Analyse how issuing securitized products through a trust works differently from using a special purpose vehicle (SPV), and tell apart the three chief SPV structures: amortizing, revolving and master trust.
The idea
A securitized product can be issued by a special purpose vehicle, a separate company that owns the assets and issues the notes. It can instead be issued through a trust, a legal arrangement in which a trustee holds the assets for the benefit of noteholders without the trust being a corporate entity itself. Either way the aim is to isolate the pool from the originator. Three structures describe how the pool behaves over time. An amortizing structure passes principal collections to investors from the start, so balances fall with the pool. It suits mortgages and auto loans. A revolving structure uses principal collections to buy new receivables during a revolving period before amortization begins. It suits short-lived credit card balances. A master trust issues many series, at different dates, against one common pool, with the seller keeping a seller's interest. Early amortization triggers end the revolving period.
Formulas
Seller's interest in a master trust
seller's interest = (receivables − notes) ÷ receivables
- receivables
- the trust's current receivables balance
- notes
- the total balance of all series outstanding
Use current receivables in the denominator. A low seller's interest can force the seller to add receivables or trigger early amortisation.
A practice question
Which feature identifies an amortizing securitization structure?
- Principal collections are reinvested in new receivables for a fixed revolving periodWhy not: That describes a revolving structure.
- Principal collected on the assets is paid to investors from the start, so note balances fall as the pool amortizes - correct
- Several series of notes are issued at different times against one common poolWhy not: That describes a master trust.
- Investors receive interest only until a single bullet date, when the whole pool is soldWhy not: That describes a bullet structure; amortizing notes return principal gradually.
In an amortizing structure principal received is passed through to investors from the beginning. Mortgage and auto loan deals typically work this way.
A harder one
Which statement correctly contrasts issuing through a trust with issuing through an SPV?
- A trust is an arrangement in which a trustee holds the assets for noteholders and has no corporate personality, whereas an SPV is a separate company that owns the assets and issues the notes - correct
- A trust is a company with its own directors and shareholders that issues the notes, whereas an SPV is a contract under which a trustee holds assets for investorsWhy not: Reverses the two: an SPV is the corporate vehicle and a trust is the legal arrangement.
- A trust is always on the originator's balance sheet, whereas an SPV is always off itWhy not: Consolidation depends on control and risk retained, not on the legal form of the vehicle.
- A trust can only issue amortizing notes, whereas an SPV can only issue revolving notesWhy not: The legal form does not restrict the cash flow structure; either can amortize or revolve.
The distinction is legal form: a trust is an arrangement with a trustee acting for beneficiaries, while an SPV is a corporate entity. Amortizing, revolving and master structures can use either.
The hardest tier
A card master trust holds USD 1,000 million of receivables, financed by USD 600 million of Series A notes and USD 250 million of Series B notes, with the remainder the seller's interest. After weak purchases, receivables fall to USD 900 million while note balances are unchanged. The seller's interest as a percentage of receivables is closest to:
- 5.9%Why not: Divides the seller's interest of 50 by the notes of 850 instead of by the receivables of 900.
- 5.6% - correct
- 15.0%Why not: Reports the original seller's interest of 150 on 1,000 and ignores the fall in receivables.
- 11.1%Why not: Uses the 100 million fall in receivables as the seller's interest.
Notes are 600 + 250 = 850, so the seller's interest is 900 - 850 = 50, and 50 / 900 = 5.6%. A low seller's interest can force the seller to add receivables or trigger early amortization.
In the app: 6 practice questions on this outcome, spaced review that brings it back before you forget it.
Start free →More in An Introduction to Securitisation
- State what securitization is, outline its process and account for what each participant does.
- Explain cash waterfall, equity piece, first-loss piece and over-collateralization as they apply within securitization.
- Account for why securitization is undertaken and what it offers.
- Outline the different kinds of credit enhancement and weigh them up.
- Account for the tools used to analyse the performance of securitized structures and name the asset classes each suits best.
- Define and calculate, for relevant securitized structures, the weighted average life (WAL), weighted average maturity (WAM), weighted average coupon (WAC), debt service coverage ratio (DSCR), monthly payment rate (MPR), default ratio and delinquency ratio.
- Cover the techniques for forecasting prepayments, and compute the PSA (Public Securities Association) rate along with the CPR (constant prepayment rate).