Securitization Structuring Issues - Pls Help

[Anna Selejan]

Dear All,​

​

I work for a West African financial consulting firm. We would like to launch the securitization industry in the region, which can be quite promising because of poor access to capital for companies and few middle to long-term investment opportunities for local investors.​

​

I am in the phase of constructing a proper securitization cash-flow model. I have read several books on securitization and on structuring, but they are all quite general and don’t really deal with the practical issues of the structuring process. I am quite new to financial engineering. So my first question is: can you recommend me some literature (books, articles, websites) where the practical issues of the structuring are tackled?​

​

As for structuring, here I stand today and if someone could answer my questions below, I would be extremely grateful.​

​

I started with a basic MBS. The underlying pool:​

• Fixed-rate mortgages with monthly annuity payment
• Possibility of prepayment, so I incorporated a PSA prepayment benchmark
• Default and recovery assumptions: fixed monthly default rate, after a, say, 6-month time lag, x% of the defaulted principal is recovered.

This model gives me the monthly cash-flows of the asset side.​

​

Concerning the liability side, I set up a structure with 2 sequentially amortizing Senior parts (S1 and S2), a Junior part (J) and the Equity part (E). As for the payment rules, I thought of the following:​

1. Fees and commissions are paid first
2. Interest is paid on S1, S2 and J
3. Principal is paid on S1 and J on a pro-rata basis. If S1 is completely amortized, S2 is amortized. (pro-rata for me means that if S1=70%, S2=15%, J=10% and E=5%, S1’s beginning pro-rata would be 70%+15%, J’s beginning pro-rata would be 10%, the remaining 5% would go to the Reserve account described in point 5.Does that make sense? Any other principal allocation methods?)
4. If there is prepayment, it is paid to S1, so that this tranche amortizes the quickest. Then to S2 until full amortization, then to J.
5. Any excess cash goes to the Reserve account. This account is filled up to, say, 5% of the initial outstanding balance of the notes. If the account is full, the excess cash goes to the Equity part.

​

So my questions:​

1. What do you think about this structure? How could I make it more robust? (n.b. to start with securitization in West Africa, I would need something quite simple and transparent, no PACs, TACs, floaters etc. just simple bonds).
2. How to deal with interest payment arrears? I thought that this is not such a big issue, because if the cash flows coming from the pool are sufficient to pay interest + principal, there’s no problem. And if not, I will use the Reserve account to make up for the difference. Or, alternatively, should I go for an interest payment arrear on one of the tranches? If so, on which one?
3. How to deal with loan default? Usually a loan doesn’t get written off as soon as the debtor is late with one interest payment. After a couple of months (say 3 months) the loan goes into default, the foreclosure process starts and some months after a percentage of the principal is recovered. How should I treat this in the structure? I thought about writing off the defaulted loan principal only when the foreclosure process ends and I know for sure how much I recovered. Then I write off the loss from the Equity or, if there is no more E tranche, from the Junior’s principal. Is that correct? But then, how do I account for the interest and principal payment gaps during the pre-recovery period?
4. As for the Equity part which bears no interest, how do I pay it out? It’s okay to give its holder the periodic excess cash, but what about the initial outstanding value? How does it amortize? Or, let’s say that there was no loan default and thus no principal write-off during the life of the structure, the Equity part receives the last cash-flows (plus the Reserve account balance if not zero) when all the other tranches have been amortized?
5. Finally, how should I proceed to define an optimal structure in terms of tranche size and interest rates?

​

I hope you can shed some light on these issues. Thank you very much in advance!!​

​

Best,​

​

Anna​

 

[quotes]

Do you know binomial models, Anna?

 

[Anna Selejan]

Yes I do. But my issue is not necessarily how to model the underlying pool's cash-flow, it's rather with the structuring of the notes whose CFs depend on the underlying. How should I match them?
Thanks.

 

[John]

Dear All,​

​

I work for a West African financial consulting firm. We would like to launch the securitization industry in the region, which can be quite promising because of poor access to capital for companies and few middle to long-term investment opportunities for local investors.​

​

I am in the phase of constructing a proper securitization cash-flow model. I have read several books on securitization and on structuring, but they are all quite general and don’t really deal with the practical issues of the structuring process. I am quite new to financial engineering. So my first question is: can you recommend me some literature (books, articles, websites) where the practical issues of the structuring are tackled?​

​

As for structuring, here I stand today and if someone could answer my questions below, I would be extremely grateful.​

​

I started with a basic MBS. The underlying pool:​

• Fixed-rate mortgages with monthly annuity payment
• Possibility of prepayment, so I incorporated a PSA prepayment benchmark
• Default and recovery assumptions: fixed monthly default rate, after a, say, 6-month time lag, x% of the defaulted principal is recovered.

This model gives me the monthly cash-flows of the asset side.​

​

Concerning the liability side, I set up a structure with 2 sequentially amortizing Senior parts (S1 and S2), a Junior part (J) and the Equity part (E). As for the payment rules, I thought of the following:​

1. Fees and commissions are paid first
2. Interest is paid on S1, S2 and J
3. Principal is paid on S1 and J on a pro-rata basis. If S1 is completely amortized, S2 is amortized. (pro-rata for me means that if S1=70%, S2=15%, J=10% and E=5%, S1’s beginning pro-rata would be 70%+15%, J’s beginning pro-rata would be 10%, the remaining 5% would go to the Reserve account described in point 5.Does that make sense? Any other principal allocation methods?)
4. If there is prepayment, it is paid to S1, so that this tranche amortizes the quickest. Then to S2 until full amortization, then to J.
5. Any excess cash goes to the Reserve account. This account is filled up to, say, 5% of the initial outstanding balance of the notes. If the account is full, the excess cash goes to the Equity part.

​

So my questions:​

1. What do you think about this structure? How could I make it more robust? (n.b. to start with securitization in West Africa, I would need something quite simple and transparent, no PACs, TACs, floaters etc. just simple bonds).
2. How to deal with interest payment arrears? I thought that this is not such a big issue, because if the cash flows coming from the pool are sufficient to pay interest + principal, there’s no problem. And if not, I will use the Reserve account to make up for the difference. Or, alternatively, should I go for an interest payment arrear on one of the tranches? If so, on which one?
3. How to deal with loan default? Usually a loan doesn’t get written off as soon as the debtor is late with one interest payment. After a couple of months (say 3 months) the loan goes into default, the foreclosure process starts and some months after a percentage of the principal is recovered. How should I treat this in the structure? I thought about writing off the defaulted loan principal only when the foreclosure process ends and I know for sure how much I recovered. Then I write off the loss from the Equity or, if there is no more E tranche, from the Junior’s principal. Is that correct? But then, how do I account for the interest and principal payment gaps during the pre-recovery period?
4. As for the Equity part which bears no interest, how do I pay it out? It’s okay to give its holder the periodic excess cash, but what about the initial outstanding value? How does it amortize? Or, let’s say that there was no loan default and thus no principal write-off during the life of the structure, the Equity part receives the last cash-flows (plus the Reserve account balance if not zero) when all the other tranches have been amortized?
5. Finally, how should I proceed to define an optimal structure in terms of tranche size and interest rates?

​

I hope you can shed some light on these issues. Thank you very much in advance!!​

​

Best,​

​

Anna​

>>>What do you think about this structure? H
this being a new structure, I would keep it simple, and allocate not only the principal prorata but also the prepayment.I might add that if you want to have S2 provide subordination to S1, why not use a sequential pay structure, pay off S1 balance fully, then S2.

Also make sure you have a healthy amount of overcollateralleration unless you have a good history of performance data on the underlying loans. At the end of the day, it is up to the investors what type of structured they would like to see. This is a buyer's market that we are in nowadays.

>>>How to deal with loan default?
in a normal deal, there's a servicer that would advance the funds until the loan either defaults and recovery is made. Look into the language of US/European deals and see how they deal with this. Here is an article: http://www.securitization.net/pdf/DBRS/USSFv8i32_24Aug09.pdf