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SECURITIZATION

• PROCESS OF TRANSFORMING OTHERWISE FINANCIAL
  ASSETS INTO MARKETABLE CAPITAL MARKET SECURITIES

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EARLY TYPICAL SECURITES

• GNMA PASS THROUGH
• AUTOMOBILE LOANS
• CREDIT CARD RECEIVABLES
• COMMERCIAL LEASES
• COMPUTER LEASES
• NOW BUSINESS LOANS

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EXAMPLE

• DAYTON HUDSON CREDIT CARD MASTER TRUST
• GO OVER

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SECURITIZATION PROCESS

• LOAN ORIGINATON - SETS TERMS
• TRUST - BUYS LOANS FROM BANK AND ISSUES
  SECURITIES
• INVESTMENT BANKER - SELLS SECURITIES FROM TRUST
• GUARANTOR -
• INVESTORS

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BUSINESS LOAN SECURITIZATION

• VERY SMALL SO FAR
• LOANS OUTSTANDING - 155 BILLION
• SECURITIZED LOANS - lt900 MILLION

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COMPARISON

• TRADITIONAL LENDING - originate, fund, service,
  monitor
• SECURITIZED LENDING - originate,sell, service

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Asset(loan) Securitized

• Illiquid
• imprecise valuation
• lender monitoring
• high operating costs
• limited rates/terms
• local investor market

• Liquid
• efficient market val.
• Third party assesses
• low operating costs
• wide range of rates
• national/global market

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REQUIREMENTS

• STANDARD CONTRACTS
• RISK RATING SYSTEM
• REPUTABLE CREDIT ENHANCERS
• STANDARDIZED LEGAL FRAMEWORK
• STANDARDIZED SERVICING QUALITY

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LOW GROWTHHIGH COST

• Specific borrower /local condition info. Needed
  for prediction of repayment
• Lack of standard loan term
• line of business/credit quality
• loan maturity
• pricing/covenants/collateral
• bank underwriting standards
• Lack of long term performance info.

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SBA GUARANTEED LOANS

• GUARANTEED PORTION SECURITIZED
• MONEY STORE INC. -380 MILLION SBA LOANS
• FREMONT FINANCIAL - 330 MILLION IN LOANS SECURED
  BY A/R, INV. AND F/A

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WHY THESE WORKED

• RIGOROUS UNDERWRITING STAND.
• SBA LOANS - VERY STANDARDIZED
• SIMILAR COLLATERAL/DOCUMENT.
• SBA CAN SUPPLY HISTORICAL LOSS EXPERIENCE DATA
• HIGH VOLUME LENDERS

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BACKUP REQUIRED

• LOSS PROTECTION ON 11-20 OF THE LOAN POOLS
• OR
• PURCHASE PRIVATE BOND INSURANCE

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MAIN BENEFITS TO LOAN ORIGINATOR

• LOANS SOLD/NO FUNDING NEEDED
• REDUCES MONITORING COSTS
• LOWER BORROWING COSTS DUE TO PREDICTABLE CASH
  FLOW FROM POOL OF ASSETS, NOT ONE

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CONT.

• RELEASE BANK CAPITAL TO OTHER PURPOSES
• MANAGE CREDIT RISK
• DIVERSIFY LOAN PORTFOLIO

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WHY FIRMS USE ASSET-BASED DEBT

• AVOID ASSET SUBSTITUTION COSTS
• Mgmt. Often replaces low risk assets with high
  risk after debt financing. Only the stockholder
  get the higher return.
• Only securitized debt ties the bond to specific
  asset - thus, no substitution

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Cont.

• Avoid underinvestment
• Equity holders of stressed companies unwilling
  to make marginal investment as only bondholders
  get the return.
• Use of asset-based security removes general
  company risk

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Cont.

• Secured debt reduces information asymmetry
  problem of management not acting in bondholders
  interests

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ISSUES FACED BY INVESTORS

• GUARANTEE ONLY PROVIDES LIMITED CREDIT PROTECTION
• INTEREST RATE RISK LIMITED BY BUYING TRANCHES
  IN DIFFERENT MATURITIES

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CONT.

• LIQUDITY RISK NOT A PROBLEM
• PERFORMANCE RISK - EX. CREDIT CARD RECEIVABLES IN
  A RECESSSION

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CONT.

• PREPAYMENT RISK - PARTICULARLY IN SECURITIES
  BACKED BY MORTGAGES
• GEOGRAPHIC CONCENTRATION

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MAIN BARRIERS TO BANK LOAN SECURITIZATION

• SIZE CONSIDERATIONS
• MIN. POOL FOR PRIVATE PLACE. -50m
• MIN. POOL FOR PUBLIC OFFER.-100m
• RECOURSE - INVESTOR HAS CLAIM IF SECURITY
  DEFAULTS
• RISK EXPOSURE - POOLED ASSETS ARE DIFFICULT TO
  MONITOR

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Cont.

• Lack of long term performance information