Securitization and Mortgage Market Task Write Up
The Assets, Research the originator, seller, and loan pool.
What can you find out about the originator of the vehicle loans?
The originator of any vehicle loan is the company that creates a special purpose vehicle for issuance of asset backed securities. In the current scenario, the relevant underlying company is ‘Volkswagen leasing GmbH’. Issuing asset backed loans is not a new or novel concept for Volkswagen. Till date, it has issued 25 publically rated German auto lease transactions. Since it has issued an enormous amount of high rated asset backed securities, therefore, due to the exceptional track record, the asset quality of this asset backed security issue is considered safe and high rated.
Who is the issuer of the ABS, and where is the issuer located? Why?
The issuer of the ABS could be a company, a trust, a special purpose entity or any other legally originated company, which issues the asset backed securities on behalf of the originator. In the current scenario, on behalf of Volkswagen leasing GmbH, a Luxembourg based special entity; VCL multi-compartment SA is issuing the securities. Till date, this SPE has successfully issued 8 ABS transactions. As depicted by its name, this entity is located in Luxembourg.
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Describe the underlying loan pool. What are the main features of the underlying assets? Any particular features, a USD-based investor, should be paying attention?
The underlying loan pool consists of two types of securities namely security A and security B. Security A consists of a major chunk of overall balance. On the other hand, the class B notes amount to just 22.5 million Euros. On a preliminary basis, the AAA and A+ rating is given to class A and class B notes respectively. Both these loans types mature in the year 2019. The interest paid on them is in the context of EURIBOR. This feature of these loans may be quite attractive for some dollar dominated investors as many times investors require fixed payments in foreign currency interbank rate.
Who is the servicer of the ongoing cash flows?
The loan servicing firms will the one which is going to receive the payments on behalf of the creditors of special purpose vehicle. In the current scenario, the servicer of the loan is the originator itself, Volkswagen GmbH. The disbursement or the cash flow, on the other hand, will be carried out by the special purpose entity, VCL multi-compartment.
What are the key legal issues in structuring an ABS deal such as this one?
There are a number of legal issues that are vital in relation to ABS deal. Firstly, there should be a clear distinction between the asset of SPE and the originator. The sale of the asset to the SPV should be complete, and the special purpose entity should have its own separate legal identity. The assets must be owned solely by the SPE. There could also be several tax issues in the origination of SPE. As the newly created SPE is a wholly owned separate legal company, therefore, the tax rate and other deductions are applicable. However, the nature of the legal aspect of SPE can be changed in order to control or handle tax related issues.
Research the issue, its trading, and its pricing. Document your answers with suitable screenshots from Bloomberg whenever appropriate.
When exactly did the issue come to market and how was it priced?
As shown in the screenshots in Appendix A, the issue first came to the market on 25th of October 2013. The interest rate on security A was EURIBOR plus 30BP. On the other hand, security B offered as rate of EURIBOR plus 67 BP. Both the securities A and B were trading at 697.5 and 22.5 million Euros respectively. Both securities were traded at Luxembourg stock exchange.
Calculate each tranche's duration.
Exhibit B shows the duration of each tranche at different levels of CPR. The CDR is fixed at 0.5%.
Investigate the price evolution and how issue has fared since coming to market. What was the last closing price? Trading volumes?
Appendix C depicts the price evolution of both securities after their issuance. The lowest price of security A was on the issuance date of 25th October 2013. After this date, the security has seen both increasing and decreasing trend. The last available price of security was at 10.288% on 22nd November 2013. On the other hand, after attaining a lowest value on 5th of November, security B’s price has been almost constant around 100.035-100.04%. Its last available price on 22nd November was 100.0288%.
What is the interest-rate risk in the structure, and what financial techniques are used to manage them?
Both securities pay a fixed rate depending upon the value of EURIBOR. EURIBOR can increase or decrease substantially in any given month. Therefore, the securities are highly exposed to the risk of low interest rate. There is also a fixed portion in the interest rate that remains unchanged. Essentially, these securities are issued at floating rates. To counter the interest rate risk, interest rate swaps are used to ensure that the value of EURIBOR remains in a tight window.
What are some of the other major risks associated with the issue? How do they affect pricing, investing, and trading in the issue?
There are various risks associated with this trading and transactions. However, only the main and crucial points will be discussed. Firstly, there is a risk of late monthly repayment. In this case, the collateral amount is extended to cater for the deficiency. Also, the credit risk of the issuer is also a major concern. This risk is mitigated by employing interest rate swaps. Additionally, another crucial risk is the market or liquidity risk. In the current scenario, there is no active market for the bonds, and once they bought, they cannot be liquidated for quite a long time. The liquidity issue should be addressed in the pricing in terms of a high return. Otherwise, the transaction might not be successful.
How does the issue’s design mitigate or exacerbate the risks? What enhancements, if at all, exist to address investor concerns?
All the major risks in the issue and further trading are mitigated to some extent. For the late monthly repayments, a separate account has been created to make sure that monthly installments are on time. Also, to reduce the risk associated with the floating rate, an interest rate swap has been initiated. In the case of minor insolvency, the warranties are present.
Provide your perspective on commingling risk, on pro rata and sequential payment methods, and how the issue is structured in this regard.
The issuer, VCL multi-compartment, is deemed to commingle the notes receivable and the amount resulting from the disposition of the vehicle. Additionally, it also bears the duty of depositing the amount in the distribution account on each payment date. Additionally, the decision related to the investment of extra or collected commingled funds also lies at the hand of VMC. At the same time, if the issuer finishes being the collector, it has to deposit the funds on the prescribed dates in the account. Also, seller risks are mitigated through a separate asset pledge. However, in case of non-deposit, investors may incur a loss. The issue structure does not take into account this issue.
The crucial factor in an issue's reception and pricing are the rating studies.
What are some of the basic assumptions in S&P rating rationale? How valid are these assumptions?
S&P has rated the securities by taking into consideration 6 broad risks. In operational risk evaluation, S&P has assumed that due to a brilliant track record of the originator, the securities should be rated high. In credit risk, S&P has made certain assumptions about the unemployment rate and the nonpayment of installments due to this issue. Additionally, S&P has assumed that the base case for a net loss would be 1%. The assumption of unemployment should be considered seriously by taking into consideration figures and numbers from external sources.
How did S&P model this securitization? What are the important features of their approach?
S&P has modeled this securitization by employing certain criteria. It has carried out a cash flow analysis by incorporating the credit risk of the installments. Additionally, certain other risks like economic outlook and counterparty risk are also considered. After carrying out the cash flow analysis, the scenario testing is being done. Scenario testing depicts the change in the value of the securities in relation to change in certain variables. After a detailed analysis, S&P has provided the final rating for both securities.
How strong is the rating agency's confidence in this particular issue?
The confidence of rating agency in the issue and the issuer is depicted after the final model for securitization has completed. S&P is very confident about security in terms of its payments of installments and risks mitigation techniques. The confidence of the rating agency, S&P, is also showed in the final ratings for the securities. Both securities are ranked exceptionally high.
What are the reasons for the rating given by S&P to the senior notes? The subordinated ones?
The rating given to securities is depended on numerous factors like credit support and comparison with past issues of these securities. In the last issue, the subordinated notes were 3% of the overall principle balance. In this issue, this percentage has decreased to 2.8%. This means that there will be less credit support for subordinated loans than before. On the other hand, the credit support for the senior notes has increased by 2%. This difference is clearly reflected in the rating of the issue. Senior notes are given a higher rating than the subordinated notes.
Duration of Tranches
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