SIM/NYU
The Job of the CFO
Financing with
Asset-Backed Securities
Prof. Ian Giddy
New York University
Asset-Backed Securities
The technique
 Legal, tax and accounting issues
 The economics
 An application
 ABS in Asia

Copyright ©2001 Ian H. Giddy
giddy.org
Asset Securitization 2
Securitization of Assets



Securitization is the transformation of an
illiquid asset into a security.
For example, a group of consumer loans can
be transformed into a publicly-issued debt
security.
A security is tradable, and therefore more
liquid than the underlying loan or receivables.
Securitization of assets can lower risk, add
liquidity, and improve economic efficiency.
Copyright ©2001 Ian H. Giddy
giddy.org
Asset Securitization 3
What is the Technique for Creating
Asset-Backed Securities?



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A lender originates loans, such as to a
homeowner or corporation.
The securitization structure is added. The bank or
firm sells or assigns certain assets, such as
consumer receivables, to a special purpose
vehicle.
The structure is legally insulated from
management
The SPV issues (usually) high-rated debt.
Copyright ©2001 Ian H. Giddy
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Asset Securitization 4
Securitization: The Basic Structure
SPONSORING
COMPANY
ACCOUNTS
RECEIVABLE
SALE OR
ASSIGNMENT
SPECIAL
PURPOSE
VEHICLE
ACCOUNTS
RECEIVABLE
Copyright ©2001 Ian H. Giddy
giddy.org
ISSUES
ASSET-BACKED
CERTIFICATES
Asset Securitization 5
The Process
Key features are:
 pooling
of a group of similar non-traded financial
assets
 transfer of those assets to a special-purpose company
which issues securities
 risk reduction by systematic risk assessment, by
diversification, by partial guarantees, etc.
 division of the benefits (and risks) among investors on
a pro-rata basis
 being offered in the form of a security (rather than, for
example, as a portfolio of loans or receivables)
 on-going servicing of the underlying assets' cash flows
through to the asset-backed security investors.
Copyright ©2001 Ian H. Giddy
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Asset Securitization 6
Finance Company Limited
Case Study: The Company
(Finance Company Limited)
Finance company whose growth is
constrained
 Has pool of automobile receivables
 Has track record
 Plans to use this as an ongoing source of
financing

Copyright ©2001 Ian H. Giddy
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Asset Securitization 8
Key Decisions
Securitize the assets
Decisions
Form of transfer
of asset
Copyright ©2001 Ian H. Giddy
Form of special
purpose vehicle
Form of credit
enhancement
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Form of
Form of cash flow
transformation of
allocation
cash flows
Asset Securitization 9
Case Study: Initial Exchanges
Finance Co.’s
Customers
Hire-Purchase
Agreement
Finance Co. Ltd
(Seller)
Rating Agency
Top Rating
Servicing Agreement
Proceeds
FCL 1997-A
(Special Purpose Co.)
Sale of Assets
Proceeds
Investors
Asset-Backed
Securities
Trustee
Trust
Agreement
Copyright ©2001 Ian H. Giddy
Guarantee
Agreement
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Financial Guarantee
Provider
(if required)
Asset Securitization 14
Case Study: Ongoing Payments
Finance Co.’s
Customers
Hire-Purchase
Payments
Finance Co. Ltd
(Seller)
Servicing Fees
Monthly HP
Payments
FCL 1997-A
(Special Purpose Co.)
Monthly ABS
Payments
Trustee
Trustee
Responsibilities
Copyright ©2001 Ian H. Giddy
Guarantee
Responsibilities
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Investors
Financial Guarantee
Provider
Asset Securitization 15
Getting a Rating: The Risks
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Credit risks
Liquidity risk
Servicer performance risk
Swap counterparty risk
Guarantor risk
Legal risks
Sovereign risk
Interest rate and currency risks
Prepayment risks
Copyright ©2001 Ian H. Giddy
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Asset Securitization 16
Risk-Management Techniques in ABS
CREDIT
ENHANCEMENT
SPONSORING
COMPANY
ACCOUNTS
RECEIVABLE
SOVEREIGN
PROTECTIONS
SALE OR
ASSIGNMENT
SPECIAL
PURPOSE
VEHICLE
ACCOUNTS
RECEIVABLE
ISSUES
ASSET-BACKED
CERTIFICATES
INTEREST RATE/
CURRENCY
HEDGES
CASH FLOW
REALLOCATION
Copyright ©2001 Ian H. Giddy
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Asset Securitization 17
Credit Enhancement:
An Alternative Approach
Rating Agency
Top Rating
Senior
Lower Rating
Finance Co. Ltd
(Seller)
Proceeds
FCL 1997-A
(Special Purpose Co.)
Subordinated
Sale of Assets
No Rating
More Subordinated
Copyright ©2001 Ian H. Giddy
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Asset Securitization 18
Choose a Structure to Suit the Type of
Assets to be Securitized
Mortgage Securitization
 Non-Mortgage ABS
 Intangibles
 Infrastructure and Project Financing

Copyright ©2001 Ian H. Giddy
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Asset Securitization 19
Asset-Backed Securities:
Legal and Regulatory Aspects

Legal
The
Transfer
The Special-Purpose Vehicle
Taxation
 Accounting Treatment
 Bank Regulatory Treatment

Copyright ©2001 Ian H. Giddy
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Asset Securitization 20
Legal Aspects
Goal: Credit quality must be solely
based on the quality of the assets and
the credit enhancement backing the
obligation, without any regard to the
originator's own creditworthiness
 Otherwise, quality of the ABS issue
would be dependent on the originator's
credit, and the whole rationale of the
asset-backed security would be
undermined.

Copyright ©2001 Ian H. Giddy
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Asset Securitization 21
Three conditions enable the separation
of the assets and the originator



The transfer must be a true sale, or its legal
equivalent. If originator is only pledging the
assets to secure a debt, this would be
regarded as collaterized financing in which
the originator would stay directly indebted to
the investor.
The assets must be owned by a specialpurpose corporation, whose ownership of the
sold assets is likely to survive bankruptcy of
the seller.
The special-purpose vehicle that owns the
assets must be independent
Copyright ©2001 Ian H. Giddy
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Asset Securitization 22
What Makes it a Sale?
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The form and treatment of the transaction
The nature and extent of the benefits
transferred
The irrevocability of the transfer
The level and timing of the purchase price,
Who possesses the documents
Notification when the assets are sold
Copyright ©2001 Ian H. Giddy
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Asset Securitization 23
What Makes it Likely to be
Consolidated?
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The difficulty of segregating and ascertaining
individual assets and liabilities
The presence or absence of consolidated
financial statements
The comingling of assets and business
functions
The existence of parent and intercorporate
guarantees and loans
The transfer of assets without strict
observance of corporate formalities.
Copyright ©2001 Ian H. Giddy
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Asset Securitization 24
Taxation Aspects
If the SPV or the transfer is subject to
normal corporate, withholding, or
individual tax rates, investors or
borrowers could in principle be subject
to additional or double taxation
Must avoid double taxation of
 Seller/servicer
 Trust or special-purpose corporation
 Investors

Copyright ©2001 Ian H. Giddy
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Asset Securitization 25
Accounting Treatment
Sale versus financing
 Consolidation
 Accounting for loan servicing

Copyright ©2001 Ian H. Giddy
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Asset Securitization 26
FASB Sale Treatment
The transferor relinquishes control of
the future economic benefits embodied
in the assets being transferred
 The SPV cannot require the transferor
to repurchase the assets except
pusuant to certain recourse provisions
 The transferor's obligation under any
recourse provision are confined and can
be reasonably estimated

Copyright ©2001 Ian H. Giddy
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Asset Securitization 27
Consolidation Treatment
International accounting standards hold
that consolidated financial statements
are more meaningful than separate
ones
 "Nonhomogeneous operation"
exception
 Finance, insurance, real estate and
leasing subsidiaries can generally be
left apart

Copyright ©2001 Ian H. Giddy
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Asset Securitization 28
Fees
Loan-origination fees. These are
deferred and recognized over the life of
the loan as an adjustment of yield.
 Commitment fees. These are to be
deferred.
 Syndication fees. These should be
recognized when the syndication is
complete unless the originator retains a
portion of the syndicated loan.

Copyright ©2001 Ian H. Giddy
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Asset Securitization 29
Bank Regulation
and Capital Requirements
Goal: Ensure that the substance and not the
form of the asset transfer is what governs
capital requirements.
The regulatory authorities may assess capital or
reserve requirements as if the financing was
a secured borrowing:

Copyright ©2001 Ian H. Giddy
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Asset Securitization 30
Bank Regulation: Issues in Asia
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Avoid excessive bank risk-taking
Discourage speculative investments
Prevent financial market scandals
Prevent circumvention of deposit regs
Encourage financing of capital investment
Discourage financing of consumption
Promote development of capital markets
Copyright ©2001 Ian H. Giddy
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Asset Securitization 31
Asset Securitization:
Cost-Benefit Analysis
Separation of Two Businesses:
Origination and Lending
SPONSORING
COMPANY
ACCOUNTS
RECEIVABLE
SALE OR
ASSIGNMENT
SPECIAL
PURPOSE
VEHICLE
ACCOUNTS
RECEIVABLE
Copyright ©2001 Ian H. Giddy
giddy.org
ISSUES
ASSET-BACKED
CERTIFICATES
Asset Securitization 33
Separation of Two Businesses:
Origination and Lending
SPONSORING
COMPANY
Asset securitization
makes sense when
the assets are worth
more outside the
company than within
But what makes them
worth more outside?
ACCOUNTS
RECEIVABLE
SALE OR
ASSIGNMENT
SPECIAL
PURPOSE
VEHICLE
ACCOUNTS
RECEIVABLE
Copyright ©2001 Ian H. Giddy
giddy.org
ISSUES
ASSET-BACKED
CERTIFICATES
Asset Securitization 34
For Banks: Capital Requirements
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In a perfect world, adding good assets would
require little additional capital, since creditors
would not see any increase in the bank's risk
But if regulatory capital requirements penalize
banks for holding such assets, they should:
securitize the good assets
profit from origination and servicing
In general, regulatory costs or rigidities create
an incentive for banks to shrink their balance
sheets by securitizing loans
Copyright ©2001 Ian H. Giddy
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Asset Securitization 35
A Bank’s Capital Savings
Securitization Cost-Benefit Analysis
(for a regulated financial institution)
Funding cost savings 
Gain/cost
($ millions)
Two-year bank notes vs pass- 1.1
though rate
Upfront costs


Underwriting
SEC filing, legal fees, etc
(2.6)
Ongoing costs

Letter-of-credit fee
(0.5)
Capital charge

Cost of capital at 25% (15%
after tax)
7.7
Net benefit
Copyright ©2001 Ian H. Giddy
5.7
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Asset Securitization 36
For Corporations: “Pure Play”
Argument
Separate the credit of the assets from the credit
of the originator:
 Identify and isolate good assets from a
company or financial institution
 Use those assets as backing for high-quality
securities to appeal to investors.
 Such separation makes the quality of the
asset-backed security independent of the
creditworthiness of the originator.
Copyright ©2001 Ian H. Giddy
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Asset Securitization 37
Sears: Asset-Backed Financing?
SEARS
Copyright ©2001 Ian H. Giddy
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Asset Securitization 38
Why Did Chrysler Use ABS in 1992?
Downgraded to B+ in early 1992
 Lost access to its normal funding
sources
 Needed to continue to fund its car loans
 Only way to do this was to securitize the
loans
 “Firms that securitize tend to have
considerably weaker credit quality than
other firms.”

Copyright ©2001 Ian H. Giddy
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Asset Securitization 39
Costs Associated with Securitization
Interest cost of the debt
 Issuance expenses of the debt
 Also:

Credit
enchancement and liquidity support
for the assets
Structuring fees payable to bankers
Legal, accounting and tax advice fees
Rating agencies' fees
Systems modifications
Management time
Copyright ©2001 Ian H. Giddy
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Asset Securitization 40
Costs Needed to Measure the Annual
Pre-Tax Impact of Securitization
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The interest on the securitized funding
The annual costs of credit enhancement/liquidity lines
Any guarantees to enhance the credit rating of any
interest rate or foreign exchange swap counterparty
Amortized front-end fees (debt issuance, credit
enhancement, liquidity lines)
Amortized transaction costs (legal, accounting,
structuring, rating, etc.)
Opportunity costs relating to any temporary cash
retention in any guaranteed investment contract
(GIC)
Annual systems/accounting/rating agency costs etc.
Copyright ©2001 Ian H. Giddy
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Asset Securitization 41
Sample Cost/Benefit Analysis
Portfolio yield
Funding cost
Default rate
Amortized upfront issuance costs
Amortized upfront securitization costs
Annual costs of guarantees and credit lines
Annual additional costs (systems, reporting, trustee fees, etc)
Effect on sponsor's marginal cost of capital
With securitization Without securitization
18.50%
18.50%
-7.22%
-9.00%
-5.00%
-5.50%
-0.10%
-0.05%
-0.20%
-0.25%
-0.25%
0.00%
Profits
5.48%
Net savings from securitization
1.53% per annum
Copyright ©2001 Ian H. Giddy
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3.95%
Asset Securitization 42
The Decision Process
Corporation or Financial Institution requires additional funds to give
customers financing or to finance a future revenue stream.
Are funds freely available from banks ?
Yes
Borrow from
banks
No
Does the firm/FI have good, self-liquidating
assets ?
No
Issue equity or
mezzanine capital
Yes
Do the assets have a sufficiently high yield
to cover servicing and other costs ?
Yes
Would the assets be worth more (have a
cheaper all-in funding cost) if they were
isolated from the company/FI ?
Yes
Copyright ©2001 Ian H. Giddy
No
No
Get out of the
financing
business
Use assets as
collateral for
on-balance
sheet debt
Securitize the assets
giddy.org
Asset Securitization 43
Asset-Backed Securities
Project Financing
Prof. Ian Giddy
Stern School of Business
New York University
Asset-Backed and Project Financing
Collateralized debt
 Securitized loans
 Non-recourse project debt
 Basic question: Why should a company
segregate the cash flows from a
particular business, and make it selffinancing?

Copyright ©2001 Ian H. Giddy
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Asset Securitization 45
Project Financing
Stand-alone, non-recourse, multi-stake,
"production payment financing"
 Structure?
 Participants?
 Funding sources?
 Risks?

Copyright ©2001 Ian H. Giddy
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Asset Securitization 46
Project Financing (Summary)
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Stand-alone, non-recourse "production payment
financing"
Sponsor's vehicle company structures multi-stake
finance
Sources: govt development financing, IBRD/IFC,
sponsor loans, supplier credits, customer credits,
institutional investors, banks, lease financing,
equity
Risks: resource quantity, input costs, technical,
timing, pre-completion, demand, operating, force
majeure, political
Risk sharing and mitigation
Copyright ©2001 Ian H. Giddy
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Asset Securitization 47
Project Financing
Definition



Steps
Lending to a single purpose entity
for the acquisition and /or
construction of a revenuegenerating asset with limited or no
recourse to the sponser
Repayment of the loan is solely
from the revenues generated from
operation of the asset owned by
the entity
Security for the loan
 the revenue generating asset
 all shares and interests in the
entity
 real property
 all contacts, permits
 authorizations, etc.; and,
 all other instruments necessary
for continuing project
operations
Copyright ©2001 Ian H. Giddy
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Project Identification
& Resource Allocation
Risk Allocation &
Project Structuring
Bidding & Mandating
Contracts
Due Diligence &
Documentation
Execution & Monitoring
Construction Monitoring
Term Loan Conversion
& Ongoing Monitoring
Asset Securitization 49
Benefits of Project Financing
Limitation of Equity Investment to
Project’s Economic Requirement Enhanced Returns
 Risk Sharing and Diversification
 Accounting Treatment Preserves
Corporate Borrowing Capacity
 Access to Long Term Financing
 Tax Benefits
 Political Risk Mitigation

Copyright ©2001 Ian H. Giddy
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Asset Securitization 50
The Risks
Political
 Resource & input
 Technical
 Construction
 Legal
 Economic




Copyright ©2001 Ian H. Giddy
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Cost overruns
Completion delays
Mounting
interest expenses
Asset Securitization 51
Eurotunnel: The Risks and the Remedies
Category
Nature
Remedy
Political
Nationalization
Govt interference
Taxes & the like
Legal
Treaty ratified
Technical
Process
Effect on completion
Repairability
Use existing technology
Construction Delays
Overruns
Repairability
Use top experts
Performance bonds
Legal
Access to control in default
Fire, injury, etc liability
Security interests
Default defn
Economic
Price competition
Rail links
Market studies
Copyright ©2001 Ian H. Giddy
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Asset Securitization 52
Sample Structure
Arranging
Bank
Sponsors /
Shareholders
SINGLE PURPOSE
PROJECT COMPANY
Equipment Warranties and
Supply Agents
Supplier
Contractor
Turnkey
Construction
Feed Stock Long Term
(e.g., fuel) Agreement
Supplier
Operator
Copyright ©2001 Ian H. Giddy
Offtake (e.g,
power purchase)
Agreement
Syndicate
Banks
Other Project
Participants:
Purchaser
Currency and Interest
Rate Hedge Providers
Multilaterals and EDA’s
Legal Counsel
Operations &
Maintenance Mgmt
Technical Consultants
giddy.org
Asset Securitization 53
Ras Laffan

Who is the issuer?
 Ras
Laffan LNG Co. Ltd. (Qatar)
 But Security Trustee (IBJ) plays unusually major
role

What assets does it have?
 Natural
gas reserves;
 LNG take-or-pay Sale and Purchase Agreement
with Korea Gas;
 Security Trust Agreement; Project Coordination
Agreement; loan refund agreement, etc.
Copyright ©2001 Ian H. Giddy
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Asset Securitization 54
Ras Laffan

What are the risks, and how are they
handled?
Qatar/regional
interference
Qatar legal system
Default on Agreements
Completion/timing
Operating
Economic (LNG market)
Copyright ©2001 Ian H. Giddy
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Asset Securitization 55
Ras Laffan: Natural Gas Project Finance
Ras Laffan
Liquified Natural Gas
LNG
Korea Gas
LNG
payments
Security Trustee
Debt service
payments
Copyright ©2001 Ian H. Giddy
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Asset Securitization 56
Mobil QM
(Mobil Corp.)
Contractors
Contractors
Contractors
Joint venture agreement
30%
Qatargas
(State of Qatar)
70%
Ras Laffan
Liquified Natural Gas
LNG
Contract
payments
Korea Gas
Residual
payments
LNG
payments
Security Trustee
(New York)
Ras Laffan
Debt service
payments
Debt service
payments
Bondholders
Banks
Export Credit
Agencies
 asiansecuritization.com
Copyright ©2001 Ian H. Giddy
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Asset Securitization 58
Ian H. Giddy
Stern School of Business
New York University
44 West 4th Street, New York, NY 10012, USA
Tel 212-998-0332
Fax 917-463-7629
ian.giddy@nyu.edu
http://giddy.org
Copyright ©2001 Ian H. Giddy
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Asset Securitization 59