 509

UK cases:...................................................................................... 510

George Inglefield:.................................................................................................. 510

Other UK cases:................................................................................................... 511

Canadian ruling in BC Tel’s case:.................................................... 512

Safe harbour law:........................................................................... 513

The factors that make or mar a true sale:.................................................... 516

The role of language used by the parties:......................................... 516

Recourse:....................................................................................... 517

Residual interest:............................................................................. 518

Servicing by the seller:.................................................................... 519

Uncertain sale consideration:........................................................... 520

Factors in determination of a sale:.............................................................. 520

Requirements of valid transfer of receivables:................................... 520

Legal or legally enforceable transfer of the receivables:........................ 520

The receivables must be existing at the time of the assignment:.......... 521

The receivables must be identifiable.............................................................. 522

The whole of a receivable should be assigned:......................................... 522

The assignor must not be the assignee......................................................... 524

It must be an assignment of rights, not obligations:.................................. 524

There must not be contractual or other restrictions on transfer:......... 527

The rights must not be personal rights:......................................................... 527

There must not be a right of set-off or claims against the originator: 527

Methods of transferring receivables:........................................................... 527

Assignment:............................................................................................................. 527

Novation.................................................................................................................. 528

Sub-participation or participation:.................................................................. 528

Declaration of trust:.............................................................................................. 529

Legal procedure for assignment of receivables:........................................... 529

English common law:...................................................................... 529

Roman-Dutch law or Civil law........................................................ 530

Procedure for assignment of actionable claims:........................................... 531

Meaning of debt or actionable claims:.............................................. 532

Instrument in writing:............................................................................................ 533

Obligor notification:.............................................................................................. 534

Cases where conveyance or obligor notification not required:........... 535

Mode of transfer of actionable claims:......................................................... 536

Equitable assignment:................................................................................. 537

What is equitable assignment:.......................................................... 537

Why equitable assignment:.............................................................. 538

Problems with equitable assignment:................................................ 539

Stamp duty on securitisation: general:......................................................... 540

FAQs on stamp duty on securitisation:............................................ 540

Why applicable to securitisation transaction?............................................ 540

What attracts the duty - the transaction or the instrument?.................. 540

What is the chargeable amount for duty purposes?................................ 540

What are the common ways to avoid the duty?....................................... 541

Can the duty be avoided by oral agreements?.......................................... 541

Can the duty be applicable to agreements electronically signed and stored?………………..    542

What is the duty applicable to revolving asset securitisation?............. 542

What is the duty applicable to future receivables securitisation?........ 542

Is the duty applicable to transfer of pass-through securities?.............. 542

Is there any duty on issue of pass through certificates?......................... 543

Avoiding stamp duty by shifting jurisdiction:................................................ 543

Situation of "receivables"................................................................. 544

Position in case of multi-State properties:........................................ 544

Stamp duties on transfer of investors’ interest:............................................ 545

Beneficial interest versus equitable interest................................................. 545

Legal nature of investors’ right in case of securitisations:...................... 546

Stamp duty on securitisation transactions: Indian case................................. 547

Reduction of stamp duty by Maharashtra:........................................ 547

Other states follow:......................................................................... 548

Lessons from India:........................................................................ 548

Stamp duty relaxations in other countries.................................................... 549

Malaysia:........................................................................................ 550

Australia......................................................................................... 551

Secured loan structures:............................................................................. 552

Legal issues in synthetic structures.............................................................. 556

Bankruptcy remote securitisation................................................................ 556

Perfection of legal interest:................................................................................ 557

Priority of claims:.................................................................................................. 557

Protecting against consolidation:..................................................................... 558

Protecting against clawback:............................................................................ 558

Structuring the SPV:.................................................................................. 559

Why SPV:...................................................................................... 559

Legal considerations:...................................................................... 560

Organisational forms of SPVs:................................................................... 560

Corporations:................................................................................. 560

Trusts:............................................................................................ 561

What is a trust:....................................................................................................... 561

Trusts and securitisation:.................................................................................... 561

LLCs:........................................................................................................................ 562

Special forms:......................................................................................................... 562

Bankruptcy remoteness of SPVs:............................................................... 562

Conditions for bankruptcy-remoteness:........................................... 563

Restriction on Objects and Powers............................................................... 563

Debt Limitations.................................................................................................... 563

Non-petition agreement:.................................................................................... 564

The Independent Director................................................................................. 564

No Merger or Reorganization......................................................................... 565

Separateness Covenants.................................................................................... 565

No free-floating assets, no net worth............................................................ 566

Limitations in constitutional documents:............................................ 566

Ownership structure of the SPV:..................................................... 567

Multi-use SPVs:............................................................................. 567

Consolidation of the SPV:.......................................................................... 568

Meaning of equitable consolidation:.............................................................. 568

General principles of consolidation:............................................................... 568

Buckhead America ruling.................................................................................. 569

Kingston Square:.................................................................................................. 569

Legal rights of the investor: legal nature of the investor's right:...................... 570

Investor's rights against the originator:.......................................................... 570

Investor's rights against the SPV:................................................................... 570

Investor's rights against the obligors:............................................................. 571

Investor's rights as holders of "security"....................................................... 572

Legal nature of a future flow securitisation:.................................................. 573

Assignability of future flows:............................................................ 574

General rule:............................................................................................................ 574

Common law:......................................................................................................... 574

Other countries:..................................................................................................... 575

Structuring future flows:.................................................................. 575

Ideal legal  framework for securitisation:..................................................... 576

UNCTRAL initiative for uniform law on assignment of receivables.............. 578

Appendix 1 Model  legal opinion for a securitisation transaction          579

Appendix 2 UNCITRAL CONVENTION.......................................... 583

Appendix 3 Provisions of the Indian Transfer of Property Act         605

appendx 4: Stamp notifications in India........................... 608

Karnataka Stamp Act, 1957...................................................................... 608

Bombay Stamp Act................................................................................... 608

Bombay Stamps Act, 1958 (As applicable to the State of Gujarat)............. 609

Tamil Nadu: Indian Stamp Act, 1899......................................................... 609

West Bengal:............................................................................................. 610

chapter 18: Legal documentation for securitisation 611

Basic structure of documentation:............................................................... 612

The pooling and servicing agreement:......................................................... 612

Identification of asset to be assigned:............................................... 613

How is the identification of receivables done:............................................ 613

Samples :.................................................................................................................. 614

Conveyance clause:........................................................................ 617

Registration, stamping, etc:............................................................................... 617

Restrictions on re-transfer, etc:....................................................................... 617

Transfer of rights, not obligations:.................................................................. 617

Any continuing or future transfers:.................................................................. 618

Contingency of the transfer not being regarded as true sale:............... 618

Consideration for the transfer:......................................................... 618

Conditions precedent:..................................................................... 619

Representations and warranties of the Seller:................................... 619

Standard representations about the Seller:................................................. 620

Standard representations about the Receivables:..................................... 621

Specific representations about the Receivables:.........................