ACCT 405 SEU Securitization & Accounting Discussion

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College of Administrative and Financial Sciences
Assignment 3
Deadline: 11 /04/ 2020 @ 23:59
Course Name: Accounting of Financial Institutions Student’s Name:
Bashaier
Course Code: ACCT 405
Student’s ID Number:
Semester: 2
CRN:
Academic Year: 2019-20-1440/1441 H
For Instructor’s Use only
Instructor’s Name:
Students’ Grade: Marks Obtained / 5
Level of Marks: High/Middle/Low
Instructions – PLEASE READ THEM CAREFULLY
• The Assignment must be submitted on Blackboard (WORD format only) via allocated
folder.
• Assignments submitted through email will not be accepted.
• Students are advised to make their work clear and well presented; marks may be
reduced for poor presentation. This includes filling your information on the cover page.
• Students must mention question number clearly in their answer.
• Late submission will NOT be accepted.
• Avoid plagiarism, the work should be in your own words, copying from students or
other resources without proper referencing will result in ZERO marks. No exceptions.
• All answered must be typed using Times New Roman (size 12, double-spaced) font.
No pictures containing text will be accepted and will be considered plagiarism).
• Submissions without this cover page will NOT be accepted.
1- What do you mean by Securitization? Explain (2.5 Marks)
Securitization is the procedure where an issuer designs a marketable financial instrument by merging
or pooling various financial assets into one group. The issuer then sells this group of repackaged assets
to investors. Securitization offers opportunities for investors and frees up capital for originators, both
of which promote liquidity in the marketplace.
In theory, any financial asset can be securitized—that is, turned into a tradeable, fungible item of
monetary value. In essence, this is what all securities are.
However, securitization most often occurs with loans and other assets that generate receivables such as
different types of consumer or commercial debt. It can involve the pooling of contractual debts such as
auto loans and credit card debt obligations.
Securitization is the method of converting the receivables of the financial institutions, i.e., loans and
advances, into bonds which are then sold to the investors. In simple terms, it is the means of turning
the illiquid assets into liquid assets to free up the blocked capital.
Securitization is the financial practice of pooling various types of contractual debt such as residential
mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets
which generate receivables) and selling their related cash flows to third party investors as securities,
which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs).
Investors are repaid from the principal and interest cash flows collected from the underlying debt and
redistributed through the capital structure of the new financing. Securities backed by mortgage
receivables are called mortgage-backed securities (MBS), while those backed by other types of
receivables are asset-backed securities (ABS).
A
Types of Securitization
1) Asset-Backed Securities (ABS)/ The bonds which are supported by underlying financial
assets. The receivables which are converted into ABS include credit card debts, student loans,
home-equity loans, auto loans, etc.
2) Residential Mortgage-Backed Securities (MBS)/ These bonds comprise of various mortgages
like of property, land, house, jewellery and other valuables.
3) Commercial Mortgage-Backed Securities (CMBS)/ The bonds that are formed by bundling
different commercial assets mortgage such as office building, industrial land, plant, factory, etc.
4) Collateralized Debt Obligations (CDO)/ The CDOs are the bonds designed by re-bundling
the personal debts, to be marketed in the secondary market for prospective investors.
5) Future Flow Securitization/ The company issues these instruments over its debts receivable in
a future period. The company meets the principal and interest through its routine business
operations, though such obligations are secured against its future receivables.
Special types of securitization
1. Master trust: A distinctive feature of credit card securitizations is the use of “master trusts” that
issue multiple series of securities backed by the same underlying receivables. In each
securitization, the issuer contributes additional receivables to the master trust, which then issues a
new series of securities. The receivables in the master trust are not segregated in any fashion, and
all the receivables collectively support all the series of securities issued. A master trust is a type of
SPV particularly suited to handle revolving credit card balances, and has the flexibility to handle
different securities at different times. In a typical master trust transaction, an originator of credit
card receivables transfers a pool of those receivables to the trust and then the trust issues securities
backed by these receivables. Often there will be many tranched securities issued by the trust all
based on one set of receivables. After this transaction, typically the originator would continue to
service the receivables, in this case the credit cards. There are various risks involved with master
trusts specifically. One risk is that timing of cash flows promised to investors might be different
from timing of payments on the receivables. For example, credit card-backed securities can have
maturities of up to 10 years, but credit card-backed receivables usually pay off much more quickly.
To solve this issue these securities typically have a revolving period, an accumulation period, and
an amortization period. All three of these periods are based on historical experience of the
receivables. During the revolving period, principal payments received on the credit card balances
are used to purchase additional receivables. During the accumulation period, these payments are
accumulated in a separate account. During the amortization period, new payments are passed
through to the investors. A second risk is that the total investor interests and the seller’s interest are
limited to receivables generated by the credit cards, but the seller (originator) owns the accounts.
This can cause issues with how the seller controls the terms and conditions of the accounts.
Typically to solve this, there is language written into the securitization to protect the investors and
potential receivables. A third risk is that payments on the receivables can shrink the pool balance
and under-collateralize total investor interest. To prevent this, often there is a required minimum
seller’s interest, and if there was a decrease then an early amortization event would occur.
2. Issuance trust: In 2000, Citibank introduced a new structure for credit card-backed securities,
called an issuance trust, which does not have limitations that master trusts sometimes do, that
requires each issued series of securities to have both a senior and subordinate tranche. There are
other benefits to an issuance trust: they provide more flexibility in issuing senior/subordinate
securities, can increase demand because pension funds are eligible to invest in investment-grade
securities issued by them, and they can significantly reduce the cost of issuing securities. Because
of these issues, issuance trusts are now the dominant structure used by major issuers of credit cardbacked securities. Various private firms (mostly commercial, investment, and mortgage banks) also
issue MBS, usually with some form of credit enhancement. Private MBS may have some credit
risk, especially those collateralized by subprime mortgages, but they are usually highly rated at
issuance.
3. Grantor trusts: are typically used in automobile-backed securities and REMICs (Real Estate
Mortgage Investment Conduits). Grantor trusts are very similar to pass-through trusts used in the
earlier days of securitization. An originator pools together loans and sells them to a grantor trust,
which issues classes of securities backed by these loans. Principal and interest received on the
loans, after expenses are taken into account, are passed through to the holders of the securities on a
pro-rata basis.
4. Owner trust: there is more flexibility in allocating principal and interest received to different
classes of issued securities. In an owner trust, both interest and principal due to subordinate
securities can be used to pay senior securities. Due to this, owner trusts can tailor maturity, risk and
return profiles of issued securities to investor needs. Usually, any income remaining after expenses
is kept in a reserve account up to a specified level and then after that, all income is returned to the
seller. Owner trusts allow credit risk to be mitigated by over-collateralization by using excess
reserves and excess finance income to prepay securities before principal, which leaves more
collateral for the other classes.
B
Which was the first non-assets, backed Securitization deal in Saudi Arabia?
Extra recently announced that it has securitized SR166mn of its receivables from installment sales
“Tasheel program”. The deal is the first non-asset backed securitization transaction for the company as
well as Saudi Arabia.
The receivables were sold to Al-Rajhi Bank in exchange for a cash inflow of SR160mn. The
securitized portion accounts for approx. 41% of their last outstanding balance of installments sales.
Al Rajhi Capital Research said the deal has multiple positive implications for the company such as
upfront recognition of future profits and cash flows, increased capacity to expand in installments sales
as well as lowering debt. We revise our topline growth estimate for 2019e to 14.3% y-o-y (from 9.7%
previously) and 9.4% for 2020e (from 7%).
Post factoring this securitization deal, Al Rajhi Capital then have a 34% increase in EPS in 2019.
“Thereby, we revise our target price to SR80/sh. implying a rating of “Overweight” with an upside
potential of 15.4%.”
Al Rahji Capital believes that Extra has managed to maintain a good credit quality for the installments
credit, maintaining an average delinquency rate below 10% and NPL ratio below 3%. “We expect this
securitization to improve its credit quality as it transfers most of the credit risk to a financial institution
that is better equipped to deal with it. Given that Al Rajhi has taken the receivables with just a discount
of 4% highlights the good credit quality.”
The credit portion of sales of Extra has been growing rapidly during the last three years – as it reached
approx. 7.5% in the last reporting period (up from 3% in FY17 and 7% in FY18 as per our estimates).
Given this securitization of 41% of their credit sales books, with more credit capacity available, we
expect this proportion to increase to 9%-10% in FY19E and stimulate Extra sales positively.
Under the securitization deal, the company would recognize an additional profit of SAR17mn ( 8% of
FY19e net income) in exchange for future interest payments expected to be collected in due course of
time previously.
The company’s debt/assets stood at 19%, with a healthy cash balance of SR223mn.
2-Pass a journal entries in the books of lease contract by creating lease receivable at its net
investment in which is equal to the minimum lease payments discounted at the rate of interest
implicit in the lease. (2.5 marks)
The lessor shall record the start of a lease by creating a lease receivable at its net investment in lease,
which is equal to the minimum lease payments discounted at the rate of interest implicit in the lease.
Journal entry posted at the start of the lease contract:
Lease receivable
$1,996,355
Asset
$1,996,355
At the time of first payment, lessor shall record receipt of cash, reduction in lease receivable and
recognition of finance income:
Cash
$500,000
Lease receivable ($500,000$460,000
40,000)
Finance income ($500,000×8%)
$40,000
The reduction in lease receivable reduces the principal balance in lease receivable to $1,536,355,
which shall reduce the next year finance income.
References:
–
https://en.wikipedia.org/wiki/Securitization
–

Securitization

–
https://xplaind.com/307789/leases
–
http://saudigazette.com.sa/article/571331
–
https://www.investopedia.com/terms/s/securitization.asp

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