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Endnotes.

(1) The Basle Committee on Banking Supervision (2002) uses the term "special purpose entity (SPE)" to define the functions of a SPV, which is a corporation, trust, or other entity organised for a specific purpose, the activities of which are limited to those appropriate to accomplish the purpose of the SPE, and the structure of which is intended to isolate the SPE from the credit risk of an originator or seller of credit exposures. SPEs are commonly used as financing vehicles in which credit exposures are sold to a trust or similar entity in exchange for cash or other assets funded by debt issued by the trust.

(2) See also Turwitt (1999).

(3) See also Kuck (1998).

(4) This possibility of selling securities as structured claims in the form of tranches has been key to the popularity of asset securitisation. If tranches are subordinated, any losses in excess of the lower tranche are absorbed by the subsequent tranche and so on, leaving the most senior tranches only with a remote probability, of being touched by defaults in the underlying asset pool (The Economist, 2002).

(5) See also Leland (1998) and Frankel (1991).

(6) Similarly mezzanine capital, equity finance and corporate bonds are other popular means of external finance with comparable structural properties.

(7) See also Muller-Stewens et al. (1996).

(8) See also Zoller (2001).

(9) This observation relates to a greater range of geographical and industrial diversity.

(10) The first asset-backed securitisation issue in its modern form was completed by Sperry Corporation, which issued computer lease backed notes in 1985 (Kendall, 1996).

(11) See also Bohringer et al. (2001).

(12) The first Pfandbrief instrument was created by the executive order of Frederick the Great of Prussia in 1769 (Skarabot, 2002; Anonymous, 1999).

(13) See also Fabozzi (1997).

(14) See also Deutsche Bank Global Markets Research (2001).

(15) A number of sectors of the economy, such as the automobile, real estate, and credit card lending industries that require large amounts of medium to long-term capital owe their development to the growth of the asset-backed securities market. The average maturity of their loan portfolios closely match the average investment horizon of such structured finance transactions such that issuers can afford to dispense with compensatory provisions for interest rate mismatches, etc.

(16) This aspect warrants particular attention in determining the state-contingent pay-offs of investors in an environment of asymmetric information governing the securitisation of loans and bank assets.

(17) For a detailed definition of traditional and synthetic securitisation structures, please refer to section III.A.a and III.A.b of this paper.

(18) The SPV is bankruptcy remote, as all the total amount of outstanding debt securities is collateralised by third-party guarantees as well as government debt or other highly rated debt securities acquired by the SPV upon receipt of proceeds from securitisation.

(19) These relationships might yield informational rents as shown by Elsas and Krahnen (1998) and Elsas (2001) in the context of German banking.

(20) Unfortunately, the case of lending coupled with ready and cheap access to liquidity results in a recipe for disaster as banks achieve suboptimal outcomes from holding loans in the long-term.

(21) See also Anonymous (2002).

(22) As the degree of collateral retention in the form of credit enhancement is determined by the difference of the pool quality and the desired rating of the securitisation transaction, most balance sheet CLOs have been collateralised by investment grade loans.

(23) Depending upon the nature of a transaction and its underlying asset class, the asset pool may need to be supported by one or more types of credit and/or liquidity support ("credit enhancement" and "liquidity enhancement") in order to attain the desired credit risk profile for the debt securities being issued. Such enhancements are commonly derived from internal sources, i.e. they may be generated from the assets themselves, or are supplied by a third party.

(24) See also Calvo (1998) for a detailed discussion of the "lemons problem" in the context of financial contagion.

(25) This insight has important implications for the provision of credit enhancement, mainly because an essential level of first loss provision required by rating agencies as one form of credit enhancement varies by the quality of the underlying reference portfolio, and assuming a linear relationship between the quality of collateral and the degree of credit enhancement--does not discriminate good from bad issuer (see also section III.B.a).

(26) Otherwise no separating equilibrium in the loan securitisation market on the basis of credit enhancement as a costly signal (assuming issuers are "first movers") would arise.

(27) See also Muller-Stewens et al. (2000c).

(28) See also Giddy (2002).

(29) i.e. the face amount of the financial asset pool is larger than the security it backs.

(30) The Basle Committee on Banking Supervision (2002) defines excess spread as "gross finance charge collections and other fee income received by the trust or special purpose entity (SPE) minus certificate interest, servicing tees, charge-offs, and other senior trust or SPE expenses. Finance charges may include market interchange fees."

(31) A specialised form of excess spread is the so-called yield spread, which comprises the difference between the coupon on the underlying assets and the security coupon. As a first defence against losses, excess servicing complements the yield spread, which may be applied to outstanding classes as principal (Giddy, 2002).

(32) See also Fabozzi (2000 and 1998), Fabozzi and Jacob (1998), Fabozzi, Ramsey and Marz (2000) as well as Fabozzi and Yuen (1998).

(33) See also Pfister (2002); Gluck and Remeza (2000); Falcone and Gluck (1998); Howard and Merritt (1997); Becker and Speaks (1996).

(34) See also DeMarzo (1999), DeMarzo and Duffle (1999), and Duffie and Garleanu (2001) for an overview of models supporting the incentive of asset retention in the securitisation process.

(35) See also Ohl (1994).

(36) See also Findeisen and Ross (1999).

(37) See also Rixen (2001).

(38) Appendix 1 includes a summary of the most important regulatory changes with respect to asset-backed securitisation in the proposal of the Basle Committee (2001) for a revision of the 1988 Basle Accord on Banking Supervision.

(39) Section IV.C highlights the analytical differences between credit ratings and structured ratings.

(40) A repurchase transaction involves the sale of securities by an entity to a counterparty, subject to the simultaneous agreement to repurchase the sold securities at a certain later date at an agreed price. The issuer of the repo agreement retains the securities concerned in the balance sheet for the entire lifetime of the transaction and values them in accordance with the accounting principles for trading assets or investment securities, respectively. Any proceeds from the sale are reported in liabilities to banks or in liabilities to customers as appropriate, since the bank gains liquidity through the temporary transfer of assets. Analogously, the converse principle holds true for reverse repo agreements. In this case securities are purchased by an entity, subject to the obligation to sell these securities at a later date at an agreed price. As the bank forgoes liquidity due to the temporary receipt of assets, such transactions are reported in loans and advances to banks, or loans and advances to customers. Both interest expense from repos and interest income from reverse repos accrue evenly over the lifetime of the transactions (Dresdner Bank, 2000).

(41) See also Batchvarov et al., (2000); as well as Herrmann and Tierney (1999).

(42) See Deutsche Bank (2001).

(43) See Batchvarov et al. (2000), 31.

(44) "discount" = book value of transferred loan volume--expected credit loss.

(45) Punjabi and Tierney (1999) underscore this point by noting that this turn of regulatory policy was terms as the so-called "full models approach" by John Mingo of the Federal Reserve Bank of New York at a speech delivered to senior regulators of major banking supervisory authorities in London in September 1998. In conjecturing that the application of the new internal ratings based approach will require qualifying banks to extend the determination of capital cover of credit risk to market and operational risk as well such that potential insolvency can be averted with certain confidence over a specific investment horizon.

(46) See also Eichholz (2000).

(47) Investment management legislation in certain countries stipulates expressis verbis the types of derivative instruments investment funds are entitled to hold in their portfolios. The credit risk treatment of credit derivatives attracts particular attention as they do not rate a mention in the German legal catalogue for instance (Burghardt, 2001).

(48) Oliver, Wyman & Co. (2002).

(49) See also Basle Committee (2003).

(50) See also Basle Committee (2001), 87f.

(51) Generally, in [subsection] 521-524 the Consultative Document to the New Basle Accord stipulates that originating banks are required to hold regulatory capital against all of their securitisation exposures arising from (i) the provision of credit risk mitigants to securitisation transactions, such as investments in asset-backed securities, (if) the retention of subordinated tranches, and (iii) the extension of liquidity facilities or credit enhancements. In case of capital deduction for securitisation exposures, banks are required to provide appropriate regulatory capital by taking 50% from Tier 1 capital and 50% from Tier 2 capital--except for regulatory provisions of any expected future margin income, which would need to be deducted from Tier 1 capital (Basle Committee, 2003).

(52) [K.sub.IRB] is the ratio of (a) the IRB capital requirement for the underlying exposures in the securitised pool to (b) the notional or loan equivalent amount of exposures in the pool (e.g. the sum of drawn amounts plus undrawn commitments).

(53) The risk weights for banks break down into two options: (i) risk weighting on the country the bank is incorporated (Option 1) or (ii) risk weighting based on the assessment of the individual bank (Option 2). Moreover, claims on banks with an original maturity of three months or less would receive a risk weighting that is one category more favourable.

(54) Similarly, securitisation exposures in second loss positions do not have to be deducted if the first loss position (most junior tranche) provides enough protection ([subsection] 529 and 532 Consultative Document to the New Basle Accord). Third-party (non-bank) investors may recognise external ratings up to "BB+" to "BB-" for risk weighting purposes of securitisation exposures, i.e. capital deduction for securitised claims applies only for rating grades of "B+" and lower.

(55) The Consultative Document to the New Basle Accord also proposes specific risk weightings according to the type of underlying exposure: (i) claims included in regulatory retail portfolios (75% risk weighting), i.e. exposures to individuals (e.g. credit card debt, auto loans, personal finance) or SMEs with low granularity (e.g. single obligor concentration must not be higher than 0.2% of overall regulatory retail portfolio) and low individual exposure (i.e. maximum counterparty exposure not higher than ?1 million); (ii) claims secured by residential property (35% risk weighting); and (iii) claims secured by commercial real estate (100% risk weighting).

(56) Hence, both the standardised approach and the internal ratings-based approach (IRB) allow for qualifying external ratings and various operational criteria (see [section] 525 Consultative Document to the New Basle Accord (2003)) to be used in the ratings-based approach (RBA).

(57) The "mark-up" of risk weights on securitisation tranches can be illustrated by comparing the IRB risk weights per se for an underlying asset class, e.g. residential mortgages and corporate loans, with the risk weights imposed on securitisation claims. The difference is the greatest especially for low investment grade ratings (e.g. "A", "Baa1" and "Baa2").

(58) i.e. public ratings only.

(59) see [subsection] 575-577 Consultative Document to the New Basle Accord.

(60) The Second Working Paper on the Treatment of Asset-Backed Securitisation also provides a simplified method of computing the effective number of exposures and the exposure-weighted average loss-given-default (Basle Committee, 2002, 36).

(61) The specification refers to a cumulative beta distribution function with parameters a and b evaluated at 1.

ANDREAS JOBST is a research officer at the London School of Economics and Political Science (LSE), Financial Markets Group (FMG), and at the Johann Wolfgang Goethe-Universitat Frankfurt am Main. He previously worked at the European Securitisation Group of Deutsche Bank Global Markets (UK) Ltd., the Bank of England and the United Nations Economic Commission for Latin America and the Caribbean (U.N. ECLAC). He is an academic contributor to the online journals Securitization.Net and bfinance.de. He holds academic titles from the University of Oxford (MBA), the University of Leicester (MA) and the University of Maryland (BA and AA) as well as the professional qualification Accredited Asset Management Specialist (ARMS).

Andreas A. Jobst

London School of Economics and Political Science (LSE) and J.W. Goethe Universitat Frankfurt am Main
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Title Annotation:Collateralised Loan Obligations (CLOs)--A Primer
Author:Jobst, Andreas A.
Publication:The Securitization Conduit
Geographic Code:4EUUK
Date:Mar 22, 2003
Words:2110
Previous Article:Appendix III: the characteristics of securitisation.
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IV. Analytical consequences arising from the characteristics of securitisation.
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References.

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