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88 Seiten, Note: 2,1
LIST OF ABBREVIATIONS
LIST OF FIGURES
LIST OF TABLES
1.2 Research Objective
1.3 Research Methodology
1.4 Organization of the Thesis
2 PORTFOLIO THEORY BY HARRY M. MARKOWITZ
2.1 Definition of a Portfolio
2.2 Portfolio Analysis
2.3 Uncertainty within a Portfolio
2.4 Relation of Securities within a Portfolio
2.5 Objectives of Markowitz’ Portfolio Analysis
2.6 Further Portfolio Theories
2.6.1 Capital Asset Pricing Model (CAPM)
2.6.2 Arbitrage Pricing Theory (APT)
2.7 Critical Appraisal
3 ASSET-BACKED SECURITIES
3.1 Definition of Asset Backed Securities as a Term
3.2 Historical Development of ABS as a Financial Tool
3.3 Basic Structure of an ABS Transaction
3.4 Asset-Backed Commercial Paper (ABCP) Program
3.5 Types of ABS
3.5.1 Mortgage-Backed Securities
3.5.2 Collateralized Debt Obligations
3.5.3 Borrowers Characteristics
3.6 Cash Flow Structures
3.6.1 Pass-Through Structure
3.6.2 Pay-Through Structure
3.7 Importance of Rating
3.7.1 Definition of Rating
3.7.2 Function of Rating for Investors
3.7.3 Rating- Systems and -Symbols
3.8 Credit Risks while Investing in ABS
3.8.1 Asset Risks
3.8.2 Structural Risks
3.9 Credit Enhancement Methods
3.9.1 Internal Enhancement
18.104.22.168 Spread Accounts
3.9.2 External Enhancement
22.214.171.124 Pool Insurance
126.96.36.199 Letters of Credit
188.8.131.52 Liquidity Facilities
3.10 Critical Appraisal
4 US SUBPRIME CRISIS
4.1 History of the Subprime Market
4.2 History of the Subprime Crisis
4.3 Reasons for the US Subprime Crisis
4.3.1 Factors in the US
4.3.2 Factors beyond the US Boundaries
4.3.3 Rating Agencies as a Further Factor
4.4 Regulations for German Banks Concerning the Subprime Crisis
4.5 Effects on Further ABS Vehicles
4.6 Critical Appraisal
5 DEUTSCHE INDUSTRIEBANK AG (IKB)
5.1 About IKB
5.2 History and Development of Deutsche Industriebank AG
5.2.1 Bank for Industry Obligations (Bafio)
5.2.2 Reorganization of Bafio
5.2.3 Deutsche Industriebank
5.2.4 Industriekreditbank AG (IKB)
5.2.5 Deutsche Industriebank AG
5.3 Influence of the Subprime Crisis on IKB
5.3.1 Overview on IKB’s Crisis
5.3.2 IKB’s Management Failures
5.3.3 IKB and Rhineland Funding
5.3.4 Effects on IKB’s Customers
5.3.5 Reorientation for IKB
5.3.6 Current Developments for IKB
6.2 Recommendation and Outlook
Abbildung in dieser Leseprobe nicht enthalten
Figure 1: Basic Structure of an ABS Transaction
Figure 2: Basic Structure of an ABCP Program
Figure 3: Calculation of the Excess Spread
Figure 4: Announced and Estimated Losses of Banks
Figure 5: An Overview of the IKB Crisis
Figure 6: Strategy of Rhineland Funding
Figure 7: IKB’s Shareholder’s Structure
Table 1: Comparison of the Rating Symbols of the Well-Known Rating Agencies
Table 2: Example for Credit Enhancement by Subordination
Table 3: Contingent Liabilities of IKB
Table 4: Liabilities of IKB
The general view once was that the financial system has become more stable because risks mainly lay not within the banks balance sheets, but with the investors and further parties involved when structuring and selling structured products such as asset-backed securities.1 As a result of the re-evaluation of subprime loans and other asset-backed securities structures as the speculative bubble busted in summer 2007, a clear increase in the risk aversion has been observable during the past few months. This, in turn, has caused problems in the interbank market since refinancing costs have increased enormously, so that not only banks are being affected by the breakdown in the US subprime mortgages.2
In addition, it can be assumed that due to the subprime market breakdown and loans given to hedge funds plus their own investments in credit products, risks have found their way back in the banks balance sheets. Recently, there has been talk of an upcoming recession.3 Only time will tell how the financial markets will continue to react on the consequences of the subprime crisis.
Basically asset-backed securities were thought to carry little or almost no risk while simultaneously bringing in a high return. They were supposed to transform risky assets into riskless ones without minimizing the return.4
In connection with high ratings there may be the question of which risks should actually be considered when investing in asset-backed securities. Furthermore, it needs to be discovered how possible problems can affect the economic performance of a company.
The objective of this paper is to reveal the difficulties in evaluating and handling the investments in asset-backed securities of German financial institutes, using the example of the Deutsche Industriebank AG. In order to achieve this aim, the following questions will be dealt with:
- What kind of problems in understanding and evaluating asset-backed securities can arise?
- What kinds of dependencies occur when investing in asset-backed securities? x How can problems emerge for banks investing in asset-backed securities?
This thesis about asset-backed securities using the example of the Deutsche Industriebank AG (IKB) contains information from sources such as books, newspapers and the Internet.
Please note that due to the fact that the consequences of the subprime crisis and the developments concerning IKB are still a main issue in the daily news. Moreover, as the number of pages of this thesis is limited, not every statement about further new consequences for the financial market and financial institutes will be discussed. The author focuses mainly on news which was issued up to the 1st of February 2008, with the exception of news about the Deutsche Industriebank AG, which includes information from the news up until the 15th of February 2008. Furthermore, it should be noted that the author only covers those topics which are the most important for finding out why IKB and other German banks failed while investing in asset-backed securities.
This study is structured as follows: first, the author begins by providing information on the portfolio-selection theory by Markowitz in chapter 2, introducing two further theories known as the Capital Asset Pricing Model and the Arbitrage Pricing Theory in section 2.6. While the Capital Asset Pricing Model in 2.6.1 is based on the portfolio theory of Markowitz, the Arbitrage Pricing Theory in 2.6.2 takes a different approach. These theories provide a smooth transition to the theoretical part of asset-backed securities in chapter 3. Chapter 3 deals with the complex structure of asset-backed securities as a financial tool. Starting with a general introduction of ABS, including its definition and historical background, the author will offer an overview of the parties involved within a basic asset-backed securities transaction in chapter 3.3. Next the author provides information about a further transaction type, namely the asset-backed commercial paper program, in chapter 3.4. An overview of the types of ABS follows. Subsequently the various existing cash flow structures within an ABS transaction are outlined. Chapter 3.7 gives an overview of the importance and functionality of ratings for ABS for all financial market parties. An overview of the risks which can occur within an ABS transaction and how they can be minimized by credit enhancements follows. The chapter ends with a critical look at the complex structure of asset-backed securities.
Chapter 4 includes information on the subprime crisis in the financial markets. After providing information on the history of the subprime market, the author outlines the development of the crisis briefly. Next, the reasons for the crisis within and beyond the USA are analyzed, taking the rating agencies into account as a further factor. The rules and regulations for German banks will be outlined before the effects on further ABS vehicles and the current development of the crisis are discussed. The chapter concludes with a critical assessment of the subprime crisis.
Chapter 5 focuses on the example of the Deutsche Industriebank AG. After a look at IKB’s history, the consequences for the bank concerning the subprime crisis are outlined. Furthermore IKB’s conduit Rhineland Funding and its SIV Rhinebridge are introduced, followed by some details about how those vehicles contributed to the problems of the Deutsche Industriebank AG. Subsequently, the author discusses the effects on IKB’s customers and the management failures. The chapter closes with the plan to reorganize IKB in the future and an overview of the current developments of this financial institute.
Finally, chapter 6 presents the author’s findings as well as a recommendation and outlook.
A portfolio is a combination of the assets of an individual, an institution or a national budget. It has the purpose of a calculated summary, display and control of financial characteristics of the portfolio and its components. The investor’s desired criteria concerning collateral, rate of return and liquidity should come together in a portfolio in total. The simultaneous inspection of the individual assets as a portfolio is the basis for the decision for its contents.5
Portfolio analysis as defined by Markowitz is based on portfolios which include a great quantity of securities. In his opinion a good portfolio is not just a list of stocks and bonds. An investor should build up their portfolio with attributes which best fits them. In order to find portfolios which are most suitable to the investor’s objective it is essential to carry out a portfolio analysis. The analysis’ purpose is to draw conclusions concerning the portfolio as a whole by collecting information on the single assets. Information like the past performance of single securities and further several types of information represent the raw data of the analysis. The belief of one or more analyst regarding the future performance of single securities represents a further source of information. Using information on the past performances of securities as an input leads to an output of portfolios displayed which had a good performance. The same happens with using the opinions of analysts as an input. The output of the analysis will be the reflections of those beliefs concerning portfolios being better or worse.6
The reason why uncertainty is a salient feature within a portfolio is the lack of understanding those economic forces which can lead to improper predictions concerning error or doubt. In addition to those economic influences there are also non-economic effects which can decide over a portfolio’s profit or loss of one or many securities. An example of a non-economic influence can be a very dry summer which leads to a poor harvest and therefore high prices for harvest goods or perhaps the success of a new product that exceeds the management’s expectations. However, the appearance of uncertainty does not imply that a good analysis is worthless. Since it is nearly impossible to predict with certainty it is of high importance to build judgments by experts and with great care.7
Securities bear the disadvantage that they tend to highly correlate in terms of returns within one asset class. This development is characteristic for an economic quantity and leads to the fact that they are most likely to go up and down at the same time, which is not satisfying concerning an entire portfolio.8
Markowitz uses the example of flipping a coin. He sets up the theory that one is not able to predict which side of the coin will appear when flipping one coin once. But he continues with the thought that if one uses many coins to flip that either head or tail will appear probably on one half of the tossed coins. Comparing the correlation of those coins to securities it can be said that once the securities reacted like those coins, which highly correlate, it would be possible to reduce risk via diversification. But if one flipped a hundred coins and every coin fell like the first one, eliminating or reducing risk by diversification would be impossible. This is because of the perfect correlation of those coins.9
In the process of portfolio allocation it is necessary to compose a portfolio which includes securities not perfectly correlated with each other. It is to be expected that a security of the same industry will correlate more than ones of unrelated industries. This leads to a higher effect of diversification once similarity between asset classes is low. Portfolios can provide an improvement in performance once the assets do not correlate perfectly on one hundred percent with each other. This is important to reduce risk, since once securities are rising and falling at the same time the portfolio does not offer protection.10
It seems that it is nearly impossible to obtain every conclusion which is important for a portfolio. Therefore it is necessary to break the basis of a portfolio analysis down into important and unimportant criteria. The decision whether criteria are relevant or irrelevant depends on the investor’s personality. Some investors may consider the relationship between the cost of living and the returns on a portfolio important while other investors would not. But there are two objectives which fit every investor. Every investor desires a high return, even though investors mostly define this return differently.11 The term return itself has different definitions depending on the context of the analysis.12 Nevertheless it can be said that return in the common sense is what you receive in comparison to what an investor invests. It is the change in the investment’s market price plus the income received over a certain period.13
Investors would like this return to be stable, dependable and definitely not uncertain. Therefore Markowitz has developed the theory of efficient portfolios. This means that there is no portfolio with a higher possible return by constant risk. Secondly there is no portfolio which has the same return by lower risk. And finally there is no portfolio with a higher return by lower risk. Choosing efficient portfolios depends on the investor’s ability and willingness to accept risk. It is important that the investor chooses portfolios which best fit his requirements, meaning choosing a portfolio providing the best combination of return and risk to the investor.14
In 1958 James Tobin provided an amendment to Markowitz’ theory of portfolio selection. He recognized that once a certain number and certain securities were given it is wise, not depending on the individual investor’s risk aversion, to invest in a so called “tangential portfolio’’. The risk addiction of an investor is only important for the allocation of assets on risk or risk-free securities should look like. Tobin’s contribution is called the “separation theorem’’. On the basis of Markowitz’ theory of portfolio selection and on Tobin’s expansion of the same Sharpe, Lintner and Mossin developed a Capital Asset Pricing Model (CAPM) in 1964.15 Their theory was one of the capital market equibilirium. According to this theory the capital market of securities which are fraught with risk is balanced once there is no surplus of supply and demand. Every available security is held by investors with everyone holding a part of the entire market portfolio.16 This means all available securities are held in proportion to their market values.17 The risk aversion of a single investor is only shown in how he combines his portfolio with risk-free securities.18 This is the idea taken up from Tobin. Sharpe supports the same idea of eliminating risks via diversification. The only question which was left unanswered was which part of risk can not be eliminated by diversification.19
The reason why the Arbitrage Pricing Theory was developed is because CAPM limited its statements concerning returns only to the factors risk and return.20 In contrast to the CAPM the arbitrage pricing theory (APT) by Stephen Ross does not consider whether a portfolio is efficient or not. The theory is an alternative to the theory of return and risk. It assumes that every return of a stock is influenced by interactive macroeconomic events or “noise’’ and “factors’’ of incidents which are unique to a company. There can be factors such as inflation, interest rate etc., but the theory does not name the factors. Each stock will be more sensitive to certain factors then others. There is the example of Exxon Mobil which would be more sensitive to an oil factor than Coca Cola.21 The main conclusion of the APT is that firstly arbitrage processes lead to balanced securities which are always evaluated correctly. Secondly it is said that it is not necessary to have further knowledge about the market theory. Furthermore the securities’ returns depend on many risk factors either macro- or microeconomic. And finally that the return consists of a risk-free part and various risk premiums.22
The portfolio selection model (portfolio theory) by Harry M. Markowitz is based on the idea of diversifying investment capital into different asset classes within a portfolio. This has the function of minimizing risk.23 Therefore Markowitz arrives at the conclusion that the number of securities in a portfolio is less important than the correlation of the securities with each other.24 Securities of unrelated industries are considered to not perfectly correlate with each other, which leads to a better portfolio performance.25 It is a fact that the correlation of assets does not remain constant but varies from time to time. This volatility is based on supply and demand and also possibly on different economic cycles. This is a normal development in the financial markets but therefore it is necessary to verify the correlations constantly.26
During the 1990’s different asset classes showed different performances, creating an ideal situation for establishing a new portfolio with rather low potential risks combined with an optimized return. However, the past two years have demonstrated that the situation of different securities not perfectly correlating has changed. It has been observed that the development of different assets classes in the financial market assimilates. The reason for this situation can be explained by a global financial system which has become highly complex with ever increasing dependencies.27 Furthermore, upon the creation of the Euro, exchange rates and interest rates were fixed in the Euroarea.28
Because of this development new securities emerge on an almost daily basis. Those products are said to have perfect possibilities for diversification but at the same time investors and banks have to judge critically whether those instruments include the desired diversification and return.29 The importance of traditional banking activities has declined in most countries because of open competition and therefore price pressures among lenders from the non-bank financial sector such as venture capital and private equity. Therefore banks have expanded to non traditional sectors such as loan securitization in order to generate fees. Asset-backed securities are said to be such an alternative product and will be introduced and discussed by the author in the following chapters.30
The term asset-backed securities (ABS) encompasses every bond that is able to act as a financial tool and cover all varieties of assets. Therefore asset-backed securities is an umbrella term for several varieties which will be described by the author in chapter 2.4.31 Assets can be securitized once they are able to generate a predictable cash flow stream.32 This type of securities are carefully structured products in a structured process whereby loans, bonds, etc. are packaged, underwritten and sold in the form of ABS.33 Therefore the securitized loans have to be relatively homogenous in terms of rates, collateral and terms.34 The goal of an asset-backed securities transaction is to convert illiquid assets into liquid securities.35 This takes place by selling selected assets without recourse to entities, which are founded only for this transaction and which is called special purpose vehicle (SPV). The SPV finances the purchase price by issuing securities which are secured (backed up) with assets.36 All required payments to the investors are derived from the cash flow from these assets. This procedure leads to a low priced refunding, which results from the separated rating of the issue and the rating of the receivable seller.37
Asset-backed securities as a financial vehicle originated in the United States in the 1970s.38 The separate banking system, which is considered to be to some extent inefficient, caused an imbalance among mortgages during that time. It was impossible to create capital compensation among the US states with a funds surplus and those with funds shortfalls. This situation was additionally made worse by economic factors and a high volatility in interest rates. Because of those difficult basic conditions for the American banks, the US Government decided to create a secondary market for mortgages to guarantee to strengthen the US states with low capital assets.39
The first securitization of a mortgage was therefore termed mortgage-backed securities (MBS) which will be outlined by the author in chapter 184.108.40.206 It was developed by the Government National Mortgage Association (GNMA or “Ginnie Mae”), which was established as a corporate instrument of the United States and guarantees the due payment of interest and principal on those securities backed by pools of mortgages and additionally insured by the FHA (The Federal Housing Administration) or the VA (The Veterans Administration).41 The motivation of GNMA is based on the fact that the market of housing finance was illiquid, inefficient, fragmented, and with different mortgage rates depending on the region during that time. This led to a lack of available and consistently priced capital, since lending institutions stored the mortgage until the principals were paid off. Up to now the GNMA has guaranteed more than 2.6 trillion US dollars in mortgage-backed securities by supporting more than 33 million households in America.42
In the 1980s ongoing deregulation led to a rapid growth of securitization as a technique within the USA. Then in the 1990s the market for securitization also grew in Europe starting off in France and Great Britain and also in Germany. Asset-backed securities are being used and are gaining more and more in popularity.43 Since that time the financial tool ABS has not only been based on mortgages, but also on consumer loans, credit card balances, boat loans, student loans, computer equipment leasing, airplane leases, high-yield bonds, life insurance policy loans, commercial real estate loans, automobile leasing and loans and other types of collateral.44
The market for asset- backed securities grew from a non-existent industry in 1970 to a $6.6 trillion industry as of the second quarter of 2003.45
Even though the asset-backed securities transaction has no standardized form, every structure of an ABS transaction has certain basic elements which occur in every transaction variation. In order to gain a deep understanding of the ABS transactions it is essential to provide information on some basic elements.46
As shown in figure 1 the special purpose vehicle (SPV) is the basic element of this ABS transaction, since it transforms illiquid assets into liquid ones. In order to be able to influence the characteristics of the cash flows securitized, the SPV buys the assets from the selling enterprise (originator) and finances the purchase price through an emission of its own securities onto the capital market, based on its asset values.47 As a rule special purpose vehicles are based in countries with low taxes like Jersey or Grand Cayman, since those countries usually require less equity capital. Furthermore they are founded as a public trust, which own themselves and have the possibility to free the buyer from value-added tax.48
The relationship between the originator and the special purpose vehicle presents the key to the aims, which are bundled with the ABS transaction. The originator sells its receivables at the purchase price. Referring to the purchase price, its refunding is effected through the SPV by structuring its cash flows and issuing adequate securities on the capital market. This is where investors acquire securities of a high credit rating while receiving interest and redemption payments in return for providing liquidity. An ABS transaction involves far more parties, which are as important as the main parties just described. This includes the service agent, rating agency, protection seller, trustee and sponsor who provides the liquidity line.49
According to: Achleitner, A. -K. (2002), p. 425 Figure 1: Basic Structure of an ABS Transaction The service agent carries the responsibility of settling the payment flows. This can either be an independent third party or the originator itself, which might also take care of servicing the investments. In this case the originator receives a fee for its additional services. The original debtor does not recognize the transfer, because of its continuing payments to the originator.50 Either the service agent or the originator receives a “service-fee’’, which is calculated percentually on the amount of the loan. The trustee acts as the intermediate between the service agent and the investors.51 The trustee’s duties include the discretionary administration of the secured assets as well as monitoring the fulfilment of the contract for the entire transaction. Furthermore, it is usually an independent auditor and fully liable for any breaches of contract.52
The sponsors such as banks provide a liquidity basis for the surplus settlement, since recoveries can be unsteady. In order to improve the credit quality the protection seller provides subordinated security basis. This improvement of the credit quality, which is also called credit enhancement, allows an excellent rating by the rating agencies. The evaluation by the rating agencies, which calculate the probability of failure, presents the key to win investors, since investors only have limited possibilities to estimate the portfolio of receivables themselves. Further information on rating will be provided by the author in chapter 2.6.53
The asset-backed commercial paper program displays a certain type of the basic structure of a classical ABS transaction as outlined in chapter 3.3. In this transaction the SPV acquires the receivables from either one or more originators to refinance those acquisitions by issuing short-dated money market papers.54 This difference is called a single seller or a multi-seller structure. The quantity of refinanced portfolios constitutes a further important criterion for the entire transaction. There are transactions with just one receivable seller, whereas the owner of the receivable refinances its self-generated receivables by an ABCP transaction. Thereby the purchase- and refinancing institution can be identical.55
On the other hand there is the multi-seller transaction, where several receivable sellers refinance their receivables together. A multi-seller transaction can include different types of refinancing. These bundled receivables will be sold to a purchase entity, which will be refinanced by a single refinancing institution, which is also called conduit.56 The advantage of a multi-seller program is that it makes a liquidity effective sale of receivables possible even for companies with a rather low store of receivables of short average terms. In spite of multi-seller programs having a higher number of sellers of receivables they should at least generate a minimum volume of €30 million.57
In contrast to the SPV’s with long-term ABS transactions, special purpose vehicles do not expire upon repayment of the receivables bought and the simultaneous redemption of the securities emitted. Instead, repayments are generally used to acquire new receivables and to redeem commercial papers that are due by emitting new commercial papers.58 The SPV in an asset- backed commercial paper program, or conduit, is to be understood as a type of fund, which refinances its purchase of receivables by issuing commercial papers.59 Those conduits are mostly founded by banks which are named sponsors in this relationship. Usually there is a general agreement between the two institutions concerning the maturity of three to five years. Receivables which fulfil certain criteria, up to an agreed upper limit are sold to the conduit, thus generating liquidity.60 This gives the banks sponsoring the conduits the possibility to provide their customers a cheaper alternative for financing.61
According to: Emse, C. (2005), p. 38
Abbildung in dieser Leseprobe nicht enthalten
Figure 2: Basic Structure of an ABCP Program
As in the case of classic long-term transactions, the cash flow arising out of the receivables sold to the conduit are transferred to the investors and used for interest and redemption payments. However, due to the fact that conduits use repayments to acquire new receivables and to redeem commercial papers that are due by emitting new commercial papers, ABCP programs are the subject to a special liquidity risk. Since ABCP’s usually have a maturity of 90 days and are normally redeemed by way of new commercial papers, repayments of or out of the receivables bought are usually due later and are generally used to buy new receivables.62 In order to avoid a shortage of liquidity (for example if no new commercial papers can be placed onto the capital market, sold to investors or because payments of the receivables are delayed) so-called liquidity facilities (see chapter 220.127.116.11) are made available in general from banks with bestpossible creditworthiness for 364 days to the total amount of the outstanding commercial papers in order to ensure the timely redemption of papers that are due. It is important to note that liquidity facilities can only be used for temporary incongruities between the conduit’s incoming and outgoing payments. Defaults in the sense of a severe credit risk normally are debited from the investor if no other forms of additional securitization in form of credit enhancements are activated.63
Even though mortgage-backed securities (MBS) are a variation of asset-backed securities, the Anglo-American literature distinguishes between the MBS and the other variations, because of their historical development, as mentioned in chapter 2.2.64 These types of securities are debt issues, made by banks or loan associations which “pool’’ the mortgage loans together.65 The special character of this form of securitization of these receivables is due to its secured residential properties. In particular banks and further financial service providers use MBS to refinance their high class portfolios.66
Mortgage-backed securities have developed several subtypes in the US, based on the idea of three different types of payments. There are interest payments, prepayments and amortization payments. Prepayments are payments which are settled before the planned date and could lead to a prepayment risk which will be described by the author in chapter 3.8. The simplest structure of an MBS is the pass-through structure (see also chapter 3.6.1). This is where cash flows are pooled and forwarded to the investors. Every investor has an identical position concerning risk and cash flows. Furthermore the type of collateralized mortgage obligations (CMO) was developed since they are able to emit various types of securities of different duration. The cash flows of the CMO’s are also pooled and relocated afterwards, but while investors receive the interest payments, the redemption payments first go into the securities which are in the first securities class. Once this securities class is satisfied concerning redemption payments those payments begin for the next securities tranche.67 A tranche is a combination of portions or slices, whereas a CMO can have as few as two or as many as 40 different tranches.68 This process of tranches spreads over the entire securities classes. This leads to securities which receive redemption payments at different times and therefore have different risk positions concerning the prepayment risk which will be discussed by the author in chapter 3.8.1. Further variations of the mortgage-backed securities are the stripped mortgage backed securities, which includes two classes with one class only receiving interest payments (IO) and the other only principal payments (PO). Besides those basic types of MBS there are also the commercial mortgage backed securities (CMBS) which securitize commercially used estates or manufactured housing backed securities, which securitize on the basis of prefabricated houses.69
The term collateralized debt obligation (CDO) is only a generic term. The group of CDOs is not homogeneous, but can be divided into two subcategories. On the one hand it can be distinguished into collateralized bond obligations (CBOs), on the other collateralized loan obligations (CLOs). While CBOs are based on bonds, CLOs have their basis in loans.70
The market for CDOs is considered to be the newest one in asset-backed securities. These papers bundle high yield debt or loans with optimizing returns by managing risk efficiently.71 A package of collateralized debt obligations includes securities rated from investment-grade to speculative grade (see chapter 3.7.3). The CDOs are of a high quality once they hold the first claim on cash flows of the package. But safety leads to relatively low return rates (see chapter 2.5).72 The speculative grade securities are the first ones bundled in a pool. After making several credit enhancements (see chapter 3.9) the investment grade securities are emitted in several tranches. Since the cash flows are reorganized within this transaction there are arbitrage possibilities which occur because of the return differences between the securities with or without an investment grade. Investors that are usually not able to invest in those asset classes because of regulatory obstacles have a chance to do so. In contrast to the CDOs, the CLOs are based on investment grade rated loans. Financial institutions use CLOs in order to influence and improve their balance sheet structure and to manage credit risks specifically. CLOs are usually much more heterogeneous because of their lacking standardization. It is to verify how their portfolios are diversified concerning if there are not only single debtors to achieve the same evaluation amongst rating agencies as normal asset backed securities transactions. The phase of structuring CLOs usually lasts for about six month. Besides those conventional CLOs there are also synthetic ones, where the assets stay in the originators accounts, but the risks are forwarded to the investors by credit derivatives. Presumably both types will continue to coexist, since both bear specific advantages.73
Borrowers are divided into two different types depending on the borrower’s credit history. The first type which is called “A” credit borrowers or prime borrowers is able to fulfil the required underwriting standards concerning its payments not exceeding the income (payment-to-income ratio).74 Underwriting is defined as the process of applying guidelines that provide standards to evaluate whether a loan should be approved or not. Those loans are also called conforming loans and mean a low risk to the lender. According to the payment-to-income ratio it is required that one’s monthly expenses such as property taxes, and insurance and mortgage payment should not exceed 25 percent to 28 percent of one’s gross monthly income. Other long-term debt payments like automobile loans or child support should not exceed 36 percent of one’s gross monthly income. Additionally, a prime borrower is required to hold cash reserves in a bank account.75
The second type of borrowers are “B” and “C” borrowers or subprime borrowers. These borrowers are defined as ones who are not able to fulfil the standards for the paymentto-income ratio. Borrowers of subprime loans include those who have had problems repaying their debt, job loss or are not able to manage their finances. The subprime mortgagers can also be divided in risk categories from “B” to “D” and every originator uses their individual profiles for classifying their borrowers into the risk categories.76 Borrowers who are rated “B” had only a few credit problems such as making a late payment or two with good reason. A borrower’s credit history which is rated “C” can include several late payments and even a bankruptcy. The loan business for subprimes grew enormously over the past years even though their guidelines are much more informal than they are for the prime borrowers. These loans are also called nonconforming loans.77
The payment of interest and redemption are transactions which result from the cash flow of the assets within an ABS transaction, which can be divided into the two sections "pass-through" and "pay-through". Depending on tax, accounting and regulatory needs issuers can then choose from these different types.78
The concept of pass-through securities is based on the possibility of forwarding payments for interest and redemption of the receivable to the investors of the securities. This happens, depending on the amount of the payments, for example once a month. The height of the payments can not be foreseen for the investors and depends on the incoming interest- and redemption payments.79 Therefore the pass-through structure is kind of a co-ownership and very similar to an investment fund. Basically there are three different types of pass-through structures. There are ordinary interest payments, ordinary redemption payments and prepayments of redemption.80 From the investor’s point of view it is problematical that the average maturity (duration) is not known.81 Especially in an economy with decreasing interest rates the borrowers might be interested in prepaying their redemptions as soon as their loan contract permits. In this case the ABS investor does not only have unexpected high flow backs from the securities, but also has to reinvest in a low interest level.82 This leads to clear disadvantages for the investor, since he has to deal with the risk of changing interest rates.83 The pass-through structure requires a relatively homogenic pool of securities for payment deadlines and their maturity.84 Furthermore, it is important that the assets have a higher yield than the pass-throughs.85
The pay-through concept has the advantage of being inexpensive, since the assets are not carried forward, but stay with their original holder. The SPV only obtains the claim of editing the cash flows which are the outcome of the assets. This correlation bears a relatively weak legal position, since the holder would have the chance to speculate on the assets. This could be avoided by credit enhancements, which will be explained by the author in more detail in chapter 3.9. The advantage of a pay-through structure is that the special purpose vehicle is able to build up a well-structured portfolio, which can serve the investor’s needs without credit enhancements, since it is possible to negotiate the cash flows of the assets to the SPV inexpensively.86
1 Cf. Brost, M. et al. (2007), p. 19.
2 Cf. Fischermann, T. et al. (2007), p. 27.
3 Cf. Gerth, M. (2007), p. 86.
4 Cf. Gundlach, M., Lehrbass, F. (2004), p. 311.
5 Cf. Spremann, K. (2006), p. 5.
6 Cf. Markowitz, H. M. (1970), p. 3.
7 Cf. Markowitz, H. M. (1970), p. 4.
8 Cf. Markowitz, H. M. (1970), p. 5.
9 Cf. Markowitz, H. M. (1970), p. 5.
10 Cf. Markowitz, H. M. (1970), p. 5.
11 Cf. Markowitz, H. M. (1970), p. 6.
12 Cf. Guilding, C. (2002), p. 70.
13 Cf. Morris, V. B., Morris, K. M. (2005), p. 50.
14 Cf. Markowitz, H. M. (1970), p. 6.
15 Cf. Sharpe, W. F. (1964), p. 425 ff.; Lintner, J. (1965), p. 13 ff.; Mossin, J. (1966), p. 768 ff.
16 Cf. Natter, A. (2002), p. 31.
17 Cf. Merton, R. C. (1990), p. 43.
18 Cf. Natter, A. (2002), p. 31.
19 Cf. Steiner, M., Bruns, C. (2000), p. 21.
20 Cf. Ross, S. A. (1976), p. 341 ff.
21 Cf. Brealey, R. A. et al. (2006), p. 199 ff.
22 Cf. Steiner, M., Bruns, C. (2000), p. 30.
23 Cf. Steiner, M., Bruns, C. (2000), p. 13 f.
24 Cf. Markowitz, H. M. (1952), p. 89.
25 Cf. Markowitz, H. M. (1970), p. 5.
26 Cf. Wilhelm von Finck AG (2007), p. 108 ff.
27 Cf. Wilhelm von Finck AG (2007), p. 108 ff.
28 Cf. European Central Bank (2003), p. 29f.
29 Cf. Wilhelm von Finck AG (2007), p. 108 f.
30 Cf. International Monetary Fund (2006), p. 107 ff.
31 Cf. Achleitner, A. -K. (2002), p. 419.
32 Cf. Glantz, M. (2003), p. 76.
33 Cf. Rosenthal, J. A., Ocampo, J. M. (1998) p. 3.
34 Cf. Glantz, M. (2003), p. 444.
35 Cf. Kuhn, R. L. (1990), p. 345.
36 Cf. Gruber, J. et al. (2005), p. 63; Ergenzinger, T. (2003), p. 311.
37 Cf. Achleitner, A. -K. (2002), p. 420.
38 Cf. Böhmer, M. (1996) p. 19.
39 Cf. Achleitner, A.-K. (2002), p. 422 f.
40 Cf. Böhmer, M. (1996) p. 19.
41 Cf. Hendersen, J. Scott, J. P. (1988), p.166 f.
42 Cf. www.ginniemae.gov, Status 26.11.2007.
43 Cf. Achleitner, A.-K. (2002), p. 423.
44 Cf. Coym, P. (1997), p. 4; Brealey, R. et al. (2006), p. 675.
45 Cf. www.americansecuritization.com, Status 26.11.2007.
46 Cf. Achleitner, A.-K. (2002), p. 424.
47 Cf. Achleitner, A.-K. (2002), p. 424.
48 Cf. Piossek, I., Wölfle, P. (2007), p. 334.
49 Cf. Achleitner, A.-K. (2002), p. 424 f.
50 Cf. Kaltenhäuser, I. (2006), p. 24.
51 Cf. Böhmer, M. (1996), p. 22.
52 Cf. Kaltenhäuser, I. (2006), p. 24.
53 Cf. Achleitner, A.-K. (2002), p. 425 f.
54 Cf. Alenfeld, C. (2002), p. 18.
55 Cf. Pfaue, M. (2003), p. 172.
56 Cf. Pfaue, M. (2003), p. 172.
57 Cf. Alenfeld, C. (2002), p. 20.
58 Cf. DG Bank (2000), p. 2.
59 Cf. Emse, C. (2005), p. 37.
60 Cf. Alenfeld, C. (2002), p. 18.
61 Cf. Fitch IBCA (1999), p. 1.
62 Cf. DG Bank (2000), p. 9.
63 Cf. Emse, C. (2005), p. 37.
64 Cf. Röchling, A. (2002), p. 13.
65 Cf. Nissenbaum, M. et al. (2004), p.74.
66 Cf. Achleitner, A. K. (2002), p. 431.
67 Cf. Achleitner, A.-K. (2002), p. 431.
68 Cf. Thau, A. (2000), p. 189.
69 Cf. Achleitner, A.-K. (2002), p. 431 f.
70 Cf. Achleitner, A.-K. (2002), p. 432.
71 Cf. Choudry, M. et al. (2002), p. 227.
72 Cf. Scott, D. L. (2003), p. 69.
73 Cf. Achleitner, A. K. (2002), p. 432 f.
74 Cf. Fabozzi, F. J. (2002) p. 286.
75 Cf. Bronchik, W. (2003) p. 25 f.
76 Cf. Fabozzi, F. J. (2002) p. 286.
77 Cf. Bronchik, W. (2003) p. 28.
78 Cf. Silver, A. A. (2001), p. 18.
79 Cf. Böhmer, M.. (1999), p. 164.
80 Cf. Ohl, H. P. (1994), p. 47.
81 Cf. Bär, H. P. (2000), p. 138.
82 Cf. Ebberg, J. (1997), p. 16; Dickler, R. A. (1991), p. 110.
83 Cf. Dickler, R. A. (1991), p. 110.
84 Cf. Böhmer, M.. (1996), p. 23.
85 Cf. Meiswinkel, C. (1989), p. 5.
86 Cf. Piossek, I., Wölfle, P. (2007), p. 334.
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