COLLATERAL CLASSES: BASIS OF CLASSIFICATION
Existing Assets and Future Flows
From the viewpoint of whether the asset pool will comprise of existing cash flows, or expected cash flows, we make a broad distinction between existing assets and future assets.
In an existing asset securitization, the cash flow from the asset exists and there is an existing claim to value. In a future flow securitization, there is no existing claim or contractual right to a cash flow; such contractual rights will be created in the future. For example, an airline company securitizing its future ticket receivables is a case of a future flow securitization, since it is based on expected cash flows. On the other hand, in case of securitization of loan receivables, we have an existing contractual claim on the cash flows—so, it is an existing asset.
The distinction between existing assets and future flows is relevant from several viewpoints:
1. In future flows, as the cash flows are to be originated in future, there is a performance risk on the originator. Sometimes, this performance risk may be mitigated by guarantee by a third party. For instance, in the case of construction of infrastructure facilities, it is quite common for some state agency to provide a guaranteed return. In either case, if the originator fails to perform, or the guarantor fails to pay the guaranteed sum, there would be no cash flows to pay the investors. Hence, future flows transactions cannot be independent of the originator. This is in direct contrast to an essential securitization principle wherein the securities are liquidated from out of assets without piggy backing on the originator. Hence, the structuring as well as rating of future flows securitizations has to bear in mind originator dependence. We return to this issue later as we discuss future flows.
2. It is also obvious that the potential users of future flows securitization are corporates, whereas the principal originators in case of existing asset transactions are financial intermediaries.
3. Given the nature of cash flows, the key risks that affect existing asset transactions such as default risk, prepayment risk, and the like are not applicable to future flows. There are other significant volatilities, mostly having to do with the business and the source of revenue, that enter the picture.
4. Off-balance-sheet treatment of securitized assets is a common feature of most securitizations. However, in the case of future flows, there is no off-balance-sheet treatment usually. This is understandable, since there is no on-balance sheet asset such as receivables, as in case of existing asset transactions, that would go off the balance sheet.
5. Motivations such as capital relief do not apply to future flows.
6. From a legal and taxation viewpoint as well, future flows are treated as closer to debt than sale of assets.
Cash and Synthetic Structures
A securitization transaction may either aim at transferring assets for cash or may simply aim at stripping the risk inherent in credit assets and transferring the commensurate risk. While the former are known as cash securitizations, the latter are called synthetic securitizations.
In the case of synthetic transactions, the focus is on risk transfer. Here, assets are not actually transferred, but the risk/returns from assets are transferred using a derivatives contract. Truly speaking, risk transfer-based transactions are not an asset class but a type of transfer technology. A synthetic transaction may relate to a pool of mortgage loans, auto loans, or, for that matter, even future flows. Hence, Figure 8.1 shows a combined picture of existing assets, future flows and risk transfers.
Retail versus Whole Sale Assets
Yet another basis for making a distinction between asset classes is by the nature of the obligors in the pool—retail versus whole obligations. The distinction between retail and wholesale loans is not merely having to do with the size of the funding but also the purpose of the loan. Normally, in case of business loans, the purpose of the loan is to acquire an asset which is a source of cash flows or cash savings. Retail loans are typically personal loans.
Securitization of corporate or business loans are termed as collateralized debt obligations (CDOs). We will discuss the special features of a wholesale loan portfolio from the viewpoint of securitization in Chapter 11.
FIGURE 8.1 Classification of Assets on Basis of Existence of Assets
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