PAYMENT WATERFALL
What is the exact position of the respective items, i.e. costs, fees, interest and principal payments on the notes etc. Îfor instance, is the principal payment on note A senior or junior to interest payment on note B etc.? Îin other words: "how and when" do investors get back their capital as well as their interest?
Are there any performance related triggers (e.g. based on delinquencies, defaults and losses) leading to a switch from pro-rata to sequential amortization (or the other way around), or an accelerated amortization (for instance, by merging the formerly segregated interest and principal waterfalls, with interest on senior notes being senior to junior notes' amortization) or to an interest deferral on a specific note (i.e. interest payment on such a note is deferred in case of cash shortage, e.g. by way of lowering the rank of such an interest payment in the deal's waterfall)?
RESERVE ACCOUNT
To what extent is the reserve account already funded as of closing and to what extent will it be (re-) filled with future excess spread?
Will the reserve account amortize at some point in time, and if yes subject to which rules is such an amortization allowed?
In case amortization of the reserve account is allowed: is there a floor that the reserve account cannot undershoot?
REVOLVING PERIOD
As investors bear the risk that the initial pool's credit quality may deteriorate due to lower quality assets being purchased after
closing, mitigants such as a set of eligibility criteria/concentration limits that the underlying assets have to adhere to (on a single asset and/or a portfolio level) should be implemented, e.g. in a leveraged loan CLOs there may be a limit such as: mezzanine loans <= 5% of the aggregated pool amount
LEGAL AND TAX ISSUES
Bancruptcy remoteness of SPV, non-consolidation of SPV (if SPV's owners go bankrupt, the assets should not fall into their bankruptcy estates), validity of assets' transfer, perfection of security interests in collateral, enforceability of all agreements as well as tax
treatment of the transaction
EXCESS SPREAD
Is excess spread used to cover losses as a first layer of protection for noteholders at all?
If yes, is excess spread used on a "use-it-or-lose-it-basis" (i.e. in case there are no losses at a certain point in time, the then available excess spread "leaves" the structure) or "trapped" (i.e. paid into a reserve account, at least to a certain extent, if not immediately used, which consequently means that it may be used to cover future losses)?
Is the excess spread guaranteed, e.g. by way of swap agreement? Typically, the underlying assets generate fixed-rate interest payments that have to be swapped into floating, as the issued notes pay investors a reference index such as Libor/ Euribor plus a spread; such a swap agreement may be arranged such that the swap counterparty receives the fixed-rate payments and pays to the SPV the WA coupon on the notes plus senior costs plus a certain amount, which would be a guaranteed excess spread.
Are performance related triggers implemented in the structure that lead to additional excess spread trapping upon the breach of such triggers, and are the trigger levels (normally limits for delinquencies, defaults and losses) reasonable taking into account the past performance of the originators' portfolios (or might they induce additional excess spread trapping too late)?
Are any detachable coupons/IO strips (please refer to page 56) incorporated in the structure that decrease the amount of available excess spread?
What is the size of fees and expenses and what is their position/ranking in the waterfall, e.g. in case fees and expenses are split into more junior and more senior portions (ranking junior and senior to certain interest payments, hence these features may decrease excess spread)?
Î in managed CDOs: the management fee should be split in the waterfall, i.e. parts of the management fee should be
junior and other parts should be senior to the various notes' interest and principal payments to align interests between investors (senior versus junior investors) as well as the manager
Îit would be positive, if senior fees/expenses are not entirely paid upfront, as more issuance proceeds from the sale of the notes can be used to purchase assets (especially in CDOs, in the opposite case, the CDO-manager may have the incentive to buy assets that currently trade below par to be able to purchase the same amount of assets with the given monies)
Description of main structures – What to look for?
TRIGGERS
Are trigger levels of performance related triggers reasonable taking into account the historical performance of the respective assets and are all kind of relevant risks such as FI/FX or legal risks mitigated by triggers (e.g., see "borrower notification" below)?
What are the consequences of trigger breaches (switch from pro-rata to sequential amortization, additional excess spread trapping, a change of the waterfall, e.g. interest payment on senior notes are now senior to principal payments on junior notes, which may have been different before etc.) and how can this breach be cured?
Borrower notification: a special trigger is based on the set-off and commingling risks described above. In case the obligors are not notified of the transfer (assignment) of their obligations, they are able to properly discharge their debt by paying to the assignor (the old owner, hence the originator), and consequently, the assignee (the SPV, however, ultimately the investors) would not have the right to demand payment from the borrower after such a discharge. Hence, the structure of a securitization transaction should trigger the borrowers’ notification in case the originator/servicer breaches certain rating triggers to assure that ABS investors do not suffer from such legal risks, i.e. that cashflows fall into the originator's bankruptcy estate upon his insolvency without the investors having claims.
COUNTERPARTY RISK
Credit strength of swap providers, credit enhancement providers etc. as well as the ability of the servicer to service the underlying assets Îthe notes' ratings are either credit linked to these counterparties (at least to some extent), i.e. the counterparties' ratings must be commensurate for a certain rating level or additional credit enhancement and/or rating triggers may be implemented to achieve a de-linkage from counterparties' ratings
COLLATERAL RISK (for synthetic deals only; please refer to page 49)
Market risk (when liquidiation of collateral is required) and/or credit risk (default of collateral provider) may occur
This can be mitigated by minimum rating levels required for the collateral, put options, asset swaps, repo agreements, rating triggers, appropriate OC levels etc. Îotherwise: no de-linkage of the notes' ratings possible (increased rating downgrade risk)
MANAGEMENT RULES, LOSS DEFINITIONS AND TECHNICAL FACTORS
Rules an asset manager has to adhere to should
– align the interests of investorsin the equity piece (they typically get the residual profit of a transaction and bear the first losses that may occur) and in senior notes (they typically get a fixed spread over Euribor/Libor and are well protected against losses by credit enhancement measures)
– offer the manager enough flexibility to use his expertise, while being protective enough to avoid too many losses
The loss definition of the respective transaction's documentation determines, which losses an investor has to bear (principal only or principal + foregone interest or principal + foregone interest + foreclosure costs). Î in other words: what is the motivation of the originator and for what purpose is the transaction conducted?
– However, when investors try to compare the performance of several deals to get a better picture of the current inherent risks, they should closely analyze early warning measures such as delinquencies or defaults (<> already realized losses) that originators report throughout the deal's life in investor reports (and moreover, should compare these measures with initial expectations from rating agencies).
– Originators also very often report so-called credit events (e.g. in German CLO or RMBS deals). Credit events (as well as defaults) are delinquencies that, however, meet certain criteria, e.g. a credit event may be reported in case of a mortgage loan being more than 90 days overdue, with the delinquent amount exceeding EUR 5,000. Investors must closely watch the respective definition of defaults and credit events, as these definitions may differ substantially between transactions,
making performance comparisons difficult.
Investors should take into account the aggregated amount of issued notes, as this is a major driver for their secondary market liquidity
Which and how many rating agencies rated the deal?
Quality, quantity and frequency of investor reports (the originator typically periodically publishes reports, which describe the performance of the underlying assets of a securitized pool (e.g. measured in terms of deliquencies, defaults and losses) and the impact of such a performance upon the issued notes)
Contents
1
Index2
Introduction to ABS3
Description of main asset classes – Overview– Glossary of main terms and definitions – What to look for?
4
Description of main structures – Overview– Glossary of main terms and definitions – What to look for?
5
Rating agencies' approach to rating ABS – General thoughts– Selected methodologies – What to look for?
6
Basel II– General Introduction
– The Standardized Approach – The Ratings Based Approach
7
Bloomberg Functions8
ContactsFIRST STEP: THE ANALYSIS OF THE ASSET SIDE OF AN ABS TRANSACTION (UNDERLYING PORTFOLIO)
Assumptions regarding the overall size and timing of defaults, losses etc. in
defined rating scenarios (without a determination of a loss distribution)