waterfall construction basic theory -...

Waterfall Construction Basic Theory

ULI Waterfall Webinar 20 March 2012

Roger Staiger III, FRICS

(202) 640-8912 [email protected]

Waterfall Diagram

Roger Staiger [email protected] 2 of 125

Pari Passu

“Pref” Rate15% good proxy for “Pref”1st Tier

Non Pari Passu split

2nd Tier 2nd Tier rate

N # Tiers

Nth Tier rate

Final Tier

Nth Tier

Example – Final DistributionX % to Promote to Sponsor(1‐X%) distribution Pari Passu

Note: Explained in detail later

Agenda (Session 1) 1) Interest Factors

Basics of Accrual, Compounding, Effective Notional Annual Rate (ENAR)

2) Waterfall Functions (MS Excel) 3) Waterfall (General Concept(s)) 4) Pro Forma Structure 5) Waterfall (Construction) 6) Securitization (Time Permitting) Roger Staiger [email protected] 3 of 125

Agenda (Session 2) Waterfall Construction

MS Excel Construction of Waterfall

Four part construction 1) Project Summary 2) Tranche’ Structures 3) Tranche’ Cash Flows 4) Investor Cash Flows

Deliverable: Final working model & process


Interest Factors

Understanding of

compounding rates

Roger Staiger [email protected]

6 of 125

Compound Interest Interest-on-Interest Components (HP-12c)

Initial Deposit (PV) Interest Rate (i) Time (n) Payment rate (PMT) Future Value (FV)

Happy 30th Birthday!


7 of 125

Future Value - Simple

tt IPVFV


Future Value – Simple (example) $100,000,000 @ Libor + 250 (one-year) Where: i = Libor + 250 = 275 (2.75%) PV = $100,000,000 it = ($100,000,000)*i = $2,750,000 FVt = PV + it FVt = $100,000,000 + $2,750,000 FVt = $102,750,000

8 of 125


9 of 125

Future Value - Compounded

tiPVFV 1Interest

Compounds Roger Staiger [email protected]

Future Value – Compounded (example)

$100,000,000 @ Libor + 250 (two-year) Where: i = Libor + 250 = 275 PV = $100,000,000 FVt = ($100,000,000)*(1+i)2

FVt = ($100,000,000)*(1+i)*(1+i)

FVt = $102,750,000*(1+i) FVt = $102,750,000*(1+0.0275) FVt = $105,575,625

10 of 125 Roger Staiger [email protected]

11 of 125

Future Value – Periods (Periodic Compounding)

mn

miPVFV

1

Where:

n: periods, e.g. years

m: intervals within 1 year

i: Annual Interest Rate


12 of 125

Future Value – Periods (Periodic Compounding) cont’d

mn

miPVFV

1

Compounding Periods:

M=2: Semiannual

M=4: Quarterly

M=365: Daily


Future Value – Periods (Periodic Compounding) example1 PV = $100,000,000 (1 year) I = Libor + 250 = 275bps M(Compounding Periods) = semiannual (2)

13 of 125

044,779,102

0278.1000,000,1000138.01000,000,100

20275.01000,000,1001

2

21

FVFV

miPVFV

mn


Future Value – Periods (Periodic Compounding) example2 PV = $100,000,000 (2 years) I = Libor + 250 = 275bps M(Compounding Periods) = monthly (12)

14 of 125

414,647,105

0565.1000,000,1000023.01000,000,100

120275.01000,000,1001

24

122

FVFV

miPVFV

mn


Effective Annual Yield (EAY) Annual equivalent yield Assumes annual compounding Converts period compounding to annual

value a.k.a. APR

15 of 125

1PVFVEAY


EAY (example1)

16 of 125

annual)-(semi 2.75% versus%78.2

0278.01000,000,100044,779,1021

044,779,1020278.1000,000,1000138.01000,000,100

20275.01000,000,1001

2

21

EAYPVFVEAY

FVFV

miPVFV

mn


EAY (example2)

17 of 125

2.75%) (versus 2.80%or 0280.0

0280.01000,000,100183,795,1021

year) 1(for 183,795,1020280.1000,000,1000023.01000,000,100

120275.01000,000,1001

12

121

EAYPVFVEAY

FVFV

miPVFV

mn


EAY (multiple Periods)

18 of 125

rtPVFVNote

:


Nominal Annual Rate

Compounding Interval Periods/Yr EAY

5% Annual 1 5.0000%

5% Semi‐annual 2 5.0625%

5% Quarterly 4 5.0945%

5% Monthly 12 5.1162%

5% Daily 365 5.1267%

5% Continuous Infinite 5.1271%

Effective Nominal Annual Rate (ENAR)

Equivalent Effective Annual Yield (EAY) when adjusting for compounding

Where: M = compounding period(s)

19 of 125

111

m

mENAR

PVFVEAY


ENAR Solved

20 of 125

mEAYENAR

EAYm

ENARm

ENAREAYm

ENAREAY

mENAR

PVFVEAY

m

m

mm

m

11

11

1111

111

/1

/1

/1


21 of 125

Future Value - Periods

Where:

ENAR: Equivalent nominal annual rate

EAY: Effective annual yield

m: Periods

mEAYENAR m 11 /1


22 of 125

Future Value – Example1 EAY = 6.00% M = Monthly compounding

5.841%or 05841.012*00.1004868.1

12*106.1

12*106.01083333.0

121

ENARENARENAR

ENAR


Future Value – Example2

23 of 125

6.00%or 06.0

112

05841.01

11

12

EAY

EAY

mENAREAY

m


Waterfall Functions

MS Excel Functions


MS Excel Functions End of Month: ‘=EOMONTH() Count: ‘=COUNT() Summation: ‘=SUM() Absolute value: ‘=ABS() Minimum: ‘=MIN() Day: ‘=DAY() XIRR: ‘=XIRR(values,dates) XNPV: ‘=NPV(rate,values,dates)


End of Month Function Returns the serial number of the last day of

the month before or after a specified number of months

“=EOMONTH(start_date,months)” Start Date = 1 January 2011 Last day of March 2011

=EOMONTH(1Jan11,2) Note: 1Jan11 must be value not a name

26 of 125


Count Function Counts the number of cells in a range that

contains numbers “=COUNT(values)”

27 of 125

A B C D E

1 4 5 Roger 6

Count 4


Sum Function Adds all the numbers in a range of cells “=SUM(values)”

28 of 125

A B C D E

1 4 5 Roger 6

Count 4Sum 16


Absolute Value Function Returns the absolute value of a number, a

number without its sign “=ABS(value)” |-a| = a; |a| = a

29 of 125

5 ‐7Absolute 5 7


Minimum Function Returns the smallest number in a set of

values. Ignores logical values and text. “=MIN(values)”

30 of 125

5 ‐7Absolute 5 7

Row1 Minimum ‐7Row2 Minimum 5


Day Function Returns the day of the month, a number

from 1 to 31 “=DAY(serial_number)”

31 of 125

2‐Feb‐11 6‐Mar‐11 22‐Apr‐11 30‐May‐11 15‐Jun‐11Day 2 6 22 30 15


XIRR versus IRR IRR discounts on a periodic basis XIRR discounted on a daily basis

Allows analyst to input actual dates of cash flows Recognized capital as a vector, not a static input

Capital has both magnitude (Qty) and direction (date)

Allows for accurate return of cash when received at irregular intervals


XIRR Requires two inputs: Values and Dates Each Cash Flow is discounted the day it

occurs

33 of 125

N

idd

ii

rate

PNPV1 365

1

10

where: di = the ith, or last, payment date d1 = the 0th payment date Pi = the ith, or last, payment


XIRR (cont’d) MS Excel solves the equation using linear

interpolation, i.e. iterative technique Third input can be added to assist MS

Excel when appropriate assumptions can be made

Note: XIRR function requires the analysis toolpak to be installed in MS Excel Excel Add-in


XIRR Example

35 of 125

1‐Jan‐11 1‐Jul‐11 1‐Jul‐12 1‐Jul‐13 1‐Jul‐14(35,000) 12,000 5,000 20,000 22,000

IRR 20.85%XIRR 26.46%Delta 5.61%


MS Excel Add-Ins (Data Analysis & Solver)


Steps for MS Excel Add-ins

5 minute break for those that have it


Step 1 – Office Button


Step 2 – Excel Options (Select)


Step 3 – Excel Options


Step 4 – Add-Ins


Step 5 – Add-Ins


Step 6 – Select Solver Add-in & Analysis ToolPak


Step 7 – Hit “OK” Select (Hit) “OK” in the lower right portion

of your screen


Step 8 – Data (once back in MS Excel)


Step 9 – Data Analysis & Solver


Verify (Data Analysis & Solver)

Under data on the ribbon bar verify that ‘Data Analysis’ and ‘Solver’ are there

If not there and you are using a PC, please email me, [email protected], after the program for assistance

If not there and you are using an Apple, please contact your administrator. Unfortunately I do not know this process (but it should be very similar)


Waterfall

Let the fun begin…


Niagara (U.S. Side) (Do not end up on the rocks!)


Waterfall Method of distributing profits among

partners within a transaction Allows for profits to NOT follow an even

distribution Profits NOT distributed Pari Passu Pari Passu: division entirely by ownership %,

80% capital, 80% of ALL cash flows distributed, 80% of risk


Simple Waterfall: Bank Model Creditor is paid first Owner is paid second

Payment by value NOT yield Waterfalls typically separate

cash flows to owners (equity)

51 of 125

DEBT

Equity

Net Operating Income (NOI)


Syndication versus Securitization Syndication separates cash flows

according to ownership % 20% ownership, 20% of risk

Securitization separates cash flows according to risk tranches Transformation of a portfolio of financial obligations

into liquid form attractive to a myriad of investors


Syndication versus Securitization (graphic)

53 of 125

Syndication Securitization

Capital Stack

Ownership Division


54 of 125

Structure Example (Generic)

Bond1 Bond2 Bond3

Bondn (y = 8.5%)

TRUST

Tranche 4 (Residual) 4th 5% Loss; y=35%

Tranche 3 3rd 10% Loss; y=15%

Tranche 2 2nd 10% Loss; y=7.5%

Tranche 1 1st Senior; y=6%

Wat

erfa

ll


Syndication/Structured Issue: Too large for single

lender Result: Bifurcate into two

tranches Senior “A” Piece Junior “B” Piece


Single Bond $100.0m 10 years

Interest only 6% Coupon WAM = 10

WAC = 6.00%

Syndication/Structured


Single Bond $100.0m 10 years


WAC = 6.00%

Tranche “A” $50.0m 10 years


WAC = 4.00%

Tranche “B” $50.0m 10 years


WAC = 8.00%

Syndication/Structured (cont’d) Tranche “A” Senior Piece Reduced Coupon Tranche “B” Junior Piece Higher Coupon

Compensates for higher risk Prepayment Recovery Rate




WAC = 4.00%



WAC = 8.00%

Syndication/Structured (cont’d)




WAC = 4.00%



WAC = 8.00%

Prepayment 1. Refinance 2. Foreclosure 3. Sale Recovery

Loss %

Risk (σ)

Order of Payments: 1. Interest Tranche A 2. Interest Tranche B

3. Principal Tranche A 4. Principal Tranche B

- Residual

Single Bond ($100.0m) (No Prepay/Default/100% Recovery)


Principal 100,000,000 WAM 10Interest 6% WAC 6%Term 10Prepay Date 10Recovery 100%

Period 0 1 2 3 → 9 10BoP 100,000,000 100,000,000 100,000,000 → 100,000,000 100,000,000Interest 6,000,000 6,000,000 6,000,000 → 6,000,000 6,000,000 Principal ‐ ‐ ‐ → ‐ 100,000,000EoP 100,000,000 100,000,000 100,000,000 100,000,000 → 100,000,000 ‐

Cash Flow (100,000,000) 6,000,000 6,000,000 6,000,000 → 6,000,000 106,000,000IRR 6.00%

Tranche A & B (No Prepay/Default/100% Recovery)


Transformation 1 2 3 → 9 10Investor A ‐ Senior 4.00%BoP 50,000,000 50,000,000 50,000,000 → 50,000,000 50,000,000Interest 2,000,000 2,000,000 2,000,000 → 2,000,000 2,000,000 Principal ‐ ‐ ‐ → ‐ 50,000,000EoP 50,000,000 50,000,000 50,000,000 50,000,000 → 50,000,000 ‐

Invstor A ‐ Cash Flow(50,000,000) 2,000,000 2,000,000 2,000,000 → 2,000,000 52,000,000

IRR 4.00%

Investor B ‐ Junior 8.00%BoP 50,000,000 50,000,000 50,000,000 → 50,000,000 50,000,000Interest 4,000,000 4,000,000 4,000,000 → 4,000,000 4,000,000 Principal ‐ ‐ ‐ → ‐ 50,000,000EoP 50,000,000 50,000,000 50,000,000 50,000,000 → 50,000,000 ‐


IRR 8.00%

Single Bond ($100.0m) (2-year prepay/90% Recovery)


Principal 100,000,000 WAM 10Interest 6% WAC 6%Term 10Prepay Dat 8Recovery 90%

Period 0 1 2 3 → 7 8BoP 100,000,000 100,000,000 100,000,000 → 100,000,000 100,000,000Interest 6,000,000 6,000,000 6,000,000 → 6,000,000 6,000,000 Principal ‐ ‐ ‐ → ‐ 90,000,000 EoP 100,000,000 100,000,000 100,000,000 100,000,000 → 100,000,000 10,000,000

Cash Flow (100,000,000) 6,000,000 6,000,000 6,000,000 → 6,000,000 96,000,000 IRR 4.95%

105bp loss

Tranche A & B (2-year prepay/90% Recovery)


Transformation 1 2 3 → 7 8Investor A ‐ Senior 4.00%BoP 50,000,000 50,000,000 50,000,000 → 50,000,000 50,000,000Interest 2,000,000 2,000,000 2,000,000 → 2,000,000 2,000,000 Principal ‐ ‐ ‐ → ‐ 50,000,000EoP 50,000,000 50,000,000 50,000,000 50,000,000 → 50,000,000 ‐


IRR 4.00%

Investor B ‐ Junior 8.00%BoP 50,000,000 50,000,000 50,000,000 → 50,000,000 50,000,000Interest 4,000,000 4,000,000 4,000,000 → 4,000,000 4,000,000 Principal ‐ ‐ ‐ → ‐ 40,000,000EoP 50,000,000 50,000,000 50,000,000 50,000,000 → 50,000,000 10,000,000


IRR 5.98%

No Loss

202bp Loss

Tranche B Sensitivity


Tranche B 1 2 3 4 5100.0% 8.00% 8.00% 8.00% 8.00% 8.00%90.0% 6.28% 5.98% 5.59% 5.06% 4.33%80.0% 4.26% 3.60% 2.74% 1.59% 0.00%70.0% 1.80% 0.68% ‐0.77% ‐2.70% ‐5.36%60.0% ‐1.40% ‐3.16% ‐5.43% ‐8.43% ‐12.55%50.0% ‐6.11% ‐8.98% ‐12.70% ‐17.65% ‐24.40%

Prepayment years

Recovery %

Tranche A suffers no losses (exposed to reinvestment rate risk)

Waterfall Considerations Separation of cash flows according to

owners’ agreement Separation of cash flows by yield, NOT by

order Order: Bank vanilla example

“Pref” Rate: Preference Rate Generally provided to Investor Acts as a coupon rate, e.g. Preferred Equity

64 of 125


Waterfall Diagram

65 of 125

Pari Passu

“Pref” Rate15% good proxy for “Pref”1st Tier

Non Pari Passu split

2nd Tier 2nd Tier rate

N # Tiers

Nth Tier rate

Final Tier

Nth Tier

Example – Final DistributionX % to Promote to Sponsor(1‐X%) distribution Pari Passu


Waterfall Split Pref Rate: Up to 15% IRR

10% Sponsor 90% Investor

15% - 20% IRR Split 20% Sponsor 90% Investor

Over 20% 40% Promote (Sponsor) 60% Split (10% Sponsor; 90% Investor)


Waterfall Split Graphic

67 of 125

15% IRR

20% IRR

20% + IRR

Sponsor10%

Sponsor20%

PromoteSponsor

40%

Investor90%

Investor80%

Investor90%

Sponsor10%


Pro Forma Structure

Incorporating the Waterfall


69 of 49

Pro Forma Structure/Logic Flow


Summary Page Pro Forma Page

(s2)

Amortization Page (s3) Inputs Section

(s1)

Analysis (s4)

70 of 49

Pro Forma Structure/Logic Flow (Waterfall Addition)


Summary Page

Pro Forma Page (s2)

Amortization Page (s3)

Inputs Section (s1)

Analysis (Project)

(s4)

Waterfall Page (Investor)

(s5)

Waterfall (Step 1) Quantify Equity Contributions Modeled in Sources/Uses

71 of 125

Sources 549,000 Operations Units I/P Finance I/P

Equity 99,000 Unit 1 ‐ One Bedroom per mont 1,500 Tranche 1

Investor 1 80,000 Unit 2 ‐ Two Bedroom per mont 2,000 Principal 400,000

Investor 2 19,000 Unit 3 ‐ Two Bedroom per mont 2,000 Term (years) 20

Debt 450,000 Unit 4 ‐ Two Bedroom per mont 2,000 Interest Rate 8%

Tranche 1 400,000 Interest Only

Tranche 2 50,000 Vacancy 1 5.00% Origination Fee 1%

Vacancy 2 5.00%

Uses 549,000 Vacancy 3 5.00% Tranche 2

Purchase Price 350,000 Vacancy 4 5.00% Principal 50,000

Renovation 165,000 Term (years) 20

Legal 3,500 Rental Escl 2% Interest Rate 15%

Bank 2,000 Interest Only

Personal 1,500 Management per Net Rev 5% Origination Fee 1%

IDC 24,700 Repairs per Net Rev 5%

Tax Escrow 1,300 Janitor per year 2600 Valuation I/P

Finance Cost 4,500 Heat per year 2130 Cap Rate 10.9%

Electricity per year 1000 Sales Expense 6%

Surplus/(Deficit) ‐ Water per year 1200 Discount Rate 10%

Property Tax per year 7800

Insurance per year 2600 Sales Period Year 10

Expense Escl 2%


Waterfall (Step 2) Quantify the project cash flows for

distribution, i.e. cash distributions Modeled on pro forma page Cash flows must not be accounting values,

i.e. no earnings, free cash flows distributed to investors AFTER debt service


Waterfall (Step 2) (cont’d) (Note: not yet…)

73 of 125

Periods 1 2 3 4 5 6 7 8 9 10 11 12

Revenue Year 1 1 1 1 1 1 1 1 1 1 1 1

Unit1 Rent 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500

Unit2 Rent 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000

Unit3 Rent 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000

Unit4 Rent 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000

Total Rent 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500

Vacancy 1 75 75 75 75 75 75 75 75 75 75 75 75

Vacancy 2 100 100 100 100 100 100 100 100 100 100 100 100

Vacancy 3 100 100 100 100 100 100 100 100 100 100 100 100

Vanancy 4 100 100 100 100 100 100 100 100 100 100 100 100

Total Vacancy 375 375 375 375 375 375 375 375 375 375 375 375

Total Revenue 7,125 7,125 7,125 7,125 7,125 7,125 7,125 7,125 7,125 7,125 7,125 7,125

Expenses

Management 356 356 356 356 356 356 356 356 356 356 356 356

Repairs 356 356 356 356 356 356 356 356 356 356 356 356

Janitor 217 217 217 218 218 218 219 219 220 220 220 221

Heat 178 178 178 178 179 179 179 180 180 180 180 181

Electricity 83 83 84 84 84 84 84 84 84 85 85 85

Water 100 100 100 101 101 101 101 101 101 102 102 102

Property Tax 650 651 652 653 654 655 657 658 659 660 661 662

Insurance 217 217 217 218 218 218 219 219 220 220 220 221

Total Expenses 2,157 2,159 2,161 2,164 2,166 2,169 2,171 2,174 2,176 2,178 2,181 2,183

Net Operating Income 4,968 4,966 4,964 4,961 4,959 4,956 4,954 4,951 4,949 4,947 4,944 4,942


Waterfall (Step 2) (cont’d) (…yet)

74 of 125

Debt

Tranch 1 3,346 3,346 3,346 3,346 3,346 3,346 3,346 3,346 3,346 3,346 3,346 3,346

Tranch 2 658 658 658 658 658 658 658 658 658 658 658 658

Tranche 1 4,004 4,004 4,004 4,004 4,004 4,004 4,004 4,004 4,004 4,004 4,004 4,004

Sales Proceeds

Sales Price ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Sales Expense ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Principal Repay ‐Tranche 1 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Principal Repay ‐Tranche 2 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Net Sales Proceeds ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Reversion FCF ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Operating FCF 964 962 959 957 955 952 950 947 945 942 940 937

Total FCF (99,000) 964 962 959 957 955 952 950 947 945 942 940 937


Note: No bifurcation (Operations/Reversion)

Waterfall (Step 3) Quantify project characteristics Is project viable as a whole?

Modigliani and Miller

Total Profit Internal Rate of Return (IRR) Multiple (Profit/Invested Capital)


Waterfall (Step 3) (Project Valuation)


Valuation:Year 1 2 3 4 5 6 7 8 9 10

RevenueRental 90,000 91,800 93,636 95,509 97,419 99,367 101,355 103,382 105,449 107,558 Vacancy 4,500 4,590 4,682 4,775 4,871 4,968 5,068 5,169 5,272 5,378

Total Revenue 85,500 87,210 88,954 90,733 92,548 94,399 96,287 98,213 100,177 102,180

ExpenseManagement 4,275 4,361 4,448 4,537 4,627 4,720 4,814 4,911 5,009 5,109 Repairs 4,275 4,361 4,448 4,537 4,627 4,720 4,814 4,911 5,009 5,109 Janitor 2,624 2,677 2,731 2,786 2,842 2,900 2,958 3,018 3,079 3,141 Heat 2,150 2,193 2,237 2,282 2,329 2,376 2,423 2,472 2,522 2,573 Electricity 1,009 1,030 1,050 1,072 1,093 1,115 1,138 1,161 1,184 1,208 Water 1,211 1,236 1,260 1,286 1,312 1,338 1,365 1,393 1,421 1,450 Property Tax 7,872 8,031 8,193 8,358 8,527 8,699 8,875 9,054 9,237 9,423 Insurance 2,624 2,677 2,731 2,786 2,842 2,900 2,958 3,018 3,079 3,141

Total Expenses 26,040 26,564 27,098 27,644 28,200 28,767 29,346 29,937 30,539 31,154

Net Operating Income 59,460 60,646 61,856 63,090 64,348 65,631 66,941 68,276 69,638 71,026

DebtTranche 1 40,149 40,149 40,149 40,149 40,149 40,149 40,149 40,149 40,149 40,149 Tranche 2 7,901 7,901 7,901 7,901 7,901 7,901 7,901 7,901 7,901 7,901

Total Debt 48,050 48,050 48,050 48,050 48,050 48,050 48,050 48,050 48,050 48,050

Net Sales Proceeds ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 308,167

Reversion FCF ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 308,167 Operating FCF 11,410 12,596 13,806 15,040 16,298 17,582 18,891 20,226 21,588 22,977

Total FCF (99,000) 11,410 12,596 13,806 15,040 16,298 17,582 18,891 20,226 21,588 331,144

DSCR 1.24 1.26 1.29 1.31 1.34 1.37 1.39 1.42 1.45 1.48Minimum 1.24

Cash‐on‐Cash 11.53% 12.72% 13.95% 15.19% 16.46% 17.76% 19.08% 20.43% 21.81% 23.21%Minimum 11.53%

PV Reversion 118,812 54.64%PV Operating 98,616 45.36%

Total 217,428 CF0 99,000 NPV 118,428 IRR 22.42%

Waterfall (Step 4) (Structure)

Construct Waterfall addition for pro forma Four Sections:

Project Summary Tranche Structures (Accruals) Tranche Cash Flows Investor Cash Flows


Waterfall (Step 4) (Structure)


Waterfall Period 1 2 3 4 5 6 7 8 9 10 11 12(Units) Total 1/31/2010 1/31/2011 1/31/2012 1/31/2013 1/31/2014 1/31/2015 1/31/2016 1/31/2017 1/31/2018 1/31/2019 1/31/2020 1/31/2021

Project Cash FlowContributions (200.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Sponsor 10% (20.0) (20.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Equity Partner 90% (180.0) (180.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Total 100% (200.0) (200.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Project

SummaryCash Proceeds for Distribution 550.0 0.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 100.0 0.0

Project Cash Flow 350.0 (200.0) 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 100.0 0.0Profit $350.0IRR 22.43%Multiple 2.75x

STRUCTURETier 1 0.0383% Daily RateBoP Balance 0.0 (200.0) (180.0) (157.0) (130.6) (100.2) (65.2) (25.0) 0.0 0.0 0.0 0.0Equity Contributions (200.0) (200.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Accrual 15.00% (128.8) 0.0 (30.0) (27.0) (23.6) (19.6) (15.0) (9.8) (3.8) 0.0 0.0 0.0 0.0Paydown 328.8 0.0 50.0 50.0 50.0 50.0 50.0 50.0 28.8 0.0 0.0 0.0 0.0EoP Balance (200.0) (180.0) (157.0) (130.6) (100.2) (65.2) (25.0) 0.0 0.0 0.0 0.0 0.0Cash left for distribution 221.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 21.2 50.0 50.0 100.0 0.0IRR Check 15.00% 128.8 (200.0) 50.0 50.0 50.0 50.0 50.0 50.0 28.8 0.0 0.0 0.0 0.0 Tranche

StructuresTier 2 0.0500% Daily Rate (Accruals)Starting Balance 0.0 (200.0) (190.0) (178.0) (163.7) (146.4) (125.7) (100.9) (71.1) (35.3) 0.0 0.0Equity Contributions (200.0) (200.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Accrual 20.00% 0.0 (40.0) (38.0) (35.7) (32.7) (29.3) (25.1) (20.2) (14.2) (7.1) 0.0 0.0Paydown 442.4 0.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 42.4 0.0 0.0Balance (200.0) (190.0) (178.0) (163.7) (146.4) (125.7) (100.9) (71.1) (35.3) 0.0 0.0 0.0Cash left for distribution 107.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 7.6 100.0 0.0IRR Check 20.00% 242.4 (200.0) 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 42.4 0.0 0.0

Cash Flows to each tranche:I. Pari Passu to an IRR of 15.00% 328.8 0.0 50.0 50.0 50.0 50.0 50.0 50.0 28.8 0.0 0.0 0.0 0.0

Sponsor 10.00% 32.9 0.0 5.0 5.0 5.0 5.0 5.0 5.0 2.9 0.0 0.0 0.0 0.0Equity Partner 90.00% 295.9 0.0 45.0 45.0 45.0 45.0 45.0 45.0 25.9 0.0 0.0 0.0 0.0

II. Splits up to an IRR of 20.00% 113.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 21.2 50.0 42.4 0.0 0.0Sponsor 20.00% 22.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.2 10.0 8.5 0.0 0.0Equity Partner 80.00% 90.9 0.0 0.0 0.0 0.0 0.0 0.0 0.0 17.0 40.0 33.9 0.0 0.0 Tranche

CashCash left for Distribution 107.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 7.6 100.0 0.0 Flows

III. Sponsor Promote 40.00% 43.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3.0 40.0 0.0

Cash to Equity 60.00% 64.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.5 60.0 0.0Sponsor 10.00% 6.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.5 6.0 0.0Equity Partner 90.00% 58.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.1 54.0 0.0

INVESTOR CASH FLOWSSPONSOR

Equity Investment (20.0) (20.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Proceeds 105.1 0.0 5.0 5.0 5.0 5.0 5.0 5.0 7.1 10.0 12.0 46.0 0.0CF 85.1 (20.0) 5.0 5.0 5.0 5.0 5.0 5.0 7.1 10.0 12.0 46.0 0.0Profit $85.1% of Total Profit 24.3%IRR 30.03%Multiple 5.25x

InvestorEQUITY PARTNER Cash

Equity Investment (180.0) (180.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 FlowsProceeds 444.9 0.0 45.0 45.0 45.0 45.0 45.0 45.0 42.9 40.0 38.0 54.0 0.0CF 264.9 (180.0) 45.0 45.0 45.0 45.0 45.0 45.0 42.9 40.0 38.0 54.0 0.0Profit $264.9% of Total Profit 75.7%IRR 21.13%Multiple 2.47x

Check TRUE

A. Project Summary

B. Tranche Structures

C. Tranche Cash Flows

D. Investor Cash Flows

Waterfall (Step 4) (Project Summary)


Waterfall Period 1 2 8 9 10 11 12(Units) Total 1/31/2010 1/31/2011 1/31/2017 1/31/2018 1/31/2019 1/31/2020 1/31/2021

Project Cash FlowContributions (200.0) 0.0 0.0 0.0 0.0 0.0 0.0Sponsor 10% (20.0) (20.0) 0.0 0.0 0.0 0.0 0.0 0.0Equity Partner 90% (180.0) (180.0) 0.0 0.0 0.0 0.0 0.0 0.0Total 100% (200.0) (200.0) 0.0 0.0 0.0 0.0 0.0 0.0 Project

SummaryCash Proceeds for Distribution 550.0 0.0 50.0 50.0 50.0 50.0 100.0 0.0

Project Cash Flow 350.0 (200.0) 50.0 50.0 50.0 50.0 100.0 0.0Profit $350.0IRR 22.43%Multiple 2.75x

Note: Years 3 – 8 hidden

Waterfall (Step 4) (Tranche Structures (Accruals))


STRUCTURETier 1 0.0383% Daily RateBoP Balance 0.0 (200.0) (25.0) 0.0 0.0 0.0 0.0Equity Contributions (200.0) (200.0) 0.0 0.0 0.0 0.0 0.0 0.0Accrual 15.00% (128.8) 0.0 (30.0) (3.8) 0.0 0.0 0.0 0.0Paydown 328.8 0.0 50.0 28.8 0.0 0.0 0.0 0.0EoP Balance (200.0) (180.0) 0.0 0.0 0.0 0.0 0.0Cash left for distribution 221.2 0.0 0.0 21.2 50.0 50.0 100.0 0.0IRR Check 15.00% 128.8 (200.0) 50.0 28.8 0.0 0.0 0.0 0.0 Tranche

StructuresTier 2 0.0500% Daily Rate (Accruals)Starting Balance 0.0 (200.0) (100.9) (71.1) (35.3) 0.0 0.0Equity Contributions (200.0) (200.0) 0.0 0.0 0.0 0.0 0.0 0.0Accrual 20.00% 0.0 (40.0) (20.2) (14.2) (7.1) 0.0 0.0Paydown 442.4 0.0 50.0 50.0 50.0 42.4 0.0 0.0Balance (200.0) (190.0) (71.1) (35.3) 0.0 0.0 0.0Cash left for distribution 107.6 0.0 0.0 0.0 0.0 7.6 100.0 0.0IRR Check 20.00% 242.4 (200.0) 50.0 50.0 50.0 42.4 0.0 0.0


Waterfall (Step 4) (Tranche Cash Flows)


Cash Flows to each tranche:I. Pari Passu to an IRR of 15.00% 328.8 0.0 50.0 28.8 0.0 0.0 0.0 0.0

Sponsor 10.00% 32.9 0.0 5.0 2.9 0.0 0.0 0.0 0.0Equity Partner 90.00% 295.9 0.0 45.0 25.9 0.0 0.0 0.0 0.0

II. Splits up to an IRR of 20.00% 113.6 0.0 0.0 21.2 50.0 42.4 0.0 0.0Sponsor 20.00% 22.7 0.0 0.0 4.2 10.0 8.5 0.0 0.0Equity Partner 80.00% 90.9 0.0 0.0 17.0 40.0 33.9 0.0 0.0 Tranche

CashCash left for Distribution 107.6 0.0 0.0 0.0 0.0 7.6 100.0 0.0 Flows

III. Sponsor Promote 40.00% 43.0 0.0 0.0 0.0 0.0 3.0 40.0 0.0

Cash to Equity 60.00% 64.5 0.0 0.0 0.0 0.0 4.5 60.0 0.0Sponsor 10.00% 6.5 0.0 0.0 0.0 0.0 0.5 6.0 0.0Equity Partner 90.00% 58.1 0.0 0.0 0.0 0.0 4.1 54.0 0.0


Waterfall (Step 4) (Investor Cash Flows)



Equity Investment (20.0) (20.0) 0.0 0.0 0.0 0.0 0.0 0.0Proceeds 105.1 0.0 5.0 7.1 10.0 12.0 46.0 0.0CF 85.1 (20.0) 5.0 7.1 10.0 12.0 46.0 0.0Profit $85.1% of Total Profit 24.3%IRR 30.03%Multiple 5.25x


Equity Investment (180.0) (180.0) 0.0 0.0 0.0 0.0 0.0 0.0 FlowsProceeds 444.9 0.0 45.0 42.9 40.0 38.0 54.0 0.0CF 264.9 (180.0) 45.0 42.9 40.0 38.0 54.0 0.0Profit $264.9% of Total Profit 75.7%IRR 21.13%Multiple 2.47x

Check TRUE


Waterfall

Construction


Project Summary (Part a)

Models Contributions from Investor(s) and Sponsor separately (Can be spread or Point-in-Time)

Assigns dates with specific cash flows Models Cash Distribution (after debt service) Quantify Project performance (check with pro forma) Roger Staiger [email protected] 84 of 125

Waterfall Period 1 2 8 9 10 11 12(Units) Total 1/31/2010 1/31/2011 1/31/2017 1/31/2018 1/31/2019 1/31/2020 1/31/2021

Project Cash FlowContributions (200.0) 0.0 0.0 0.0 0.0 0.0 0.0Sponsor 10% (20.0) (20.0) 0.0 0.0 0.0 0.0 0.0 0.0Equity Partner 90% (180.0) (180.0) 0.0 0.0 0.0 0.0 0.0 0.0Total 100% (200.0) (200.0) 0.0 0.0 0.0 0.0 0.0 0.0 Project

SummaryCash Proceeds for Distribution 550.0 0.0 50.0 50.0 50.0 50.0 100.0 0.0

Project Cash Flow 350.0 (200.0) 50.0 50.0 50.0 50.0 100.0 0.0Profit $350.0IRR 22.43%Multiple 2.75x

Tranche Structures (Accruals) (Part b)

Calculate Daily rate (note: daily, i.e. 365/year) from target

Calculate Accrual amount for Tranche Calculate distribution from accrual Check the IRR (verify)


STRUCTURETier 1 0.0383% Daily RateBoP Balance 0.0 (200.0) (25.0) 0.0 0.0 0.0 0.0Equity Contributions (200.0) (200.0) 0.0 0.0 0.0 0.0 0.0 0.0Accrual 15.00% (128.8) 0.0 (30.0) (3.8) 0.0 0.0 0.0 0.0Paydown 328.8 0.0 50.0 28.8 0.0 0.0 0.0 0.0EoP Balance (200.0) (180.0) 0.0 0.0 0.0 0.0 0.0Cash left for distribution 221.2 0.0 0.0 21.2 50.0 50.0 100.0 0.0IRR Check 15.00% 128.8 (200.0) 50.0 28.8 0.0 0.0 0.0 0.0 Tranche

StructuresTier 2 0.0500% Daily Rate (Accruals)Starting Balance 0.0 (200.0) (100.9) (71.1) (35.3) 0.0 0.0Equity Contributions (200.0) (200.0) 0.0 0.0 0.0 0.0 0.0 0.0Accrual 20.00% 0.0 (40.0) (20.2) (14.2) (7.1) 0.0 0.0Paydown 442.4 0.0 50.0 50.0 50.0 42.4 0.0 0.0Balance (200.0) (190.0) (71.1) (35.3) 0.0 0.0 0.0Cash left for distribution 107.6 0.0 0.0 0.0 0.0 7.6 100.0 0.0IRR Check 20.00% 242.4 (200.0) 50.0 50.0 50.0 42.4 0.0 0.0

Tranche Structures (Accruals) (Part b) (Hints)

Daily Rate Accrual


00038298.010.151

1Pref_Rate1RateDaily 365

1

3651

DR

30Accrual20010.000382981Accrual

1DR1Accrual365

BoPDays

Tranche Cash Flows (Part c)

Separate tranches by split percentages (X2) Calculate remaining split for promote Calculate Cash to Equity after promote


Cash Flows to each tranche:I. Pari Passu to an IRR of 15.00% 328.8 0.0 50.0 28.8 0.0 0.0 0.0 0.0

Sponsor 10.00% 32.9 0.0 5.0 2.9 0.0 0.0 0.0 0.0Equity Partner 90.00% 295.9 0.0 45.0 25.9 0.0 0.0 0.0 0.0

II. Splits up to an IRR of 20.00% 113.6 0.0 0.0 21.2 50.0 42.4 0.0 0.0Sponsor 20.00% 22.7 0.0 0.0 4.2 10.0 8.5 0.0 0.0Equity Partner 80.00% 90.9 0.0 0.0 17.0 40.0 33.9 0.0 0.0 Tranche

CashCash left for Distribution 107.6 0.0 0.0 0.0 0.0 7.6 100.0 0.0 Flows

III. Sponsor Promote 40.00% 43.0 0.0 0.0 0.0 0.0 3.0 40.0 0.0

Cash to Equity 60.00% 64.5 0.0 0.0 0.0 0.0 4.5 60.0 0.0Sponsor 10.00% 6.5 0.0 0.0 0.0 0.0 0.5 6.0 0.0Equity Partner 90.00% 58.1 0.0 0.0 0.0 0.0 4.1 54.0 0.0

Investor Cash Flows (Part d)

Create Final Cash Flows for Sponsor and Investor Review cash flow distribution, i.e. IRRs Built in Self-Test



Equity Investment (20.0) (20.0) 0.0 0.0 0.0 0.0 0.0 0.0Proceeds 105.1 0.0 5.0 7.1 10.0 12.0 46.0 0.0CF 85.1 (20.0) 5.0 7.1 10.0 12.0 46.0 0.0Profit $85.1% of Total Profit 24.3%IRR 30.03%Multiple 5.25x


Equity Investment (180.0) (180.0) 0.0 0.0 0.0 0.0 0.0 0.0 FlowsProceeds 444.9 0.0 45.0 42.9 40.0 38.0 54.0 0.0CF 264.9 (180.0) 45.0 42.9 40.0 38.0 54.0 0.0Profit $264.9% of Total Profit 75.7%IRR 21.13%Multiple 2.47x

Check TRUE

Securitization (Detail)

Time Permitting


90 of 125

Securitization Transformation of a portfolio of financial

obligations into liquid form attractive to a myriad of investors

‘Value’ of obligations depends on ability/willingness of obligator to pay, i.e. Risk

Financial Obligation Portfolios (Examples): Mortgages (Commercial & Residential) Automotive Loans Credit Card Loans


91 of 125

Structuring Transforming financial obligations into palatable

financial assets by means of cash flow segmentation & risk

Types of Instruments 1) Direct obligations of corporates and sovereigns 2) Derivatives, e.g. Swaps & Futures 3) *Securitized & Structured Financial Assets


92 of 125

Direct Obligations Obligation created by issues for investors Equities Treasuries Corporate Debt Convertibles


93 of 125

Derivatives An asset whose value depends upon an

underlying asset Swaps & Futures (see other lectures)

Represent zero sum game (In Theory Only)


94 of 125

Securitization Transforms raw assets into tradeable units Allows bifurcation of Origination & Investment

Functions Structuring rearranges cash flows and risk

Structuring financial instruments similar to transforming physical Real Estate assets

“Working the Asset”


Major Asset Classes 1) MBS

Residential Commercial

2) Credit Cards 3) Automobile Loans 4) Home Equity Line of

Credit (HELOCs)

5) Manufactured Housing

6) Student Loans 7) Equipment Leases


96 of 125

Critical Concepts to Consider 1) Collateral 2) Credit Enhancement 3) Standardization 4) Liquidity


97 of 125

Collateral Raw commitments that support

transaction (Mortgage, i.e. home) Cash Flow & Credit Characteristics

determine performance + drive structuring

Must understand collateral of specific asset + portfolio consideration (Critical)


98 of 125

Credit Enhancement Process of protecting payment stream to

investors Result from: External guarantee Interesting structuring

Subordination Waterfall Structure Order of payments


99 of 125

Standardization Process of taking dissimilar loan types

and terms & transforming within a portfolio

Portfolio versus Asset Analysis


Asset 1 Asset 2 Asset 3 Asset 4 Asset 5 Asset 6 Asset 7 Asset 8

Asset 9…

Each Asset has individual

characteristics, i.e. exposed to unsystematic

risk

Portfolio of Assets 1 – 9

Standard: Coupon Terms

Diversified, standardized Portfolio, i.e. exposed to

systematic risk only (allegedly)

100 of 125

Liquidity Ability to transfer assets among investors Increasing liquidity goal to securitization Measures:

Bid-Ask Spread Amount of time to sell a position

@ Fair Value, i.e. not deeply discounted


101 of 125

Tax, Accounting, Legal Issues 1) Tax

Will there be tax @ Trust Level 2) Accounting

Securitization treated as ‘Sale’ or ‘Financing’? 3) Legal

Does Trust or legal entity have sufficient title to assets? Issuing firm protected from bankruptcy &/or disruptions


102 of 125

Mortgage-Backed Security Process

John & Jane America want a home J&J meet mortgage broker Mortgage Broker and Mortgage

Banker meet to originate loan M. Banker sells loan to Dealer Dealer structures loan and sells Norway purchases loan structure

Education High School High School

College

Graduate School Unknown Unknown

No Recourse (Paid Immediately)


Realtor (Paid Immediately) = High School

Default Losers = John&Jane & Norway

103 of 125

Dealer/Risk Sharing Paid up-front (immediate) Structures product with assistance

Lawyers, Accountants, Rating Agencies

Sells product into Capital Markets Risk born by John/Jane & Capital Markets

(Norway) NO risk by Mortgage Broker, Mortgage Banker,

and Dealer (or Realtor!)


104 of 125

Loan Servicer Receives payments and distributes to

investors according to agreement Handles paperwork for loan Responsible for collections in event of

default Low-risk business

Paper administrators


105 of 125

Default Case Guarantor called to cover any losses Servicer “Special Servicer” passes payments

on to appropriate investors Servicer “Special Servicer”, guarantor and

trustee compensated immediately for services No risk


106 of 125

Allocation of $$$ (T = 0) Mortgage Broker Mortgage Banker

Dealer

Borrower Receives Investor Pays

97 98 99

100


Realtor paid at T = 0

107 of 125

Allocation of Interest Payments

Investor Receives

Guarantor Servicer

Spread to Investor Option Cost to Investor

Duration Cost to Investor

Funding Cost to Investor Borrower

Pays


108 of 125

Securities – Investment Characteristics

1) Principal repayment timing 2) Amount & form of interest payment 3) Credit quality of instrument (Risk)

t

Risk of Receiving

Interest Pay (Form and Quantity)


Price of Asset

109 of 125

Risk Measures 1) Spread

Difference between the yield on the investment and yield on base instrument (Compensates for Risk)

2) Rating (Provide “independent” risk assessment) S&P, Moodys, Fitch

3) Duration/Convexity (See Whitepaper) Duration: Measure of sensitivity of price to interest

rates (Rate of change (1st Derivative)) Convexity: Change in Duration as interest rates

change (Rate of change of change (2nd Derivative)) Roger Staiger [email protected]

110 of 125

Securitization - Classification Sale versus Financing Issues:

Financial Regulatory Tax Accounting Strategic


111 of 125

Financial Advantages Asset Sale (Off-Balance Sheet)

Risks 100% transferred to buyer (Seller has Reps/Warrants)

Cost lower than securitization

Financing (Securitization) Several classes created & sold (Off-Balance Sheet)

Issuer retains residual class Residual considered “equity”


112 of 125

Financial Transaction (versus sale) Financing expenses Sale Expenses 1. Coupons Paid Corporate: 2. U/W fees 1. Debt 3. Administration Costs 2. Equity

Which is cheaper/beneficial? How each changes risk of institution?

- How changes makeup of corporate BS Securitization


113 of 125

Securitization & Capital Structure Firms generally limited to amount of debt

on Balance Sheet (Capital Structure) Structure Off-Balance Sheet activities in Special

Purposes Entities (SPEs) Remember Repo 105 (classic example)

Securitization may permit greater debt issuance Free equity for more transactions


114 of 125

Residual Interest “Equity” like Held by issuer Illiquid & Complex instrument Bear prepayment & credit risk Generally no risk beyond tranche (residual)

Risk is loss of interest only


115 of 125

Regulatory - Securitization Rated security have lower capital

requirements Rated securities may allow firms to lower

capital requirements Lower capital requirements increase leverage Double edged sword


116 of 125

Tax Securitization Issues general prefer financing ‘tax’

treatment Asset sale requires immediate recognition

of gain/loss on transaction Asset types:

1) Trading 2) Available-for-Sale


117 of 125

Asset Types 1) Trading

Must hold @ market value and/or fair value 2) Available-for-Sale

Held on book @ lower of: Cost Market value (hence Bear Stearns bailout)

3) Loans in Portfolio Considered “Held-to-Maturity’

Held at original cost


118 of 125

Accounting - Securitization Firms prefer to record securitization as

“sale” (Reduces capital requirements) Strengthens Balance Sheet - generally

Can lead to income instability How flow through accounting

statements?: Depends on how residual classified

Sale versus Trading


119 of 125

Strategic - Securitization Increase origination of loan product Adjust portfolio of assets

Securitize to maintain control of assets Lost leader but strategic play Increase assets under control while

reducing capital requirements


120 of 125

Balance Sheet – Pre-Securitization


Assets ($m) Ratios Calc ValueCash 25,000 D/E 340/50 6.80 Loans 300,000 Current 25/45 0.56 Investments 60,000 PP&E 50,000 Assets Delta

Total Assets 435,000 300,000 → 30,000 270,000

Liabilities ($m) Liability Reduction 280,000 Short‐Term 45,000 45,000 → 30,000 15,000 Long‐Term 340,000 340,000 → 75,000 265,000

Total Liabilities 385,000 Equity (Gain on Sale)

Equity ($m) 50,000 50,000 → 60,000 10,000

121 of 125

Balance Sheet – Post-Securitization


Assets ($m) Ratios Calc ValueCash 25,000 D/E 75/60 1.25Residuals 30,000 Current 25/30 0.83Investments 60,000 PP&E 50,000 Previous Values:

Total Assets 165,000 Ratios Calc ValueD/E 340/50 6.80

Liabilities ($m) Current 25/45 0.56Short‐Term 30,000 Long‐Term 75,000

Total Liabilities 105,000

Equity ($m) 60,000

122 of 125

Balance Sheet – Cost of Capital Securitization can decrease cost of

capital (reduced corporate “risk”) If securitization coupon < Corporate

WACC Cost of Capital reduced

* Firms value maximized @ point of WACC minimization


123 of 125

Securitization Factors - Balancing

Financial

Regulatory Tax

Accounting

Strategic All five must

balance


124 of 125

Structuring Entity Generally structured as Trust

Trust not subject to taxation Trust issues securities Established legal separation between issuer &

pool of assets Bankruptcy – Remote of Trust


125 of 125

Structure Example (Generic)

Bond1 Bond2 Bond3

Bondn (y = 8.5%)

TRUST

Tranche 4 (Residual) 4th 5% Loss; y=35%

Tranche 3 3rd 10% Loss; y=15%

Tranche 2 2nd 10% Loss; y=7.5%

Tranche 1 1st Senior; y=6%

Wat

erfa

ll


waterfall construction basic theory -...

Documents