1. FASRI Office Hours Securitizations Catherine Shakespeare

2. How does a securitization work? Assets Account Receivables A Account Receivables B Account Receivables C Pooled AAA Tranche Mezzanine A Retained Interest Mortgage-backed Securities

3. What is a CDO? Collateralized Debt Borrowing Mortgage-backed Securities Assets Mezzanine C (From another securitization) Mezzanine C (From another securitization) Mezzanine B (From another securitization) Mezzanine B (From another securitization) AAA Tranche Mezzanine D Residual Account Receivables A Account Receivables B Account Receivables C Pooled Pooled ABC AAA Tranche Mezzanine A Retained Interest

4. CDO 2 Assets Mortgage-backed Securities (MBS) AAA Tranche Mezzanine G Residual Collateralized Debt Borrowing Account Receivables A Account Receivables B Account Receivables C Pooled ABC AAA Tranche Pooled DEF AAA Tranche Mezzanine A AAA Tranche Mezzanine D Residual Retained Interest Mezzanine A Mezzanine B (from another MBS) Mezzanine C (from another MBS) Mezzanine E (from another MBS) Mezzanine F (from another MBS)

5. What happens on when the cash flows disappear? Assets Account Receivables C Pooled AAA Tranche Mortgage-backed Securities Account Receivables A Account Receivables B Mezzanine A Retained Interest Note:Indicates the default portion

6. Extends into the CDO market Collateralized Debt Borrowing Mortgage-backed Securities Assets Pooled Pooled ABC AAA Tranche Account Receivables A Account Receivables C Account Receivables B Mezzanine A Mezzanine B (From another securitization) Mezzanine C (From another securitization) AAA Tranche Mezzanine D Residual Note:Indicates the default portion Retained Interest

7. House of cards start to fall…. Assets Mortgage-backed Securities (MBS) Collateralized Debt Borrowing Account Receivables C Pooled ABC AAA Tranche Pooled DEF Mezzanine A Account Receivables A Account Receivables B Mezzanine A Retained Interest Mezzanine B (from another MBS) Mezzanine C (from another MBS) Mezzanine D AAA Tranche Mezzanine E (from another MBS) Mezzanine F (from another MBS) Residual AAA Tranche Mezzanine G Note:Indicates the default portion Residual

8. Asset Derecognition Asset sold for cash, seller has no further involvement Asset sold for cash, seller has a call option to repurchase the asset, option way out of the money Asset sold for cash, seller has a call option to repurchase the asset, option way in the money Firm has a call option to purchase an option never owned

9. Asset Securitization: Conceptual Issues What are the basic conditions for removing an asset from the books?  Is failure to meet the definition of an asset sufficient? –If not, is there a flaw in the definition?  Implications of answer –Income statement – gain/loss –Balance sheet – don’t remove asset cash received is a loan

10. Asset Securitization: Conceptual Issues Does ownership history matter? Can part of an asset be derecognized? Modifications introduced as part of the transfer  Derivatives or guarantee –Derivative offsets risks but introduces a new source of risk (counterparty performance) –Cash flows may come from sources other than the asset Should these differences affect the accounting treatment?

11. Asset Securitization: Conceptual Issues Is legal isolation required? Does the order of the transactions matter?  Fixed price call option to repurchase a previously owned asset, versus the same option on an asset never owned Can pieces of an asset be sold?  Strict control might say no, strict components would say yes  How would you divide the asset? –Cash flows, risk How does derecognition interact with the choice of measurement attributes?

12. Asset Securitization: Possible Approaches Risk and Rewards  Compare transferor’s exposure before and after the transfer –Should we look at max exposure or expected exposure? Control  Assets are placed beyond reach of the transferor and creditors  Transferee must be able to pledge/exchange assets –Should we really look to the transferee to determine the transferor’s accounting? Components Approach  Focus on the contractual pieces –Every call put etc would be separately valued