MorgaN      StearnS    CorporatioNStrategic Management Partners                            •   Copyright ©2012
STRUCTURED     FINANCE      Accessing   Capital Marketsthrough Securitization    Presented by      MorgaN StearnS       Co...
SETTING THE SCENEStructured Finance has become an increasinglyimportant tool in todays financial markets.“With the credit ...
CONCEPT OF A            STRUCTURE FINANCEStructured finance is used (in the broadest term) to describe a sector offinance ...
DEFINING       STRUCTURE FINANCEStructured finance can be attractive to a business that does not have much in the wayof ma...
distinctions within          structure finance                                  by Andreas (Andy) Jobst                   ...
Boundaries between                 Conventional vs.                Structured FinanceThe flexible nature of structured fin...
(Boundaries between        Conventional vs.    Structured Finance (cont.)In the second case, for instance, an Islamic loan...
ANATOMY OF A        STRUCTURE FINANCE                                An Overview                      SPECIAL PURPOSE VEHI...
ANATOMY OF A       STRUCTURE FINANCE             (cont.)Who will form the SPV? Morgan Stearns Corporation who will charter...
ANATOMY OF A        STRUCTURE FINANCE                               (cont.)                               An Overview     ...
ANATOMY OF A        STRUCTURE FINANCE                                    (cont.)Why do Structure Finance Need Securitizati...
ANATOMY OF A        STRUCTURE FINANCE              (cont.)What is the impact of Securitization on the Capital Market?• Sec...
ANATOMY OF ASTRUCTURE FINANCE        (cont.)Securitization framework                       •   Copyright ©2012
ANATOMY OF A         STRUCTURE FINANCE                                    (cont.)                          An Overview    ...
ANATOMY OF A        STRUCTURE FINANCE                                (cont.)How are CMT Advisors determined and recommende...
An Overall Scope of       Structure FinanceConclusion• Structured finance is a large, diverse and growing market. And it i...
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MS 2012 Structure Finance Guide

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Comprehensive Structure Finance Guide

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Transcript of "MS 2012 Structure Finance Guide"

  1. 1. MorgaN StearnS CorporatioNStrategic Management Partners • Copyright ©2012
  2. 2. STRUCTURED FINANCE Accessing Capital Marketsthrough Securitization Presented by MorgaN StearnS Corporation • Copyright ©2012
  3. 3. SETTING THE SCENEStructured Finance has become an increasinglyimportant tool in todays financial markets.“With the credit crisis and ensuing economic downturn, however, conventional finance’swinning streak had come to an end. Deal volumes have fallen dramatically, revenue growthrates that once topped 50 percent per year have plunged, and risk provisions have soared. “Structured Finance resurgence has been turning the crisis to an advantage andgiven rise to optimism. Over the past several years, the rise of structuredfinance—the business of accessing capital through capital market investments tobuild power plants, airports, roads, ships, and other expensive assets; to financetrade flows; and to acquire companies—has mirrored the global economicexpansion. Indeed, it is the allocation of capital by structured finance that in avery real sense makes economic expansion possible. Structured financingoperations have spanned into a wide array of instruments: leveraged buyouts,management buy-outs, restructuring, industrial projects, infrastructure projects;restructure secured debt; term loans, operating loans and asset-based securedlending.The concepts and strategies have been limited to High Net Worth corporationsand although accessible to mid to large-scale transactions in the emergent market,there are few that have knowledge to these opportunities.For well over a decade, Morgan Stearns Corporation has made it possible forcompanies in emergent markets to seize the opportunity through StructuredFinance. In summary, with the use of structured finance, many companies aregiven an opportunity for new life that would not have been possible otherwise. • Copyright ©2012
  4. 4. CONCEPT OF A STRUCTURE FINANCEStructured finance is used (in the broadest term) to describe a sector offinance that was created to help transfer risk using complex legal andcorporate entities. This risk transfer as applied to securitization of variousfinancial assets has helped to open up new sources of financing. Structured finance transactions rely on the concept of a special purpose vehicle (SPV) to provide improved predictability of outcome compared with a corporate credit in relation to a number of risk factors. The key feature that distinguishes structured finance transactions from a corporate credit is the structural isolation or "de-linking" of an underlying pool of assets from the corporate credit risk of the owner or "originator" of those assets. This is typically achieved in structured finance by the sale of an identifiable and specific pool of the originators assets to an SPV so that neither the assets, nor their proceeds on realization, will be available for distribution as part of the bankruptcy estate of the originator. The separation of a pool of underlying assets from the corporate credit risk of the originator is enhanced by using an SPV. Legal restrictions imposed on an SPV limit the business activities it is allowed to undertake. Unlike the corporate owners of the underlying pool of assets being securitized, SPVs are not intended to be operating businesses. Where an SPV has been restricted in its business activities and therefore has no (or a known) credit history, this improves the certainty of outcome for a structured finance transaction by reducing the risk of other creditors taking bankruptcy or other recovery action against the SPV. The SPV formation document, the documents relating to a particular transaction and the associated legal opinions are key documents for an analyst in assessing the extent of the separation of the assets from the bankruptcy risk of the originator, the benefits to any particular structure in using an SPV and consequently, whether a particular transaction can be classified as a structured finance transaction. • Copyright ©2012
  5. 5. DEFINING STRUCTURE FINANCEStructured finance can be attractive to a business that does not have much in the wayof material assets, but does have a strong client prospects and documented history ofmonthly billing coupled with consistent pay histories of the customers. Investors areoften willing to lend money to corporations of this nature, and do so at a lower rate ofinterest than a standard bank loan.For the business that is looking to expand, and needs cash to do it, structured financemay represent the most cost efficient way to manage the fund raising. Along with thelow amount of red tape involved with structure finance, this option also can movevery quickly, often much faster than obtaining a standard business loan.When more conventional methods of obtaining a business loan are either undesirableor not possible, there is always the option of structured finance. Structure financeessentially is the process of making a loan based on a strong performance in cash flowin the past. Rather than other assets being used as collateral, funds are advanced basedon the history that indicate a consistent flow of cash into the borrower’s business thatwill allow for the timely and orderly repayment of the loan amount.• Structured finance is also an excellent way for a company that is emerging from a rough period to get the operating capital it needs to get back on its feet and begin to grow once again.• Structured finance are applied to eliminate the higher interest liabilities, effectively exchanging them for lower interest and more manageable repayments, can be the answer. While the traditional finance sector may be hesitant to loan funds to companies emerging from this sort of situation, a structured finance scheme would take into account the stable and consistent cash flow from customer orders and consider the corporation a good risk.Structured finance can be considered a mode of CDO, or collateralized debtobligation. CDOs are basically a kind of structured credit product that is idea whenthere is some transfer risk with a company, but there is also potential for growth.Structured finance is ideal when the element of risk transfer makes an appeal toconventional finance sources unproductive, unattractive, or simply impossible. • Copyright ©2012
  6. 6. distinctions within structure finance by Andreas (Andy) Jobst of the Monetary and Capital Markets Department of (IMF)• Structured finance encompasses all advanced private and public financial arrangements that serve to efficiently refinance and hedge any profitable economic activity beyond the scope of conventional forms of on-balance sheet securities (debt, bonds, equity) in the effort to lower cost of capital and to mitigate agency costs of market impediments on liquidity. In particular, most structured investments (i) combine traditional asset classes with contingent claims, such as risk transfer derivatives and/or derivative claims on commodities, currencies or receivables from other reference assets, or (ii) replicate traditional asset classes through synthetication.• The premier form of structured finance is capital market-based risk transfer (except loan sales, asset swaps and natural hedges through bond trading, whose two major asset classes include asset securitization (which is mostly used for funding purposes) and credit derivative transactions (as hedging instruments) permit issuers to devise almost an infinite number of ways to combine various asset classes in order to both transfer asset risk between banks, insurance companies, other money managers and non-financial investors in order to achieve greater transformation and diversification of risk.• Structured finance are invoked by financial and non-financial institutions in both banking and capital markets to establish forms of external finance are either (i) unavailable (or depleted) for a particular financing need, or (ii) traditional sources of funds, which are too expensive for issuers to mobilize sufficient fund for what would otherwise be an unattractive investment based on the issuer’s desired cost of capital.• Structured finance offers enormous flexibility in terms of maturity structure, security design and asset types, which allows issuers to provide enhanced return at a customized degree of diversification commensurate to an individual investor’s appetite for risk. Overview of risk transfer instruments(**) ** - From the Journal Derivatves & Hedge Fund, Received(in revised form): 7th June, 2007 • Copyright ©2012
  7. 7. Boundaries between Conventional vs. Structured FinanceThe flexible nature of structured finance straddle the indistinct boundary betweentraditional fixed income products, debentures and equity on one hand and derivativetransactions on the other hand. Notwithstanding the perceivable difficulties ofdefining the distinctive nature of structured finance, functional and substantivedifferences between structured and conventional forms of external finance seem to bemost instructive in the way they guide a critical differentiation.The following definition reflects such a proposition if we compare two financialarrangements that share the same objective:a) Investment instruments are motivated by the same or similar financial objective from both the issuer’s and the investor’s point of view, but they differ in legal form and functional implementation. They also might require a different valuation due to a varying or different transaction structure and/or security design.b) Investment instruments are substantively equivalent (i.e. they are evaluated exactly the same in line with an equilibrium price relation), but they differ in legal form and might require a different valuation due to a varying or different transaction structure and/or security design.In the first case, pure credit derivatives are clear examples of structured products forcredit risk transfer, which allow very specific and capital-market priced credit risktransfer. Credit insurance and syndicated loans share the same financial objective;however, they do not constitute an arrangement to create a new risk-return profilefrom existing reference assets. Another example in this vein would be the comparisonof MBS and Project finance-and-brief-style transactions. Although both refinancingtechniques convert a credit claim or a pool of claims into negotiable securities, theyrepresent two distinct forms of covered bonds obtained from securitizing the sametype of reference asset either off-balance sheet (asset-backed securitization) or on-balance sheet (“Pfandbrief-style” securitization), or even through syntheticsecuritization. • Copyright ©2012
  8. 8. (Boundaries between Conventional vs. Structured Finance (cont.)In the second case, for instance, an Islamic loan becomes a structured financeinstrument whenever its formation through replication of conventional asset classesinvolves a contingent claim. In Islamic finance traditional fixed income instrumentsare replicated via more complex arrangements in order to establish compliance withthe religious prohibition on both interest earnings (riba), the exchange of money fordebt without an underlying asset transfer, and non-entrepreneurial investment.Structured finance redresses these moral impediments to conventional forms ofexternal finance.In review, Islamic banks use synthetic loans for debt-based bond finance, where theborrower re-purchases, or acquires the option to re-purchase, own assets at a mark-upin a sell-and-buyback transaction (on existing assets as a cost-plus sale (murabahah)or future assets as project finance (istina)). The lender can refinance the selling priceand/or the indebtedness of the borrower via the issuance of commercial paper.Alternatively, the ijarah principle prescribes an asset-based version of refinancing asynthetic loan, where the lender securitizes the receivables from a temporary lease-back agreement as quasi-interest income. The debt transaction underlying each ofthese forms of refinancing reflects a put-call parity-based replication of interestincome, where the lender holds the ownership (stock S) of the notional loan amountand writes a call option (C) to the borrower to acquire these funds at an agreedpremium payment subject to the promise of full payment of principal and mark-upafter time T (put option P). Both options have a strike price equal to the mark-up andthe notional loan amount. So the lender’s position at the time the synthetic loan ismade is S-C+P, which equals the present value of principal and interest repayment ofa conventional loan. - From the Journal Derivatves & Hedge Fund, Received(in revised form): 7th June, 2007 excerpts by Andreas (Andy) Jobst of the Monetary and Capital Markets Department of (IMF) Washington, DC. • Copyright ©2012
  9. 9. ANATOMY OF A STRUCTURE FINANCE An Overview SPECIAL PURPOSE VEHICLE (SPV)A SPV, also known as a special purpose entity (SPE), is a legal entity created for theclient (known as the sponsor or originator) by transferring assets to the SPV, to carryout specific purpose or circumscribed activity, or a series of such transactions.• Companies use securitization as an investment instrument through creating another corporation or legal entity known as Special Purpose Vehicle (SPV) that is a subsidiary to the originating company. The originating company then transfers the assets to the SPV, which issues securities that are collateralized by the assets with the proceeds transferred back to the originating company.• SPVs have no purpose other than the transaction(s) for which they were created, and they can make no substantive decisions. The attributes of SPVs can be best described into five categories; (1) finance-ability (2) credit enhancement (3) securities and agreements (4) sources of funds and (5) sovereign support.• Morgan Stearns principally employs SPVS as a financial corporation, set up for a specific purpose; including the structured investment vehicle (SIV) and their attributes are important benefits in the financial and legal risk considerationsThe Insfrastructure strategy for a Client’s SPV are:• To underwrite and conduct a Securitization in the issuance of financial conduit endorsed by client’s Values and supplemented CDO or ABS, as determined by the designated Risk Management underwriter and equivalent to a value that would meet the total amount of the funding.• Arrange an Extraordinaire Financing that will facilitate capital funds to formulate a Debt Restructure and/or Recapitalization of the investments provided to the client for the project that will result in optimizing the values and net worth of the company.• In that the funds are generated under an investment structure and provided to the client’s project under an intercreditor finance. In essence, setting up a credit facility internally in a jurisdiction beyond the client’s base of operation, whether to formulate a Debt Restructure and/or Recapitalization of the investments that will result in optimizing the values and net worth of the company. • Copyright ©2012
  10. 10. ANATOMY OF A STRUCTURE FINANCE (cont.)Who will form the SPV? Morgan Stearns Corporation who will charter and accrediteda legal entity, under a corporate name normally similar to the company ; for theprincipal purposes of a prescribed use of consolidate specific assets of the companyand enhance these assets to support the objectives of establishing the financial abilityin a broader Global capital market through proper securities and agreements.What are the Pre-requisite in forming the SPV? There are no pre-requisites requiredby the client in the process of chartering and accrediting the SPV for StructureFinance, other than the full cooperation to the SFA by providing the essentialunderwriting documents required during the securitization and placement of thecapital market investments in accordance with the terms and conditions offered by theProffer.Are there a requirement for fee? The fees for setting up a SPV, executing thesecuritization and financing agenda normally in the range of 1/10th of 1 basis point,normally in the range of $82,000 up to $175,000; which is itemized and deferred to bepaid at closing and covered by the funding. The fees cover retainers and registrycost derived by the CMT’s Auditor; Fund Administration; Securitization (Legal)Counsel; Capital Market Underwriters.**NOTE - The client is normally required to appropriate the factual budget towardslogistical cost and expenses referred as “out of pocket costs; normally that areunavoidable and are unable to defer till closing , such as the corporate charter filingsand other logistics such as clerical and professional preparation of the InvestmentRecommendation (prospectus) documentation and submissions. • Copyright ©2012
  11. 11. ANATOMY OF A STRUCTURE FINANCE (cont.) An Overview SECURITIZATIONSecuritization is the method utilized by participants of structured finance tocreate the pools of assets that are used in the creation of the end productfinancial instruments. In essence, securitization takes place to make theilliquid assets of the firm available for investment.The assets are pooled to make the securitization large enough to beeconomical and to diversify risk. The SPV takes title to the assets and thecash-flows are “passed through” to the investors in the form of an assetbacked security.Through a combination of fixed income asset, they are enhanced throughABS arranged by the SFA in conjunction with the CDO Manager andSecuritization underwriter, selected to produce a Financial Conduit. The SFAundertakes the task of structuring it into an SPV.Goal of engaging a securitization partly, and aimed at creating a syntheticasset, specifically tailored to set attractive values for investors by increasinga level of interest by broadening our investment outreach beyond thecompany’s fund sources, and access these funds into an investment to meetthe capital needs of the client. • Copyright ©2012
  12. 12. ANATOMY OF A STRUCTURE FINANCE (cont.)Why do Structure Finance Need Securitization?[The need for cash to grow and expand the business. By aising equity and borrowing through debtis difficult, expensive and can distort the financial leverage of a company. Equity and bonds aretwo sources of “on-balance sheet” financing]• Securitization, on the other hand, is an “off-balance-sheet” source of funds. According to the FASB, rules governing securitization pool of Assets Rating Agency (assuming all conditions are met) cash and proceeds from the sale of assets are added to assets, while the transferred asset itself is taken off the balance sheet.• ABS offer increased liquidity through a broader market.What is the form of Pooled Assets?• CMBS - A CMBS involves the issue of mortgage-backed assets by an issuer (typically a Special Purpose Company), the return on which is determined by reference to the performance of a portfolio of corporate loans or other similar debt obligations. The credit exposure – and return – is Synthetically created by the issuer executing a credit default swap with a counterparty. These instruments are used in a variety of trading strategies to hedge risk and to give investors exposure to the credit markets without having to buy the underlying assets of the company. One of the great attractions for arrangers of a synthetic CDOs is the ability to issue assets and/or securities without actually owning any assets to back those securities. Essentially, they are able to look at investor demand and appetite for particular levels of risk and return, and create a synthetic asset, specifically tailored to meet investor demand. Based on these values, we look at a type of structured credit product which is attracting an increasing level of interest from arrangers and investors alike. • Copyright ©2012
  13. 13. ANATOMY OF A STRUCTURE FINANCE (cont.)What is the impact of Securitization on the Capital Market?• Securitization reduces transaction costs in the capital market by creating a market for financial claims, which otherwise, would have remained illiquid, (i.e. limited trading).• Securitization saves intermediation costs, since the specialized intermediary costs are service related and generally lower.• Securitization promotes saving since it offers a security to investors with guaranteed interest or payments and an assurance of credit quality and safety nets in the form of trustees.• Securitization leads to diversification of risk since it pools several financial assets with differing features together and offer them to investors. When the ownership of the asset becomes spread among a wide base of investors, it becomes diffused, thus reducing the inherent risk in financial transactions.• Securitization promotes the idea of capitalists being trustees of resources and not owning them. Just as financial assets can be securitized, physical assets can also be securitized, which means that an entity can make use of physical resources without actually owning them.The benefits of Securitization in the Capital Markets have led to an increase in thevolume and value traded of ABS on the capital market. In year 1995, the value ofABS deals amounted to $ 316.3 billion, which increased greatly to $ 1,4 trillion inthe third quarter of year 2011. • Copyright ©2012
  14. 14. ANATOMY OF ASTRUCTURE FINANCE (cont.)Securitization framework • Copyright ©2012
  15. 15. ANATOMY OF A STRUCTURE FINANCE (cont.) An Overview STRUCTURED FINANCE ADMINISTRATOR(s)There are two administrators in the Structure Finance transaction - the STRUCTUREFINANCE ADMINISTRATOR (SFA) and the FUND ADMINISTRATOR.The role of the Structure Finance Administrator (SFA) -• The SFA (Morgan Stearns) acts as the Secretary to the SPV; and coordinates with the implementation of the SF strategy throughout every key aspect of the infrastructure from concept to closing. SFA also entails assembling and engaging all Capital Market Team (CMT) Advisors into the Structure Finance Agenda in accordance with the terms and conditions of the funding.• The Fund Administrator is best described as the Custodian of all Investment Funds and keeps the funds in line between the SPV and Parent company and also ensure the funds are in keeping with the region’s regulatory laws.The Importance to employ the services of A STRUCTURED FINANCEADMINISTRATOR in the process of arranging ABSThe traditional role of a SFA is to avoid the difficulties which arise in a direct investor-borrower relation (the company and investors). The difficulties could be one or more of thefollowing:• Transactional Difficulty: An average small investor usually has a small amount of money to lend, whereas the companys needs could be massive. The intermediary bank pools the funds from small investors to meet the typical needs of the company.• Informational Difficulty: An average small investor would not be aware of the borrower company or would not know how to appraise or manage the loan. The intermediary fills up this gap.• Perceived Risk: Investors usually perceive banks to be of a lesser risk compared to investing directly in a company, though in reality, the financial risk of the company is transposed on the bank. However, the bank is a pool of several such individual risks, and hence, the investors preference of a bank to the borrower company is reasonable. • Copyright ©2012
  16. 16. ANATOMY OF A STRUCTURE FINANCE (cont.)How are CMT Advisors determined and recommended that and designatedby the SF Administrator?It is among a key responsibility of the SF Administrator to carefully weighedto essential needs of a client’s Structure Financing and determined that whichAccredited Financial Firm will compliment financial strategy and selectlocalized advisor for legal and Funds. Thus the recommendations areconsidered an essential component in the development and realization of thelandscape of all Structured Financing plans. All CMT Consultants arecarefully selected due to their qualifications and expertise in the areas of theirassignment.How and when will a client come to contact or who will introduce theCMTs?The SF Administrator undertakes all selected CMT Consultants, normallyrecommended during the TRC Steering reviews of a client’s finance request;involved in the structuring and fulfillment of the SF agenda on behalf of itsClient. Although they are recommended during the Proffer; they areactivated and confirmed and synchronized into the SF Agenda, immediatelyafter the execution of the Engagement accords and charter of the SPV. • Copyright ©2012
  17. 17. An Overall Scope of Structure FinanceConclusion• Structured finance is a large, diverse and growing market. And it is generally profitable, with leading banks generating returns on capital of 25% and better. However, there is wide variation in profitability, both between products and between deals within a product. This variation in profitability is caused, in part, by the opacity of (risk adjusted) profitability and, in part, by the disproportionate share of economic profit captured by SF originators (ie.Morgan Stearns).• These two facts make structured finance a smart business. Winning tactics and selecting the right deals in which to participate are all about expertise – in structuring deals for clients and in measuring the risks those deals entail.• Strong distribution is also essential, to maximise the profitability of individual deals and to increase capital velocity and origination capacity. For clients who can maintain or build the required smarts, structured finance will remain a profitable business. • Copyright ©2012

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