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Moderator:
Michael Belfatti, ACE Financial Solutions
Panelists:
Patrick McCormick, American Re
Scott Orr, American Re
Introduction
 Part 1
 General overview of credit enhancement
 Part 2
 Credit enhancement illustration
General Overview of Credit Enhancement
 What is credit enhancement?
 What forms exist?
 What is enhanced?
 What needs does it satisfy?
What is credit enhancement?
 Credibility
 Capacity for belief
 Enhancement
 To increase or improve in value, quality,
desirability, or attractiveness
What forms exist?
 Financial Guaranty
 Credit Derivative
 Excess Spread
 Subordination
 Over-Collateralization
 Cash Reserves
Financial Guaranty
 Guaranty Insurance Company
 Obligor unable to make payment
 Guarantee
 Timely Interest
 Ultimate Principal
Credit Derivative
A
B
Receives Premium
Pays Premium
Pays Par Amount
of Defaulted Security
Receives Par Amount
of Defaulted Security
Receives Recoveries
Excess Spread
Collateral
Security
Interest Cash Flow
Interest Cash Flow
LIBOR + 300 bps
>
LIBOR + 100 bps
Subordination
 Layers
 Lowest layer absorbs first
losses
Senior Debt
Subordinated Debt
Equity
Over-Collateralization
Collateral
Security
Notional
Value
Notional
Value
>
Cash Reserves
 Extra collateral held as cash
 Credit enhancement and
Liquidity
What is enhanced?
 Municipal and international bonds
 Asset backed securities
Municipal and International Bonds
 Local, state, government agencies
 General obligations
 Limited recourse obligations
 International similar
General Obligation Example
 City of Los Angeles seeks funds
 Chooses to issue bond
 Repayment based on taxing powers
and assets
 Financial Guarantor guarantees
timely interest and ultimate principal
if Las Vegas defaults on bond
payment
Asset-Backed Securities
 Backed by pool of assets
 Asset cash flows cover bond interest
and principal
Asset-Backed Securities - Examples
 Mortgage-backed securities
 Credit card receivables
 Auto loan receivables
What needs does it satisfy?
 Cost
 Marketability
 Liquidity
 New and complex asset classes
 Reduce need for credit analysis
Mortgage Backed Securitization Illustration
Lender
 Financed the asset
 Owns the asset
 Low or unrated corporate entity
 Services the loan on the asset
Mortgage Backed Securitization Illustration
Lender
Originates
Pool of $100MM of residential
mortgage loans to “tarnished”
credit borrowers
-
Single family, owner occupancy
13% Wtd. average coupon
75% Wtd. average loan to value
Geographically diversified
Mortgage Backed Securitization Illustration
Lender
Originates
$100MM mortgage loan pool
Trust
- “New” owner of assets
- Bankruptcy proof
- Special purpose vehicle
Mortgage Backed Securitization Illustration
Lender
Originates
$100MM mortgage loan pool
Trust
$98MM Bonds
- AAA rated (“BBB” shadow rating)
- Monthly payments of principal and Interest
- Payments directly related to payments on
underlying mortgages
- 8% coupon rate
Mortgage Backed Securitization Illustration
Lender
Originates
$100MM mortgage loan pool
$98MM Bonds
Trust
Investors
- Pension fund
- Insurance Companies
- Receipt of monthly
P&I
Mortgage Backed Securitization Illustration
Lender
Trust
Originates
$100MM mortgage loan pool
$98MM Bonds
Financial Guaranty Insurance Policy
- From one of five “AAA” providers
- Guarantees timely payment of
interest and ultimate payment
of principal
- Unconditional and irrevocable
Investors
Competing Execution
Senior / Subordinate Structure
$100MM Bonds
$90mm ‘AAA’ 8% coupon
Trust
$8mm ‘BBB’ 9% coupon
$2mm UR 15% Coupon
8.3%
wtd. average
Credit Enhancement
( Loss Coverage Protection)
 Borrower Equity
 Overcollateralization
– $100MM Mortgages vs. $98mm Bonds
 Excess Spread
13.00% Weighted average mortgage rate
- .75% Fees
- 8.30% Weighted average bond rate
= 3.95% Excess Spread
Critical Players in Bond Insurance
Securitization Market
 Originator/Lender
 Investment Banker
 Rating Agency
 Bond Insurer
 Reinsurer
Investment Banker






Middleman
Bring sellers & buyers of assets together
Bring sellers & buyers of risk together
Work for asset originator (Lender)
Take little to no risk
Receives fees from originator
Rating Agency
 Independent party assessing risk on
investors behalf
 Originator pays fee
 Works with all parties
 Investor demand and Credit Enhancement
levels are key
 Underwrite all facets of securitization
process
Bond Insurer
 Primary relationship with lender
 Frequent Interaction with Investment
Banker
 Rating agency involvement
 Ultimate risk taker
 Receives premium from originator
 Thorough and in-depth underwriting
approach
Reinsurer
 Bond insurer are sole risk partners
 “Risk Share” arrangement
 Receive share of fee from bond insurer
 Perform “higher level” underwriting
review
 Employees have extensive industry
knowledge
Bond Insurer Underwriting Process
 Banker or Issuer will relay opportunity
 Opportunity will undergo comprehensive
analytical process
– Finance Company/Lender
– Asset Pool
– Structure
 Ongoing monitoring of transactions
Reinsurance Underwriting Process
 Receive primary insurer underwriting
material/output
 Confirm/refute bond insurers underwriting
approach/results
 Solicit rating agency input
Critical Players in Bond Insurance
Securitization Market
 Originator/Lender
 Investment Banker
 Rating Agency
 Bond Insurer
 Reinsurer