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Pierpont Securities LLC
pierpontsecurities.com ©2012 Pierpont Securities, a member of FINRA and SIPC
P R O P R I E T A R Y A N D C O N F I D E N T I A L 2
SECURITIZATION OVERVIEW
SECURITIZATION Section I: Definition Section II: Process Section III: Analysis Appendix: Market Defined Terms
TYPES OF INVESTMENTS
Bonds Also known as fixed income securities or debt securities
Mutual Funds
A collection of stocks and bonds Pooled money managed by an investment manager
Alternative
CHARACTERISTICS AND FEATURES
Bond
A bond is simply a loan to a company or government. Bonds are typically issued with a predetermined rate of interest and a
schedule of principal repayment. Bonds are called fixed-income because the bond Face Amount is a fixed
amount expected to be paid back by maturity.
Characteristics and Features
TYPES OF BONDS
Debentures: Bond backed by the credit of the issuer (company or government).
- Corporate bonds - Senior / Subordinate / Convertible
- Municipal bonds - General Obligations / Revenue Bonds / Assessment Bonds
The Issuer is able to borrower money based for a specified time at a rate based on the
Issuer’s credit or ability to repay.
*************************************************************** If a borrower,
1. does not have the capacity to borrow based on their credit worthiness, 2. is not inclined to or in the business of financing an asset in which they have interest, or 3. determines their required return of an asset they own is more than what the market
deems is appropriate,
***************************************************************
SECURITIZATION
Securitization The process through which an issuer creates a financial instrument by combining
other financial assets and then marketing different tiers of the repackaged instruments to investors. The process can encompass any type of financial asset and promotes liquidity in the marketplace.
http://www.investopedia.com/terms/s/securitization.asp#ixzz2LvRiTfPP
An Issuer needs capital or would like specific risk transfer, but - cannot borrower as much money as needs based on credit profile and income alone, and - is willing to borrow money based on assets it owns, should consider asset-based financing through securitization.
Borrower Asset Financing Lender
Individual House Mortgage Bank/Finance Company
Company Car Loans Asset-Backed Security Bond Investor
Company Mortgages Mortgage-Backed Security Bond Investor
RATIONAL / BENEFITS
Issuer Benefits 1) Sale of Assets / Risk Transfer –
Can lead to an improvement in seller’s debt and capital ratios.
2) Cost of Funds –
Total cost of funds is often less expensive than available alternatives; the isolation of the assets allows investors to focus on the risks associated with the assets.
3) Higher Advance Rate –
Maximize loan to value.
4) Diversification – Access to new sources of capital and different
investors.
5) Match Funding – Naturally, assets and liabilities are matched in
tenor and price.
through servicing and reporting without obligation.
Investor Benefits 1) Credit Quality –
Able to analyze quality of investment based on historical loss and prepayment rates of underlying assets.
2) Yield –
3) Liquidity –
Most securities are actively traded on the secondary market and can be financed.
4) Predictable Cash Flows –
5) Transparent Risk – Standard reporting and data available on most
bonds.
SECTION II
PROCESS
The process of converting a specific, typically homogeneous, pool of illiquid, cash flowing,
receivables or assets into a security begins by isolating the Issuer from the bankruptcy risk of the seller and originator.
Assets • Identify Assets
• Measure all-in cost-of-funds
PROCESS, IDENTIFY ASSETS
1) Identify Assets; determine pooled characteristics, concentrations and risks. In addition to the overall quality of the individual assets, considerations for ratings and investor interest
include the availability of historical information, originator/servicer quality, predictable performance, and pool diversification.
Various assets without hard collateral can also be securitized as long as they have a predictable stream
of cash flows, including film royalties, energy efficiency loans, time shares and structured settlements.
Receivables
commercial) -Business Loans
Collateral Characteristics Pooled
WA Maturity: 28.5 years
WA FICO: 785
PROCESS, CREATE SPV
2) Sell the assets into a newly created special purpose vehicle (“SPV”).
Seller / Servicer - Bank
- Finance Company - Manufacturer
Grantor Trust Passive entity / Limited ability for time tranching
Owner Trust Partnership structure / Tranching
Master Trust Flexible structuring / Lower cost for repeat Issuers
PROCESS, BASE ASSUMPTIONS
3) Determine baseline asset cash flows using historical information, assumed
performance and various asset characteristics relative to current market conditions. Prepayment rate / Extension probability / Default rate / Loss given default / Timing of recovery
Monthly Coupon Interest Principal Cashflow Losses Balance
Sched
Bal Recovery
4/25/13 3.68 2,000 9,600 11,600 0 636,900 900 8,700 3,300 0
5/25/13n 3.68 2,000 9,400 11,400 0 627,500 900 8,500 4,400 0
6/25/13 3.68 1,900 9,300 11,200 0 618,300 900 8,400 5,400 0
7/25/13 3.68 1,900 9,100 11,000 0 609,100 900 8,200 6,400 0
8/25/13n 3.68 1,900 9,000 10,800 0 600,200 900 8,100 7,400 0
9/25/13 3.68 1,800 8,800 10,700 0 591,300 900 8,000 8,400 0
10/25/13 3.68 1,800 9,500 11,300 300 581,500 900 7,800 8,300 800
11/25/13 3.68 1,800 9,400 11,200 300 571,900 900 7,700 8,100 800
12/25/13n 3.68 1,800 9,200 11,000 300 562,400 800 7,600 8,000 800
1/25/14n 3.68 1,700 9,100 10,800 300 553,100 800 7,400 7,900 800
2/25/14 3.68 1,700 8,900 10,600 300 543,900 800 7,300 7,700 800
3/25/14 3.68 1,700 8,800 10,400 300 534,900 800 7,200 7,600 800
4/25/14 3.68 1,600 8,600 10,300 300 526,000 800 7,100 7,500 700
5/25/14n 3.68 1,600 8,500 10,100 200 517,200 800 7,000 7,400 700
6/25/14 3.68 1,600 8,400 9,900 200 508,600 800 6,800 7,200 700
7/25/14 3.68 1,600 8,200 9,800 200 500,200 800 6,700 7,100 700
8/25/14 3.68 1,500 8,100 9,600 200 491,800 800 6,600 7,000 700
9/25/14 3.68 1,500 8,000 9,500 200 483,700 800 6,500 6,900 700
10/25/14n 3.68 1,500 7,800 9,300 200 475,600 700 6,400 6,800 700
11/25/14 3.68 1,500 7,700 9,200 200 467,700 700 6,300 6,600 700
12/25/14n 3.68 1,400 7,600 9,000 200 459,900 700 6,200 6,500 700
1/25/15n 3.68 1,400 7,500 8,900 200 452,200 700 6,100 6,400 600
2/25/15 3.68 1,400 7,300 8,700 200 444,700 700 6,000 6,300 600
PROCESS, STRUCTURE DEBT
4) Test credit enhancement features and use investor appetite to finalize ‘waterfall’ and
estimate cost-of-funds.
Credit Enhancement
- Hyper-amortization
The asset cash flows collected monthly are distributed according to the priority of the trust, trust Waterfall.
Flow of Funds Example: - Trust expenses - Servicer Fees - Trustee Fees - Senior Interest - Senior Principal - Mezz Interest - Mezz Principal - Subordinate Interest - Subordinate Principal
PROCESS, OPTIMIZE ECONOMICS
Factors that impact the amount and cost of financing include rating
agency sentiment, investor appetite and Issuer objectives. The bonds are structured to accommodate investor’s risk / return profiles.
Pooled Assets
individual assets pooled together.
RISK ASSESSMENT
Risks associated with the quality of the underlying assets and concentrations in the
portfolio will impact subordination levels and pricing of bonds.
Risk Factor Example / Definition
Historical Information
Limited data could impact ability to obtain reasonable leverage; future performance may vary greatly from historical
Regulatory Risk May affect future liquidity and asset performance
Callability / Prepayment
Liquidity Various events may affect investors’ ability to sell bonds
Conflicts of Interest Issuer or servicer conflict of interest if ownership interest in controlling class
CREDIT ENHANCEMENT
Structural can features within the trust can be used to offset the risks of the portfolio and
thus, optimize the deal economics. The job of the structurer is to optimize the value of the assets by creating different risk
profiles of the cash flows according to investors’ opinions.
Credit Enhancement Example / Definition
Subordination Senior securities get paid before mezz or junior
Excess Spread Net rate on assets is greater than interest rate on bonds; excess interest can be used to pay principal
Over-collateralization Asset balance is greater than bond balance; can also be created through excess spread paying principal
Letter of Credit Issuer guarantee
Event Triggers Upon specified event (i.e. asset performance) cash flows can hyper-amortize
Hyper-Amortization All cash collected (net of fees) used to pay senior interest then principal
Reserve Fund Initial cash reserve or reserve built over time
SECURITZATION
Receivables
commercial) -Business Loans
Seller / Servicer - Bank
- Finance Company - Manufacturer
SPV - Master Trust - Grantor Trust - Owner Trust
Credit Enhancement - Subordination - Excess Spread
- Over-collateralization - Letter of Credit - Bond Insurance
SAMPLE ECONOMICS
Price Proceeds ($ 000s)
WAL (yrs) Rating
A1 50,000 Senior 2.50 % 14.9 % 225 / 2.50 % 100-00 50,000 3.5 AAA
A2 150,000 Senior 3.25 % 14.9 % 265 / 3.25 % 100-00 150,000 5.5 AAA
IO 235,000* Interest-Only 1.50 % n/a 5.00 % 3-24 8,813 n/a AAA
B 25,000 Mezz 5.00 % 4.3 % 475 / 6.00 % 95-00 23,750 7.2 BBB
C 10,000 Subordinate 5.00 % 0.0 % 12.00 % 70-00 7,000 7.8 NR
R NR
Asset Basis: 100-00
SECTION III
ANALYSIS, INVESTOR PERSPECTIVE
Question: What rate of return would you require to lend cousin Tommy $ 20,000 to buy a
$ 25,000 motorcycle? Information you would likely want to know: - When will I get my principal back? - How easy is it to sell the motorcycle if he can’t pay for it? - How does the value depreciate over time? - How much debt does cousin Tommy already have?
Answer: Don’t want the risk!
Modified Question: What rate of return would you require to lend 1,000 cousin Tommy’s $ 20,000
to buy a $ 25,000 motorcycle, assuming that any one default would be absorbed by the equity?
Information you would likely want to know: - When will I get my principal back? - How diverse is the pool of assets? - Historically, what is the default rate? - What happens if the borrowers prepay early?
(More than 400 borrowers would have to default, assuming a loss severity of 50%, for your principal
repayment to be at risk).
Answer: It depends on how long my investment is. I am comfortable with the credit risk,
but require a return that is a spread to government security with a comparable maturity.
APPENDIX- MARKET
MARKET
Outstanding U.S. Bond Market Debt ($ trillions)
As of Q3 2012, $37.7 trillion of U.S. bonds were outstanding.
MARKET
Outstanding U.S. Bond Market Debt
Asset-Backed Money Markets Fed Agency Securities Corp Debt Mtge Related Treasury Municipal
MARKET
APPENDIX- DEFINED TERMS
TERMS
Bond Equivalent Yield: The yield calculated using semi-annual coupons with compounding in all periods and a 30/360 day type. Constant Prepayment Rate (CPR): Annualized equivalents of single monthly mortality (SMM). CPR attempts to predict the percentage of principal
that will prepay over the next 12 months based on historical principal pay downs. CPR is measured on 1 month, 3 month, 6 month, 12 month, or since issue basis.
Constant Default Rate (CDR): An annualized rate of default on a group of mortgages, typically within a collateralized product such as a
mortgage-backed security (MBS). The constant default rate represents the percentage of outstanding principal balances in the pool that are in default, which typically equates to the home being past 60-day and 90-day notices and in the foreclosure process.
Convexity: The second derivative of a security's price with respect to its yield, divided by the security's price. A security
exhibits positive convexity when its price rises more for a downward move in its yield than its price declines for an equal upward move in its yield.
Derivative: A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is
merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.
Duration: Also known as MacCauley's duration. The weighted average maturity of the security's cash flows, where the
present values of the cash flows serve as the weights. The greater the duration of a security, the greater its percentage price volatility.
TERMS
Modified Duration: The percentage price change of a security for a given change in yield. The higher the modified duration of a
security, the higher its risk. Ad/ModDuration = [duration / {1 + (IRR/M)}]; where IRR is the internal rate of return and M is the number of compounding periods per year.
Original Issue Discount: A bond with its par value discounted at the time it is issued. The difference between the purchase price and the
adjusted price is considered income in addition to any interest that may be paid. If held to maturity, no capital gains tax will be paid since the gain is considered interest.
Premium: If a fixed-income security (bond) is purchased at a premium, existing interest rates are lower than the coupon
rate. Investors pay a premium for an investment that will return an amount greater than existing interest rates. Tick: The minimum price movement of a trading instrument. Weighted Average Life: The average number of years that each dollar of unpaid principal due on the mortgage remains outstanding.
Source: Bloomberg

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