Master trust structure

A master trust structure is structured as explained in Section 2.3 and can be used for the securitization of either short-term or long-term assets. This securitization structure is a self-contained structure in which the transaction is specifically organized for one originator. The SPV is characterized by a master trust. The master trust issues series of investor certificates and seller certificates with a medium to long term maturity (over one year) (Fabozzi & Choudhry, 2004). The originator is expected to retain a percentage of the principal in the certificates which is called seller‟s interest in the asset portfolio. The seller‟s interest is primary used to absorb daily fluctuations in the amount of receivables of the trust, arising from many factors, such as delinquent payments and early termination (Fabozzi & Choudhry, 2004). In addition, seller‟s interest provides more alignment between the originator and investors, because the originator would also benefit from a well serviced transaction. The investor‟s certificates give investors an undivided beneficial interest in the asset portfolio of the issuing trust (Sabarwal, 2006). These may be divided into several asset classes with different seniority. The main feature of a master trust structure is that the trust has the possibility to issue multiple series of securities from the same trust on an on-going basis. Each additional series of securities will be backed by the whole asset portfolio and not only by the added part of the portfolio (Tavakoli, 2008). The master trust structure is a very flexible securitization structure, due to the possibility of issuing new series of certificates can be done from the same master trust structure. New portfolios can easily be added to the existing transaction, so that it is not necessary to organise a new transaction. Thereby, it can save costs and effort.

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Issuance of new series changes the characteristics of the underlying portfolio. This means that the composition and performance of the securitized asset pool can change during de term of the transaction. Moreover, new series can differ in size, maturity, credit rating and interest rate (Tavakoli, 2008). Every series has an expected final payment date and a legal termination date. At the expected final payment date, the investors are expected to receive the last principal payment. After the legal termination date, investors have no rights to any additional cash flow. Despite the differences between issued series, they are all covered by the entire portfolio and have to meet predetermined requirements of the credit rating agency. Each additional issued series has to be assessed by the rating agent. The master structure allows originators to choose a cash flow structure to repay the investors in securities. This can be divided into the following structures:

 Pass-through

 Pay-through 4.1.1 Pass-through

A pass-through structure is a cash flow structure to repay principal investments to investors. These are sometimes also called amortizing transactions, uncontrolled amortization or fast pay structure (Fabozzi & Choudhry, 2004; and Tavakoli, 2008). In pass-through structured ABS, the originator sells a portfolio of assets via a true sale to an SPV. The main feature of a pass-through structure is the way of repayment of interest and principal to investors. Investors that invest in a pass-through ABS take a direct exposure on the performance of the asset portfolio in the securitization (Fabozzi & Choudhry, 2004). They actually invest in pass-through certificates issued by the SPV. They obtain a share of ownership in the underlying cash flow generating asset portfolio.

The repayment of principal and interest is passed-through (or returned) to investors during the lifetime of the securitization transaction to repay the initial invested amount and interest. This is depending on the performance of the asset portfolio. The pass-through structure is particularly applicable for assets with longer maturities and assets with interest and principal payments that depend on the amortization schedule (see Figure 13). In the early periods, most of the repayment is allocated to the interest instead of the principal. Later on, most of the repayment is allocated to the principal instead of interest. The proceeds from the asset portfolio are collected by the servicer and passed through to investors. In the event of shortcomings or late payments in the securitized asset portfolio, payments to investors are (to some extend) covered by credit enhancements.

Figure 13: Pass-through or amortization structure (Source: Fabozzi, & Choudhry, 2004). 4.1.2 Pay-through

In a pay-through structure, the originator sells a portfolio of assets via a true sale to an SPV just as in the case of a pass-through structure. However, a pay-through structure is somewhat different than a pass-through structure. The main feature of a pay-through ABS is that it is a borrowing structure and

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not participation (Tavakoli, 2008). Investors do not directly own the underlying assets, but are only invested into a bond backed by these assets. This enables issuing entities to de-synchronize or to manipulate the cash flows into separate cash payment streams (Fabozzi & Choudhry, 2004). Thereby, it is possible to reconstruct the repayment of cash flows to investors into different levels of debt. A pay-through structure, sometimes also called a revolving transaction, is often used for assets with short term maturities (between 60-120 days) and is divided into two periods, namely the revolving period and the controlled amortization period (Sabarwal, 2006). In the revolving period, the only payments made to investors are interest payments. The other proceeds received from the securitized asset pool are used to service and maintain the securitization, by paying servicing fees and purchasing new assets. This structure ensures a predictable payment stream for investors.

Pay-through structures have a predetermined legal end date. Investors are expected to receive all of their principal back before the legal end date of the securities. Principal investments are paid back to investors during the controlled amortization period or pay-out period. Fabozzi & Choudhry (2004); and Tavakoli (2008) distinguish two different forms how the principal can be returned to investors during the controlled amortization period by soft or hard bullets. When the structure is structured with a hard bullet, the principal is stored in a reserve account during a certain period (the controlled amortization period) and paid back in one payment to the investors through a hard (single) bullet payment. The soft bullet repayment starts earlier paying back the principal. Instead of depositing the principals into a reserve account, they are paid in several instalments during the controlled amortization period (generally 1 to 3 years). The pay-through structure is displayed by an example in Figure 14.

Figure 14: Pay-through or revolving structure with soft bullet (grey) and hard bullet (black) controlled amortization period (Source: Fabozzi, & Choudhry, 2004)

Both pass-through and pay-through structures can be combined into a hybrid structure. In a hybrid structure can be chosen for a short revolving period (for generally 0-2 years), followed by a pass- through structure (Fabozzi & Choudhry, 2004). The revolving period can be used to optimize the asset portfolio in the first two years. The hybrid structure is often used for medium to long term assets.