Securitization past, present and future

PA LG R AV E M AC M I L L A N S T U D I E S I N BANKING AND FINANCIAL INSTITUTIONS S E R I E S E D I TO R : P H I L I P M O LY N E U X Securitization: Past, Present and Future Solomon Y Deku and Alper Kara Palgrave Macmillan Studies in Banking and Financial Institutions Series editor Philip Molyneux Bangor University Bangor, United Kingdom The Palgrave Macmillan Studies in Banking and Financial Institutions series is international in orientation and includes studies of banking systems in particular countries or regions as well as contemporary themes such as Islamic Banking, Financial Exclusion, Mergers and Acquisitions, Risk Management, and IT in Banking The books focus on research and practice and include up to date and innovative studies that cover issues which impact banking systems globally More information about this series at http://www.springer.com/series/14678 Solomon Y Deku • Alper Kara Securitization: Past, Present and Future Solomon Y Deku Nottingham Trent University Nottingham, UK Alper Kara Loughborough University Loughborough, UK Palgrave Macmillan Studies in Banking and Financial Institutions ISBN 978-3-319-60127-4    ISBN 978-3-319-60128-1 (eBook) DOI 10.1007/978-3-319-60128-1 Library of Congress Control Number: 2017946324 © The Editor(s) (if applicable) and The Author(s) 2017 This work is subject to copyright All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations Cover illustration: Stéphanie Kara Printed on acid-free paper This Palgrave Macmillan imprint is published by Springer Nature The registered company is Springer International Publishing AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland Preface This book provides an overview of the historical and recent developments in the global securitization markets It explores how and why securitization is created and examines multiple securitization instruments It investigates, by reviewing the academic evidence, how securitization influenced bank lending behaviour and why securitization, once acclaimed as an innovative mechanism for economy-wide efficient risk distribution, became a contributing factor to the 2007–2009 financial crisis It also looks at the future of the securitization markets in light of the regulatory changes after the financial crisis The book has several purposes Firstly, it aims to explore if and how securitization changed financial intermediation and lending behaviour by reviewing the pre- and post-financial crisis theoretical and empirical literature The book’s distinctive feature is bringing the growing post­­­ crisis academic research to the attention of a wider audience by critically appraising the recent empirical evidence in comparison with pre-crisis arguments on securitization Secondly, it aims to examine the interaction between originator banks and investors under the inherent presence of information asymmetries in ABS transactions Here the book provides fresh insights from recent academic research on whether and how banks misled investors in buying poor quality securitization securities prior to the financial crisis Thirdly, it aims to evaluate regulatory weaknesses in the years leading to the financial crisis and whether the v vi  Preface new regulatory measures are impeding the desired level of activity in the securitization market Another distinctive feature of the book is the comparison of the US and European markets throughout the text These are the two main securitization markets in the world and they display several differences in terms of structure, products, historical developments and regulation With its thought-provoking insights, the book should prove to be of particular value for students, practitioners and academics We specifically thank Martin Scheicher and Stefanie Wehmeyer for their contribution by writing Chapter We are grateful to David Marques-Ibanez, Steven Ongena, Yener Altunbaş, Philip Molyneux, Aydın Özkan, Mark Rhodes, Elvis Hernandez-Perdomo, Jingsi Leng, Alberto Franco Pozzolo, as well as to the participants of seminars held at the University of Hull and Loughborough University for very helpful comments, suggestions and support on the papers that provided original material for the various chapters of the text Thanks are also due to Natasha Denby for editing of the manuscript and to Stéphanie Kara for providing the cover image of the book Finally, thanks to our families and loved ones for their patience and support during the project The views expressed in this book are the authors’ own and not necessarily reflect those of the Nottingham Trent University and the Loughborough University   Solomon Y Deku Alper Kara Contents 1 Introduction  1 2 Mechanics of Securitization  7 3 Securitization Structures 31 4 A Historical and Regional Overview of Securitization 57 5 Effects of Securitization on Banks and the Financial System 93 6 Valuation of ABS Under Asymmetric Information113 7 The Role of Securitization in the 2007–2009 Crisis131 8 Securitization: Key Trends Since the Crisis145 9 Concluding Remarks169 Index173 vii List of Abbreviations ABCP ABS ABSPP AFME ARM BCBS BoE CBO CCP CDO CLO CMBS CMO CMU CP CPR CRR EBA ECB ECBC EIF EL ESF Asset Backed Commercial Paper Asset Backed Security ABS Purchase Program Association for Financial Markets in Europe Adjustable Rate Mortgage Basel Committee on Banking Supervision Bank of England Collateral Bond Obligation Collateralized Commercial Paper Collateral Debt Obligation Collateral Loans Obligation Commercial Mortgage Backed Security Collateralised Mortgage Obligation Capital Markets Union Commercial Paper Constant Prepayment Rate Capital Requirements Regulation European Banking Authority European Central Bank European Covered Bond Council European Investment Fund Expected Loss European Securitisation Forum ix x  List of Abbreviations EU European Union EUR Euro FCIC Financial Crisis Inquiry Commission FHA Federal Housing Administration FNMA Federal National Mortgage Association Freddie Mac Federal Home Loan Mortgage Corporation FSB Financial Stability Board GAAP Generally Accepted Accounting Principles GBP British Pound GDP Gross Domestic Product GNMA Government National Mortgage Association GSE Government Sponsored Entity HQA High Quality Assets IFRS International Financial Reporting Standards IO Interest Only IOSCO International Organization of Securities Commissions IRB Internal Rating Based LAPA Liquidity Asset Purchase Agreement LBO Leveraged Buyout LIBOR London Interbank Offer Rate LLA Liquidity Loan Agreement LTV Loan to Value MBS Mortgage Backed Security P2P Peer to peer PAC Planned Amortization Class PC Participating Certificates PD Probability of Default PSA Pooling and Servicing Agreements REMIC Real Estate Mortgage Investment Conduit RMBS Residential Mortgaged Backed Security RTC The Resolution Trust Corporation S&L Savings and Loans SEC Securities and Exchange Commission SEC-ERBA Securitisation External Ratings – Based Approach SEC-IRBA Securitisation Internal Ratings – Based Approach SEC-SA Securitisation Standardised Approach SIFMA Securities Industry and Financial Markets Association SIV Structured Investment Vehicle 8  Securitization: Key Trends Since the Crisis    161 also increasingly motivated banks to target relief in risk-weighted assets A key driver was the provision of ample central bank liquidity which had steadily reduced funding risk in the EU banking sector (see also Bindseil and Laeven 2017) This change in banks’ motives in particular affected synthetic securitizations Synthetic securitizations differ from true sale securitizations primarily with regard to the transfer of risk from the originator to the investor Whereas in traditional securitizations the securitised assets are sold to an SPV, in a synthetic securitization the assets remain on the originator’s balance sheet The underlying assets’ credit risk is transferred by financial guarantees or credit derivatives to the investor, who receives a fee for assuming exposure to the credit risk Depending on the investor, the transaction is structured as a funded or unfunded securitization A funded transaction involves the issuance of notes, either by an SPV or the originator, which are purchased by the investor The note proceeds are used to compensate the protection buyer in case of the occurrence of a credit event in the securitised assets Consequently, the originator is not exposed to the protection seller’s default risk, as in an unfunded transaction (Figs. 8.2 and 8.3) As a market segment, synthetic securitization has seen growing activity in the last few years In 2013, estimated volume only equalled EUR 20 billion whereas, in 2016, the market size was estimated at around EUR 94 billion (DB 2017) Issuer Guarantee Note Proceeds Guarantee Fee Reference Pool Note Proceeds First Pledge Agreement SPV Interest and Principal Interest and Principal from Collateral Cash Collateral Account Senior Note Mezzanine Note Threshold Excess Fig 8.2  Partially funded synthetic securitization (Source: Authors own figure) 162  M Scheicher and S Wehmeyer Senior Tranche Guarantee Agreement Reference Pool Guarantee Fee Mezzanine Tranche Threshold Excess Spread Fig 8.3  Unfunded synthetic securitization (Source: Authors own figure) Synthetic transactions conducted by an originator that also hold the loans on its balance sheet are known as “balance sheet synthetic securitizations” Those instruments differ from arbitrage synthetic securitizations, whose objective was primarily the arbitrage of credit spreads and which were tailored to investor needs (EBA 2015) As mentioned before those arbitrage-based transactions have shrunken dramatically since the outbreak of the financial crisis In contrast, balance sheet synthetic securitizations allow the originator to manage its credit risk and capital consumption Moreover, balance sheet synthetic securitizations reduce the administrative efforts and complexity of the asset sale, the servicing of the underlying assets and provide more flexibility on the eligible asset classes, e.g SME loans Whereas traditional securitizations and ABCP transactions are subject to the upcoming STS framework, balance sheet synthetic securitizations are currently excluded However, a limited preferential treatment for the originator bank retaining senior tranches in SME securitization is envisaged.13 A qualifying prudential treatment is currently being discussed for senior tranches retained by the originator, if the balance sheet synthetic securitization meets certain criteria Those criteria are partially consistent with the STS criteria relevant for true sale transactions, whereas other criteria need to be replaced or adjusted to reflect the specificities of balance sheet synthetic securitizations and the fact that the focus is on tranches retained by the originator, whereas the STS framework is designed to protect investors At present a qualifying capital treatment is only envisaged for transactions that are backed by SME exposures and 8  Securitization: Key Trends Since the Crisis    163 where credit risk is transferred through a guarantee to a public or supranational guarantor The widespread and large-scale use of synthetic credit risk transfer may expose banks to new challenges First, the complexity of a bank’s balance sheet may increase due to the general opacity of synthetic transactions (e.g frequently purely bilateral transactions) Second, banks which widely make use of synthetic transactions may also face “flowback risk” This concept describes the scenario of banks that have securitised large amounts of credit risk and then suddenly face a cyclical downturn where investor appetite for new transactions sharply deteriorates In such a systemic situation, banks can then either extend the underlying loans (with credit risk then flowing back to their balance sheets, their capital situation will worsen) or deny borrowers new or extended loans, which might lead to a sharp decline in the supply of credit to the real economy.14 Conclusions Hardly any other financial product has been subject to such significant changes in its regulatory treatment as securitization Since the height of subprime crisis, many regulatory changes have already been put in place but at the time of writing, some elements of the new framework are not yet ready In particular, the EU legislation on the new securitization framework is currently being finalised At the moment, there are a number of challenges before an active securitization market can restart Some market observers are skeptical that the new regulatory framework will really manage a “re-launch” of the ABS market.15 In this context, a comparison of the securitization sector with its major competitor for long-term bank debt funding, the covered bond market is helpful The latter market segment, which has a long tradition in the EU financial system, has been more sheltered from incentive problems compared to ABS.  A key factor is that traditional covered bonds typically have a much stricter regulatory framework and a simpler ­structure which ties their incentives more strongly to those of the investors Hence, the covered bond market provides some evidence 164  M Scheicher and S Wehmeyer that the current regulatory reforms of the ABS market should indeed help improve the climate for ABS issuance Securitization and in particular the STS approach is a priority for current work on creating a Capital Market Union (Constancio 2016) In particular, a healthy European securitization market is indicative of a functioning capital market in the EU. In this respect, the objectives of the proposed regulations of promoting the further integration of Union financial markets, diversifying funding sources and unlocking capital for sound lending to the real economy are widely welcomed The development of a common set of substantive rules across the Union regulatory framework for all securitizations is also a significant step towards regulatory harmonisation and consistency (see also ECB 2016) Overall, policymakers currently conclude that the proposed regulations strike the right balance between the need to revive the European securitization market by making the securitization framework more attractive for both issuers and investors, and the need to maintain the prudential nature of the regulatory framework.16 Notes See Ashcraft and Schuermann (2008) for a more detailed discussion of the subprime crisis European Commission “Proposal for a regulation of the European Parliament and of the Council laying down common rules on securitization and creating a European framework for simple, transparent and standardized securitization and amending Directives 2009/65/EC, 2009/138/EC, 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012’’ (30 September 2015) See Art 404-409  in the CRR (Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012) The Securities and Exchange Commission, the Board of Governors of the Federal Reserve System, the Department of Housing and Urban Development, the Federal Housing Finance Agency, the Federal Depositors Insurance Corporation and the Office of the Comptroller of 8  Securitization: Key Trends Since the Crisis    165 the Currency: Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, codified as Section 15G of the Securities Exchange Act of 1934 Regulation (EU) No 462/2013 of the European Parliament and of the Council of 21 May 2013 amending Regulation (EC) No 1060/2009 on credit rating agencies (CRA III) Article 8c CRA III Article 8d CRA III Article 8b CRA III Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) 10 See e.g http://www.reuters.com/article/abs-regulations-idUSL5N1F M5KN 11 For a background discussion on the euro area crisis see Blundell-­Wignall (2012) 12 Source: https://www.ecb.europa.eu/mopo/implement/omt/html/index en.html 13 European Commission “Proposal for a regulation of the European Parliament and of the Council laying down common rules on securitization and creating a European framework for simple, transparent and standardized securitization and amending Directives 2009/65/EC, 2009/138/EC, 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012’’ (30 September 2015), Art 270 CRR 14 See http://www.fi.se/contentassets/15612df21ea642f0971ba98055398203/ pm-vardepapperisering-2016-12-01-eng.pdf 15 See e.g Batchvarov (2016), https://www.ft.com/content/44d18c80-e6d711e5-bc31-138df2ae9ee6 16 Cf Section 1 in ECB (2016) References Adrian, T., Fleming, M., Shachar, O., & Vogt, E (2017) Market Liquidity After the Financial Crisis Federal Reserve Bank of New York Staff Reports no 796 AFME (2014) High Quality Securitisations for Europe: The Market at a Crossroad London: AFME Andersen, L., & Sidenius, J. (2005) CDO Pricing with Factor Models: Survey and Comments Journal of Credit Risk, 1, 71–88 166  M Scheicher and S Wehmeyer Ashcraft, A., & Schuermann, T (2008) Understanding the Securitization of Subprime Mortgage Credit Federal Reserve Bank of New York Staff Report no 318 Bank of England, European Central Bank (2014, May) The Case for a Better Functioning Securitisation Market in the European Union Discussion Paper, May Batchvarov, A (2016) Securitisation Does Not Deserve Toxic Tag [Online] Financial Times Available at: Accessed 15 Dec 2016 BCBS (2006, June) Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework—Comprehensive Version Basel: BCBS BCBS (2009a, July) Enhancements to the Basel II Framework Basel: BCBS BCBS (2009b, July) Revisions to the Basel II Market Risk Framework Basel: BCBS BCBS (2013, January) Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools Basel: BCBS BCBS (2014, July) Revisions to the Securitisation Framework Basel: BCBS BCBS (2015, January) Revised Pillar Disclosure Requirements Basel: BCBS BCBS (2016, July) Revisions to the Securitisation Framework Basel: BCBS BCBS/IOSCO (2015, July) Criteria for Identifying Simple, Transparent and Comparable Securitisations Basel:BCBS Bindseil, U (2016) Evaluating Monetary Policy Operational Frameworks Jackson Hole conference paper Bindseil, U., & Laeven, L (2017) Confusion About the Lender of Last Resort Vox.EU Blundell-Wignall, A (2012) Solving the Financial and Sovereign Debt Crisis in Europe OECD Journal, 2011(2), 201–224 Borio, C (2008) The Financial Turmoil of 2007–?: A Preliminary Assessment and Some Policy Considerations BIS working paper no 251 Boudghene, Y., Maes, S., & Scheicher, M (2010) Asset Relief Measures in the EU – Overview and Issues SSRN working paper no 1677310 Constancio, V (2016, March 21) Capital Markets Union and the European monetary and financial framework Keynote speech at Chatham House, London Coval, J., Jurek, J., & Stafford, E (2007) Economic Catastrophe Bonds Harvard Business School working paper, 07-102 Deutsche Bank (2017) Synthetic Securitisation: Making a Silent Comeback DB Research European Banking Authority (2015) Report on Synthetic Securitisation EBA/ Op/2015/26 8  Securitization: Key Trends Since the Crisis    167 European Central Bank (2016) Opinion of the European Central Bank of 11 March 2016 on Securitisation Market, CON/2016/11 Available at https:// www.ecb.europa.eu/ecb/legal/pdf/en_con_2016_11_f_sign.pdf Fender, I., & Mitchell, J. (2009, September) The Future of Securitization: How to Align Incentives? Bank for International Settlements Quarterly Review, 3, 27–43 Fender, I., Tarashev, N., & Zhu, H (2008, March) Credit Fundamentals, Ratings and Value-at-Risk: CDOs Versus Corporate Exposures Bank for International Settlements Quarterly Review, 1, 87–101 FSB (2010, October 27) Principles for Reducing Reliance on CRA Ratings Gorton, G., & Metrick, A (2012) Securitization NBER working paper no. 18611 Gorton, G., Metrick, A., & Xie, L (2014) The Flight from Maturity NBER working paper no 20027 Haldane, A (2009, April 28) Rethinking the Financial Network Speech at the Financial Student Association, Amsterdam Hull, J.  (2009) The Credit Crunch of 2007: What Went Wrong? Why? What Lessons Can Be Learned? University of Toronto, working paper IMF (2015) Revitalizing Securitization for Small and Medium-Sized Enterprises in Europe IMF Staff Discussion Note 15/07 Kraemer-Eis, H., Passaris, G., Tappi, A., & Inglisa, G (2015) SME Securitisation  – At a Crossroads? Working paper 2015/31 EIF Research & Market Analysis Longstaff, F., & Rajan, A (2008) An Empirical Analysis of the Pricing of Collateralized Debt Obligations Journal of Finance, 64, 529–563 McDonald, R., & Paulson, A (2015) AIG in Hindsight The Journal of Economic Perspectives, 29(2), 81–105 Concluding Remarks This book provided an overview of the historical and recent developments in the securitization markets in with respect to academic evidence In particular, it provided insights on factors responsible for the growth of securitisation, the role of this mechanism in the 2007–2009 financial crisis, how it has changed bank lending behaviour and whether investors  – as buyers of securitised assets  – understood the risks The book also looked at the near future and how regulatory changes may affect this market Having a better understanding of what happened in the securitization markets during the pre-crisis period can help to develop a robust securitization market We hope to the book will provide insights in this direction Securitization is the process of transforming a portfolio of financial assets into marketable securities with differing risk profiles from the original underlying assets It has moved banks from a more traditional banking model, where banks made loans and hold them until maturity, to a model where these originated loans were sold on to third parties as securitised assets The European and the US securitization markets are the largest in the world; however, both have experienced unique paces of development primarily due to regional institutional differences in © The Author(s) 2017 S.Y Deku, A Kara, Securitization: Past, Present and Future, Palgrave Macmillan Studies in Banking and Financial Institutions, DOI 10.1007/978-3-319-60128-1_9 169 170  9  Concluding Remarks their respective mortgage markets The US securitization markets have developed significantly since the 1970s, primarily due to the influence of government sponsored enterprises and the innovation of private issuers European market started to become more active much later, in the 1990s, and was mainly driven by private institutions and has an alternative to securitization instruments in the form of covered bonds Prior to the 2007–2009 financial crisis, it was widely believed that securitization provided benefits to many market participants  – such as banks, borrowers and investors – in the financial system Some academic arguments and evidence supports this standpoint By transforming illiquid assets into tradable instruments, securitization provided an alternative source of financing for banks It reduced their dependency on deposits and provided diversification of financing sources which led to lower cost of financing Higher liquidity levels and higher rates of asset turnover increased banks’ profitability Securitization is argued to have made the financial system more stable and integrated by diversifying the risk economy-­wide However, some pre-crisis academic studies also highlighted the risks Securitization incentivises banks to take on more risk, reduce screening and monitoring incentives and, consequently, lead to a drop in bank lending standards These effects, combined with the catalytic role of elastic underlying credit markets, can destabilise the banking sector and endanger financial stability Securitization markets grew exponentially prior the 2007–2009 financial crisis Some concerns relating to the possible adverse effects of securitization on bank behaviour and the financial system overall materialised in the build-up and during the crisis Part of the empirical literature draws direct links between securitization and the crisis Securitization led to riskier bank lending and accumulation of risk in the financial system culminating in the 2007–2009 financial crisis Banks lowered their lending standards especially in the mortgage market by extending and securitizing risky mortgages On the other hand, evidence from the corporate loan securitization is more ambiguous and inconclusive Credit rating agencies misled ABS investors as well as the regulators by underestimating the risks of these instruments Evidence also shows that issuers’ close relationship with rating agencies resulted in inflated ratings Finally, loopholes in the capital adequacy regulations, the Basel Accords, ­encouraging 9  Concluding Remarks    171 bank securitization have contributed significantly to the accumulation of risks in the banking sector through these structured instruments Investors, who experienced large losses holding ABS, were criticised for their overreliance on credit ratings Evidence shows that they tried to incorporate risks beyond credit ratings and did not rely solely on rating agencies assessment Investors tried to circumvent the perceived information asymmetries barriers in various ways They valued issuer reputation especially during periods where information asymmetries in credit markets intensify Investors were sceptical about possible rating shopping and inflated ratings and required higher returns for such deals They favoured reputable trustees to protect their interest Finally investors relied more on local bank expertise and were aware of the impact of rapid and excessive loan growth of bank portfolios on the quality of ABS generated from these pools In the aftermath of the financial crisis, regulators sought to address misaligned interests by issuing a series of proposals aimed at increasing transparency, tightening capital and liquidity requirements, reconfiguring the norms in the credit ratings industry and imposing more due diligence requirements on investors These reforms have undergone multiple revisions to balance the need for a better securitization market against the increasing costs of compliance Index 2007–2009 financial crisis, 1, 2, 5, 9–67, 98, 99, 103, 104, 106, 114, 115, 121, 132, 134, 141, 169, 170 asset risks credit risk modelling, 21 asymmetric information, 4, 73, 96, 97, 102, 113, 137 attachment point, 14 A B NUMBERS & SYMBOLS ABS, accretion bonds See Z-Bonds accrual bonds See Z-Bonds adjustable rate mortgages, 63 adverse selection, 4, 7–135 Alt-A, 67 amortising structures pass through, 12–13 arbitrage, 50 arbitrage CDOs, 50 asset backed commercial paper (ABCP), 36–40 asset backed securities, balance sheet CDOs, 50 Basel I, 6–64, 68, 89, 96, 97, 103, 140 Basel II, 51, 68, 97, 103, 146, 147, 153 Basel III, 71, 74, 78, 97, 147 beta, 105 Building Society Act, 80 C callable commercial paper, 38 capital requirements, 74 © The Author(s) 2017 S.Y Deku, A Kara, Securitization: Past, Present and Future, Palgrave Macmillan Studies in Banking and Financial Institutions, DOI 10.1007/978-3-319-60128-1 173 174  Index Capital Requirements Regulation, 78 capital structure, 95 cash collateral account, 19 cash flow CDOs, 52 cash securitization, 32 CBOs, 51 CDOs See Collateralized debt obligations (CDOs) cedulas, 76 certification value, 117, 118 cliff risk, 154 CLOs, 51 CMBS See commercial mortgage backed securities (CMBS) CMOs See collateralised mortgage obligations (CMOs) collateral invested amount, 19 collateralised mortgage obligations (CMOs), 8–43, 60, 61 collateralized commercial paper programme, 40 collateralized debt obligations (CDOs), 49–53 commercial mortgage backed securities (CMBS), 47–8 conditional prepayment rate, 47 constant prepayment rate, 47 cost of funding, 94–5 counterparty risk, 23 covered bonds, 9–75, 159 credit enhancement, 3, 7, 12, 15–19, 41, 42, 62, 65, 77, 80, 81, 95, 120 credit enhancement, 16–19 credit ratings, 1, 3–113, 119, 120, 124, 125, 138, 140, 147, 148, 152, 171 credit ratings process, 21–3 credit risk, 2–160 credit risk management, 94 credit support See credit enhancement D detachment points, 14 disclosure, 72–3 Dodd Frank Act, 71 dual recourse, 76 due diligence, 75 E equity retention, 113, 117, 118 equity tranche, 15, 19, 20, 50, 105, 157, 158 Eurosystem, 159 excess spread, 17 expected loss (EL) based tranching, 15 F Federal Home Loan Mortgage Corporation (Freddie Mac), 59 Federal National Mortgage Association (FNMA – Fannie Mae), 58 financial stability, 2, 4, 7–104, 132, 133, 170 first loss piece, 9, 20, 23, 41, 96, 103, 104, 157 floating-rate bonds, 45 flow-back risk, 163  Index     175 Government National Mortgage Association (GNMA), 58 government sponsored enterprises, 24 liquidity premium, 99 liquidity support, 42 LLA See liquidity loan agreement (LLA) loan sale, H M G hard bullet, 13 hybrid programme, 40 I initial yield spreads, 119, 120 insolvency foreclosure procedures, 27–8 issuer reputation, 114, 118, 123, 125, 171 J jumbo mortgages, 63 market risk, 99, 105, 146, 147 market value CDOs, 52 master trusts, 14 MBS See mortgage backed securities (MBS) monetary policy, 106, 159 monitoring incentives, 1–100, 104, 106, 115, 137, 170 moral hazard, 4, 23, 100, 104, 113, 117, 124, 134 mortgage backed securities (MBS), 7–42 multi seller conduits, 39 N L LAPA See liquidity asset purchase agreement (LAPA) legal risk regulatory risk, 22 lending standards, 1, 100, 103, 104, 106, 123, 133, 134, 136, 137, 141, 170 letter of credit, 18 liquidity asset purchase agreement (LAPA), 42 liquidity loan agreement (LLA), 42 nonconforming mortgages, 63 O obligations foncières, 76 operational risk, 99 administrative risk, 22 originate to distribute, 93 originate to hold, 93 originate-to-distribute, 9–10 originate-to-hold, 9–10 originator, 11 over-collateralisation, 18 176  Index P P2P securitization, 53–4 PAC See planned amortization class (PAC) participating certificates, 43 pass-through, 33, 43 pay through, 33 Pfandbriefes, 76 planned amortization class (PAC), 5–44, 60 pool factor, 46 prepayment, 47 prepayment risk, 59, 63, 124, 135 private label non agency, 24 probability of default (PD) based tranching, 15 programme level credit enhancement, 41 puttable commercial paper, 38 regulatory arbitrage, 96, 106 regulatory capital arbitrage, 6–96, 104 REMIC See collateralised mortgage obligations (CMOs) (see Real Estate Mortgage Investment Conduit (REMIC)) reputational risk, 119 re-securitization, 154 residuals, 46 Resolution Trust Corporation (RTC), 48, 62 retained interest residual interest, 19–21 return on assets, 98 revolving structures, 13 risk management, 95 risk retention, 1–150 S R rating agencies, 5, 11, 41–138, 151, 152, 165, 170, 171 rating bias, 114, 119 rating risk, 120 rating shopping, 119, 120, 125, 171 Real Estate Mortgage Investment Conduit (REMIC), 43 Real Real Estate Mortgage Investment Conduit Estate Mortgage Investment Conduit, 61–2 recourse, 11, 27, 29, 40, 47, 65–67, 76, 77, 79, 88, 96, 101, 113 regulation, 71–2 Savings and Loans crisis, 25, 62, 89 securities backed conduits arbitrage conduits, 40 securitization, 8–9 instruments, 34 process, 10–12 securitization structures, 31 sellers share, 14 sequential pay, 44 sequential pay tranches, 14 servicer, 11 Simple Transparent and Standardised, 71 single seller conduits, 39 skin in the game, 71 soft bullet, 13  Index     special purpose vehicle (SPV), 2, 8, 11, 22, 120 types, 12–14 stripped mortgage-backed securities, 46 stripping, 46 structural analysis, 22 structured finance CDOs, 51 Structured Investment Vehicle, 36, 40 subordination, 3, 9, 15–17, 22, 81, 139 sub-prime lending, 5, 132, 133 subprime mortgages, 63 surety bonds, 18 synthetic securitization, 105, 160–162 funded/unfunded, 32–3 systematic risk, 102, 105, 119 triggers, 22 true sale, 11, 33, 72, 88, 97, 101, 148, 161, 162 trustees, 2–120, 125, 171 U underinvestment, 95 underwriter, 12 underwriting issuance, 23 W weighted average coupon, 46 weighted average life, 46 weighted average loan age, 46 weighted average maturity, 46 Y T TAC See target amortization class (TAC) target amortization class (TAC), 45 tranching, 14–16 transaction credit enhancement, 41 yield, 47 Z Z-Bonds, 45 177 ... Kara, Securitization: Past, Present and Future, Palgrave Macmillan Studies in Banking and Financial Institutions, DOI 10.1007/978-3-319-60128-1_1 2  1 Introduction of these securities and prudential... S.Y Deku, A Kara, Securitization: Past, Present and Future, Palgrave Macmillan Studies in Banking and Financial Institutions, DOI 10.1007/978-3-319-60128-1_2 8  2  Mechanics of Securitization credit... 1 Introduction  1 2 Mechanics of Securitization   7 3 Securitization Structures 31 4 A Historical and Regional Overview of Securitization  57 5 Effects of Securitization on Banks and the Financial System 93