LO 35.3: Analyze the differences in the mechanics o f issuing securitized products

LO 35.3: Analyze the differences in the mechanics o f issuing securitized products using a trust versus a special purpose vehicle (SPV) and distinguish between the three main SPV structures: amortizing, revolving, and m aster trust.
The three main special purpose vehicle (SPV) structures used in the securitization process are amortizing, revolving, and master trust. The master trust is a special type of structure that is used for frequent issuers. The difference in how payments are received over the asset-backed securitys life determines whether the ABS is better suited to the amortizing or revolving structure.
In an amortizing structure, principal and interest payments are made on an amortizing schedule to investors over the life of the product. Because payments are made as coupons are received, this type of structure is referred to as a pass-through structure. Amortizing structures are very common with the securitization of products that have amortization schedules such as residential mortgages, commercial mortgages, and consumer loans. Amortizing structures
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are valued based on the expected maturity and the weighted-average life (WAL) of the asset. The WAL is the time-weighted period that the underlying assets are outstanding. Because borrowers of mortgages and consumer loans often have the option to pay off the loans early, the WAL must include pre-payment assumptions to estimate the rate at which principal is repaid over the life of the loans.
Revolving structures are used with products that are paid back on a revolving basis. Thus, under the revolving structure, principal payments of the assets are paid in large lump sums rather than a pre-specified amortization schedule. Credit card debt and auto loans are examples of products that are securitized using a revolving structure due to their short time horizon and high rate of pre-payments. Under a revolving structure, payments are not simply passed through. Rather, principal payments are often used to purchase new receivables with criteria similar to assets already in the pool. Investors are repaid by principal payments through controlled amortization or in single lump sum payments referred to as soft bullet payments.
Professors Note: The term revolving structure is similar in nature to a revolving loan issued by a commercial bank to a corporation. Under the terms o f a revolving loan, the corporation has a line o f credit and is required to pay down that line o f credit to zero every year. Thus, the loan does not amortize to reduce the balance, rather the balance is reduced in large lump sum payments.
A master trust structure allows an SPV to make frequent issues or multiple securitizations. The originator transfers assets to the master trust SPV who in turn issues new notes from this asset pool. Master trusts are often used in the securitization of mortgages and credit card debt.
Figure 3 illustrates the securitization process for credit card asset-backed securities (ABS) using the SPV master trust structure. The pool of credit card receivables is changing over time. However, the master trust structure enables the SPV to issue multiple ABS through the single trust. Investors from different series receive payments from the entire pool of credit card ABS.
Excess spread is created from the high yield credit card debt less the cost of issuing the ABS. The excess spread is the difference between the cash inflows from the underlying assets and the cash outflows in the form of interest payments on the ABS issues. After administration expenses are covered, any remaining excess spread is held in a reserve account to protect against future losses. If there are no future losses, the remaining excess spread is returned to the originator.
As illustrated by Figure 3, under a trust arrangement two distinct SPVs are created. The additional entity is created to further distance the originator from the issuer and the underlying assets. A common arrangement will involve a master trust, or special purpose vehicle (SPV), and a grantor trust. In contrast to the previous approach (i.e., corporation), the assets do not serve directly as collateral. Under this arrangement, the originator sells the assets to the master trust (SPV 1) for cash, but the master trust in turn deposits the assets in the grantor trust (SPV 2). The master trust receives a beneficial interest in the grantor trust, which represents the same economic position as if only one SPV was employed. Now the claims of the securitized products are backed by the beneficial claim on the master trust rather than on the assets themselves.
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Credit card debt is not collateralized and typically suffers from a low rate of recovery in the event of default. Therefore, a financial guarantor is used as a credit enhancement. If there are payment defaults for a series, the excess spread is shared to cover the losses. The ability of SPV master trust structures to sell multiple issues to investors that share excess spreads over these multiple series makes this structure very different from the amortizing and revolving structures.
Figure 3: Master Trust Structure
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