Library/CFA (Chartered Financial Analyst)/JuiceNotes 2024 Fixed Income/Fixed-Income Securitization

Fixed-Income Securitization

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Securitization Process and Parties5 min

Securitization involves transferring ownership of assets from an original lender (seller) to a bankruptcy-remote Special Purpose Entity (SPE). The SPE issues securities to investors. Key parties include the Servicer (collects payments), Trustee (safeguards assets), and the Seller. This structure isolates the assets from the seller's bankruptcy risk.

Key Points

Securitization pools illiquid assets into liquid securities.
The SPE is a bankruptcy-remote entity separate from the seller.
The Servicer manages collections and administrative duties.
Benefits include lower funding costs for issuers and risk diversification for investors.

Covered Bonds5 min

Covered bonds are debt obligations issued by financial institutions backed by a segregated pool of assets. Unlike ABS, these assets remain on the issuer's balance sheet. Investors have dual recourse: a claim on the cover pool and a claim on the issuer. The pool is dynamic, meaning non-performing assets must be replaced.

Key Points

Assets remain on the issuer's balance sheet.
Investors have dual recourse (pool and issuer).
Cover pools are dynamic and monitored by third parties.
Redemption regimes include hard-bullet, soft-bullet, and conditional pass-through.

Credit Enhancement and Tranching6 min

Structures use credit enhancement to mitigate risk. Internal enhancements include overcollateralization (assets > liabilities), excess spread (asset yield > coupon), and subordination (senior/subordinate tranching). Subordination creates a waterfall structure where losses are absorbed by junior tranches first.

Key Points

Internal enhancements: Overcollateralization, Excess Spread, Subordination.
External enhancements: Letters of credit, guarantees.
Tranching redistributes credit risk (credit tranching) or prepayment risk (time tranching).
The 'equity' tranche is the first to absorb losses.

RMBS and CMOs7 min

RMBS are backed by residential mortgages. Agency RMBS are guaranteed by GSEs or the government, while non-agency are private. Prepayment risk is a major factor, divided into contraction risk (rates fall) and extension risk (rates rise). CMOs use structures like sequential pay and PACs to manage this risk.

Key Points

Agency RMBS have government or GSE backing.
CMOs redistribute prepayment risk to different tranches.
Sequential pay tranches retire in order.
PAC tranches offer stable cash flows if prepayments stay within a range.

Non-Mortgage ABS and CMBS7 min

Non-mortgage ABS include auto loans (amortizing) and credit cards (non-amortizing with a lockout period). CMBS are backed by commercial properties and feature call protection (lockout, defeasance) and balloon risk. CMBS analysis relies heavily on DSCR and LTV ratios.

Key Points

Credit card ABS have a lockout period where principal is reinvested.
CMBS offer call protection at the loan or structure level.
Balloon risk is a type of extension risk in CMBS.
DSCR = Net Operating Income / Debt Service.

Questions

Question 1

What is the primary role of the Special Purpose Entity (SPE) in a securitization transaction?

Fixed-Income Securitization

Questions

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