Transcript ABCs of ABSs - American Securitization Forum

See the Disclosure Appendix for the Analyst
Certification and Other Disclosures.
ASF Securitization Institute:
ABS 101
January 29, 2006
Mary E. Kane
212-816-8409
mary.e.kane @citigroup.com
Citigroup Global Markets Inc.
ABS and Mortgage Credit Strategy & Analysis
The ABS Market
•What Are ABSs?
•Why are so many rated triple-A?
•What is credit enhancement?
•How do ABSs differ from other markets?
Citigroup Global Markets
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ABSs — Better Built Bonds
Citigroup Global Markets
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What Are ABSs?
•Bonds backed by financial assets
•Typically consumer receivables
•Different from other fixed income obligations in that creditworthiness
derives from sources other than the paying ability of the originator of the
underlying assets
•Through structure, as de-linked from event risks of originator
•Bankruptcy-remote structure
•Nonconsolidation and true sale legal opinions
Citigroup Global Markets
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ABSs —Bonds (Mostly) Secured By Consumer
Assets
• Pools of consumer assets secure ABS bonds
• ABSs inaugurated the concept of structured products
• Some off-the run deals backed by commercial and other asset types
Citigroup Global Markets
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How Did This Market Get Started?
•
The first ABSs came to market in 1985 (Sperry Univac lease deal)
•
Auto ABSs followed (1986 -- Chrysler $250 million)
•
•
•
The concept developed from the secured lending units of commercial
banks (receivables and inventory lenders)
Asset-backed securities, called ABSs, are bonds backed by specified
pools of financial assets (such as credit cards, autos, HELs)
The creditworthiness derives from sources other than the paying
ability of the originator of the underlying assets
•
About 90% of outstanding issues are rated triple-A
•
In 1985, the total market supply totaled $1.2 billion
Citigroup Global Markets
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What Else Happened in 1985?
•
•
The first seat belt law came into effect in the United States
Martina Navratilova is third person to win 100 tennis tournaments
(Evert and Connors)
•
Bruce Springsteen’s Born in the USA topped the charts
•
Billy Joel wed supermodel Christie Brinkley (divorced in 1994)
•
April -- Coca Cola changes its secret formula
•
June – Coca Cola announces it will bring back their 99-year old
formula
Citigroup Global Markets
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ABSs — Growth Engine of the Fixed Income Markets
$800
Auto Loans
Credit Cards
$700
HELs
MH
Student Loans
Other
$ Millions
$600
$500
$400
$300
$200
$100
$0
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Source: Securities Data Corp.
•
•
•
•
Conventional term issuance — $717 billion in 2005
$1,460 billion, including resi mortgages
Topped corporate issuance for second consecutive year
Growth + 20% year-over-year / 22% compound annual growth rate
Citigroup Global Markets
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Global ABS and MBS Market Size
Outstanding Debt:
Mortgage-related debt A
$5.80 trillion
Corporate bonds
$5.00 trillion
US Treasuries
$4.10 trillion
Money Market
$3.30 trillion
Federal Agency
$2.60 trillion
Municipal debt
$2.20 trillion
Asset-backed securities
$2.15 trillion
Note: ABSs as of December 31, 2005. Others as of September 20, 2005.
A
Includes agency and nonagency pass-throughs and CMOs
Source: The Bond Market Association and Bloomberg
• ABSs are self-liquidating
• Outstandings less than other sectors, because the assets are
short, and pay off rapidly
Citigroup Global Markets
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ABS Benefits Are Numerous
•
Topnotch credit quality —
About 90% of ABSs are triple-A
Only 20 triple-A rated corporate issuers in the BIG index
•
Security —
Better to be a secured creditor than unsecured
•
Diversity and investment diversification —
Consumer assets back pools, representing broad
geographical mix
•
Predictable cash flow —
ABS structure relies on long term, consistent performance
•
Reduced event risks —
De-linked from bankruptcy risk
Citigroup Global Markets
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Superior Ratings Transition Rates
Moody’s Global Structured Finance Annual Ratings: ABS Transition Matrices (1983-2004 average)
From
AAA
AA
A
Baa
Ba
B
Caa or below
AAA
AA
A
BBB
BB
B
98.97%
5.70%
1.12%
0.40%
0.13%
0.06%
0.69%
91.01%
2.85%
0.60%
0.10%
0.20%
2.12%
92.83%
2.54%
0.71%
0.08%
0.07%
0.71%
2.05%
90.48%
3.38%
0.47%
0.03%
0.19%
0.66%
3.34%
86.12%
2.00%
0.02%
0.13%
0.24%
1.34%
3.72%
85.98%
0.05%
0.42%
Source: Moody’s Investors and Citigroup.
r
Corporate Finance Rating Transition Rates (1983-2004 average)
Triple-A
To
Double-A
Single-A
Triple-B
Double-B
From
Moody
S&P
Moody
S&P
Moody
S&P
Moody
S&P
Moody
S&P
Aaa
Aa
A
Baa
Ba
B
91.68%
0.92%
0.04%
0.04%
0.01%
0.01%
7.53%
90.61%
2.50%
0.25%
0.03%
0.05%
0.76%
8.03%
91.09%
5.66%
0.55%
0.21%
0.32%
5.52%
87.62%
5.60%
0.55%
0.02%
0.08%
0.62%
5.01%
83.30%
6.00%
0.01%
0.19%
1.06%
8.41%
82.27%
0.03%
0.03%
0.36%
2.09%
10.90%
91.68%
0.92%
0.04%
0.04%
0.01%
0.01%
7.53%
90.61%
2.50%
0.25%
0.03%
0.05%
0.76%
8.03%
91.09%
5.66%
0.55%
0.21%
Source: Moody’s Investor’s, Citigroup.
• 98.97% of triple-A ABSs remain triple-A compared to only 91.68% for
corporates
Citigroup Global Markets
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Creating a Valid Structure
OBJECTIVES:
•
•
Create a structure that is de-linked from the bankruptcy risk of the
seller/servicer (remove event risk)
Establish a security interest in the assets and proceeds
METHODS:
• Originator sells receivables into a bankruptcy-remote trust in a
“true sale”
• True sale — an arms-length transaction without recourse
• Trust has independent Board of Directors and nominal
capitalization
• Seller/servicer receives a market fee to service the receivables
• Investors receive bankruptcy-remote and nonconsolidation
legal opinions
Citigroup Global Markets
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Monitoring the Process
Originator &
Seller
Investors
Bankruptcy
Remote
Trust or SPV
Security
interest
Performance
statements
Trustee(s)
Citigroup Global Markets
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Investor Base
•
•
•
Wide-ranging investor base / inherent structure diversity
fits numerous needs:
Fixed and floating
Short- and longer-term maturities
Selection of ratings
A Full Spectrum of Investors:
•
•
•
•
•
•
•
•
ABCP, conduit and money market investors
Banks
Sec (securities) lenders
Money managers
Domestic investors
International investors
Hedge funds
CDOs
Citigroup Global Markets
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Product Array
On-the-Run Products
Some Off-the-Run Products
Credit Cards
Future flows
Autos
Aircraft
Home Equities
Insurance premiums
Stranded Assets
Mutual Fund “B” Share Fees
Student Loans
Entertainment & film royalties
Equipment
Intellectual property
CLOs / CBOs
Tax Liens
Manufactured Housing
Lottery receipts
Citigroup Global Markets
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ABS Risks
Collateral Risks
•Asset performance history
•Credit losses
•Asset yields
•Asset diversification
•Underwriting practices and
consistency
•Consumer credit measures
•FICO scores
•LTV
•Debt-to-income, etc.
Seller/Servicer
Risks
•Unsecured ratings
•Public, private or nonprofit
•Sources of capital, liquidity
and funding (should be
diversified)
•Headline risks
•Hot, warm or cold backup
servicers
•Interest rate risks
•Prepayment risks
Citigroup Global Markets
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Read the Documents
•Servicer / seller reps and warrantees
•Payment priority (waterfall)
•Any conflicts of interest?
•Default definition
•Voting rights
•Performance statement — sufficient to evaluate performance?
•Prefunding or right of substitution?
Citigroup Global Markets
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What Is Credit Enhancement?
• ABSs are credit enhanced, unlike conventional unsecured corporate
bonds
• Credit enhancement occurs when the security’s credit quality is
raised above that of the sponsor’s unsecured debt or that of the
underlying asset pool
…issues triple-A rated ABSs
double-B rated seller/servicer …
Citigroup Global Markets
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Types of Credit Enhancement
• Subordination — Trust assigns priority to cash flow allocation.
Junior classes called “subordinate”, and superior classes “senior”
• Overcollateralization — Trust has an excess of collateral over
bonds issued
• Excess Spread — Margin by which the yield on the pool exceeds
the pool expenses
• Turboing – Excess spread reduces pool balance instead of paying it
out to seller. Accelerates the reduction of senior classes over the
subs. The subordinate classes grow proportionally to the transaction
because seniors reducing more rapidly, thus increasing credit
enhancement
• Cash reserve account — An account available for needed liquidity
and to absorb losses
Citigroup Global Markets
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Credit Enhancement Snapshot
Asset Pool — $1.2 billion
Triple-A Class A Notes — $0.900 billion
Single-A Class B Notes — $0.2 billion
Overcollateralization — $0.1 billion
Other Types of Credit Enhancement:
Surety bonds
• Third-party or parent guarantee
• Excess Spread
• Letter of Credit
Citigroup Global Markets
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How Excess Spread Is Credit
Enhancement
Excess spread = Yield minus expenses
Excess spread:
Pool yield
Deal WAC
Servicing & Trustee fees
Excess spread
7.12%
3.99%
2.00%
1.13%
• Cash flow is king
• Excess spread is available to absorb credit losses
• “Waterfall” states that trust must retain excess spread if needed in
the transaction / cannot pay to servicer unless all required principal
and interest payments are current
Citigroup Global Markets
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Typical Credit Enhancements — On-the Run
Sectors
Class Rating
Triple-A
Double-A
Single-A
Triple-B
Double-B
Cash Reserve Account
Excess Spread
O/C
Credit Cards
12.25%
NA
7.00%
excess spread
NA
0
7.80%
NA
Autos
12.81%
NA
9.87%
7.91%
5.95%
1.00%
1%-4%
5%
Student Loans
3.00%
excess spread
NA
NA
NA
0.25%
1%-1.5%
undercollateralized
HELs
Initial
Target
19%
38%
11%
22%
6%
12%
3%
6%
1.30%
2.60%
1%
NA
3.50%
3.50%
1.30% 1.3% IB / 2.6% O.B
Source: Citigroup.
• Significant credit enhancement differences among sectors reflect
variations in expected losses, structure differences and interest rate risks
• Student loans have the least enhancement because are 98% to 100%
reinsured by the U.S. government
• HELs have the most enhancement because they have both credit and
interest rate risk
Citigroup Global Markets
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Rating Agencies Process
•Collateral and servicer evaluation
•Examine static pool data – more data is better
•Seller / sevicer – investment grade or noninvestment grade / relation
to transaction structure
•Collateral risks – economic, underwriting, regulatory
•Rating limitations
•Default probability
•Timely or ultimate interest and / or principal
Source: Citigroup.
Citigroup Global Markets
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Rating Agencies Approach to Credit
Enhancement
S&P Rating Loss Multiple
AAA
AA
A
BBB
BB
2000
2001
2002
4–5 times base case losses
3–4 times
2–3 times
1.75–2 times
1.5–1.75 times
2003
2004
2005
2.5
Prime Auto Loss Curves
Cumulative Losses (% of Original
Balance)
• Base case losses range
from 1.0% to 2.0%
2.0
1.5
1.0
Prime Cumulative Losses
0.5
0.0
0
5
10
15
20
25
30
35
40
45
50
Deal Age (Months)
Source: Citigroup.
Citigroup Global Markets
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How Are ABSs Structured?
• Bullet / soft bullet — Looks like a corporate security with all principal
due on one maturity date in a single payment
• Fully amortizing — Returns principal to investors throughout the life of
the security
• Controlled amortization — Revolving debt assets (HELOCs, credit
cards, trade receivables, dealer floorplan loans) provide investors with a
predictable repayment schedule even though the assets are not
amortizing.
• Sequential pay — All principal cash flows go to the shortest class until
repaid, them to the next one until all classes fully retired
• Pro rata pay — Trust pays cash flows simultaneously to senior and sub
investors
• Fixed or floating interest rate (or combined) — Term ABS market
benchmarks to swaps or LIBOR, and ABCP conduits to LIBOR
Citigroup Global Markets
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Principal Payments in a Floating-Rate HEL Deal
• Each triple-A backed by its own collateral group
• Failure of stepdown test makes the subordinates sequential payers
Citigroup Global Markets
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ABS Prepayments
• A Zero-CPR (constant payment rate) — every consumer pays
their loan as originally scheduled
• Factors Affecting Speeds:
• Refinancing
• Defaults
• Curtailments
Citigroup Global Markets
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ABS Prepayment Terms
• CPR (constant payment rate) — measures prepayments as a
percentage of the current outstanding loan balance, expressed
as a compound annual rate – 10% CPR means that 10% of the
pool’s current balance is likely to prepay over the next year
• HELs and student loans use CPR
• ABS (asset backed speed) — measures prepayments as a
percentage of the original outstanding loan balance
• Auto loans, auto leases and RV loans use ABS
• Prepayment curve (PPC) uses a ramp to measure speeds —
student loan consolidation ramp starts at 0 CPR, rises to 8% in
equal increments over 120 months
Citigroup Global Markets
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Measuring ABS Prepayments
CPR Pricing
Actual CPR
Linear (Actual CPR)
18
16
14
CPR (%)
12
10
8
6
4
2
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Source: Citigroup.
Month
• Routinely, some loans will default or otherwise prepay
• Prepayments are relative to the Zero-CPR schedule
• Prepayments form patterns / Wall Street quants decipher the
prepayment behavior
Citigroup Global Markets
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Auto Prepayments
Average 2000
Average 2003
Linear (Average 2002)
3.00
Average 2001
Average 2004
Average 2002
Average 2005
2.50
ABS (%)
2.00
1.50
1.00
0.50
SUBPRIME SPEED CURVE
0.00
-0.50
1
3
5
7
9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47
Month of Transaction
Source: Citigroup.
• No refinancing incentive for autos
• Prepayments very stable
• Most price at 1.5 ABS
Citigroup Global Markets
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Prepayments on 2/28 HEL Hybrids
Aggregate Speeds for a Top-Tier Issuer
Total pps
Voluntary pps
Defaults
80
70
CPR (%)
60
50
40
30
20
10
0
0
Source: Citigroup.
10
20
30
40
50
60
70
Loan Age
• First rate reset and expiration of penalties lead to high speeds
• Deals often priced at constant 28% CPR
Citigroup Global Markets
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HELs Are Champions of Stability
Fixed-Rate; Jul 98 – Jul 04
HEL
60
Fannie Mae
50
50
40
40
1 Mo CPR (%)
1 Mo CPR (%)
60
Floating-Rate; Jul 98 – Jul 04
30
20
Fannie Mae 3x1
30
20
10
10
0
Jul 98
HEL
Jul 99
Jul 00
Jul 01
Source: Citigroup.
Citigroup Global Markets
Jul 02
Jul 03
Jul 04
0
Jul 98
Jul 99
Jul 00
Jul 01
Jul 02
Jul 03
Jul 04
Source: Citigroup.
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ABSs Versus Other Fixed-Income Securities
• ABSs sold to average life rather than stated maturity date
• Cash flow characteristics often mirror MBSs (some corporate
bond-like)
• Prices respond to changing interest rates (rates fall / prices rise
and vice versa)
• Floaters better insulated / coupon changes more frequently
• Rate changes may influence the asset prepayments
• Early amortization risks – some assets (credit cards) have
payout or early calls if pool deteriorates
• Callability — many ABSs have an optional call when pool
reaches 10% balance —investor risk if issuer fails to call
• Servicer risk — will the servicer survive the life of the transaction
to service the transaction?
• Mainly institutional market
Citigroup Global Markets
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Disclaimer
ANALYST CERTIFICATION
I, Mary E. Kane, hereby certify that all of the views expressed in this report accurately reflect my personal views about any and all of the subject securities, issuers, currencies,
commodities, futures, options, economies or strategies. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or
view(s) expressed in this report.
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