Culp Chapter 16, Securitization

Discussion in 'P2.T6. Credit Risk (25%)' started by Hend Abuenein, Feb 18, 2012.

  1. Hend Abuenein

    Hend Abuenein Active Member

    Hi David,

    With regards to issuing securities through the approach of creating a trust, you say that :

    Would you please clarify farther the form that these beneficial interests take so that they would back the claims on the issued securities?

    I understand that the grantor trust has fiduciary responsibilities towards the master trust on these assets as its deposits. But what exactly happens in case these assets fail to produce cash flows adequate to cover issue's obligations towards investors?

    Thank you
  2. Hend Abuenein

    Hend Abuenein Active Member


    Would you please explain what the description "Non Passive" means for SPE?

    Thank you
  3. Hi Hend,

    I don't know, sorry. I looked in my (formidable) library, but I can't find anything exactly on point; an exacerbating factor is recency. As I am certain you realize, this is from Culp's chapter on securitization and since FAS 140 has been updated, some of him is outdated (e.g., I had to bug GARP for two years to delete references to QSPE). I don't know if recency is an issue here (I don't know if the utilization of grantor/master trusts has changed) but the caveat is, as you would expect: the securitization structures can have motivations according to TAXES, ACCOUNTING (e.g., off balance sheet), and/or LEGAL (e.g., bankruptcy remote), each of which may or may not have changed since the publication of Culp.

    In this case, from the investor perspective, I don't know why the nature of their claim would be materially different; that is, instead of selling securities (credit linked notes) to investors which are collateralized (directly) by the assets (loans) in the SPE; the 2-trust SPE sells securities collateralized by beneficial interests in a trust that actually owns the assets. (Dear investor: your collateral is not assets-in-the-trust, but a beneficial interest in assets-in-the-other-trust). The motivation is, rather, legal and I suppose tax-driven. However, I do not think it is accounting driven. What I mean is, I don't *think* the 2 trusts achieves anything special w.r.t off balance sheet treatment or investor economics. Instead, the whole point is to give make the assets more bankruptcy-remote from the originator. (the protection motive here is, "if the originator goes bankrupt, can the originator's creditors claim these assets." This is a different issue than the performance of the securitized assets)

    Re "What exactly happens in case these assets fail to produce cash flows adequate to cover issue's obligations towards investors?"
    It's still a securitization, right? The junior invested to absorb those "fails." A failure of some assets to produce cash flow is not a legal event per se: it's a design feature.

    Here is the source Culp, in case it's useful:

    Sorry for the length, I would be shorter if i actually knew the answer to your question ! I hope you are doing well! :)
  4. Hend Abuenein

    Hend Abuenein Active Member

    Hi David,

    Thank're always more polite than I am :)
    I hope you're doing well too, and I appreciate that you're working with us on a Saturday.

    Reading through this chapter and the Enron case really steers my thoughts away from FRM and the exam.
    The bigger picture of how the financial system is being run/created looks really ugly to me.

    I hope someday we'll have time to share thoughts about this.

    Thanks again
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  5. Hend Abuenein

    Hend Abuenein Active Member

    Would you let me know the answer to my second question here please.
    It's in reply #2.
  6. Hi Hend,

    According to Culp Chapter 30 (not assigned, but this is clearly Culp's reference): "An entity is a VIE if by design either (1) it cannot finance its activities without additional subordinated financial support or (2) its equity holders, as a group, do not have the direct or indirect ability to make decisions about the VIE's activities"

    "Passive" is therefore an issue, and a legal matter, of who has decision rights (control; I know from experience that partnership can sub-divide these decision rights, so i doubt it's a clean yes/no matter; i.e., there are typically big strategic decisions versus smaller tactical decisions such that active/passive sometimes doesn't do just to the continuum of DECISION RIGHTS). Although, again, i don't know if Culp (the source) is current on this issue.

    Thanks, David
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