Abbey National
(Master Trusts and Soft Bullets in MBS)
compiled by
Prof. Ian Giddy
New York University

Asset Securitization

Asset-backed securities constitute a growing segment of the European and global capital markets. The asset securitization technique, while complex, has won a secure place in corporate financing and investment portfolios because it can, paradoxically, offer originators a cheaper source of funding and investors a superior return. Not only does securitization transform illiquid assets into tradable securities, but it also manages to transform risk by means of the separation of good financial assets from a company or financial institution with little loss of revenue. The assets, once separated from the originator, are employed as backing for high-quality securities designed to appeal to investors.

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Ian Giddy has taught finance at NYU, Columbia, Wharton, Chicago and in 30+ countries abroad for the past two decades. He was Director of International Fixed Income Research at Drexel Burnham Lambert from 1986 to 1989. The author of more than fifty articles on international finance, he has served at the International Monetary Fund and the U.S. Treasury and has been a consultant with numerous corporations and financial institutions in the U.S. and abroad. He is the author or co-author of The International Money Market, The Handbook of International Finance, Cases in International Finance, Global Financial Markets, Asset Securitization in Asia and The Hudson River Watertrail Guide.

Prof Ian Giddy
Stern School of Business
New York University
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    Article on Use of the Master Trust Structure in Asset-Backed Securities

Master trusts mark new era for European ABS
Date: December 01 2000
Author: Jules Evans

When Abbey National launched Europe's biggest ever ABS deal, it showed how issuers can use master trust structures to meet investors' needs more closely. Now that this formula has proved itself, the market is likely to experience a boom in issuance - especially because bond investors are looking at ABS as a safe haven while corporate debt spreads swing. Jules Evans reports.

Standard & Poor's recently released the results of the first ever survey of default levels in the UK ABS market. The findings were encouraging: there has not been a single case of default in the UK. In contrast, in the corporate bond market there has been an increase in the risk of default this year, and there have been more ratings downgrades than upgrades. 

The increasing interest in ABS is being met by rising levels of issuance. Borrowers are being shown what securitization can do for them - unlocking slumbering assets, taking transactions off-balance-sheet and reaching wider groups of investors than they had access to with traditional ABS. The synthetic CLO market in particular has shown record amounts of issuance this year, as banks use the synthetic structure to take risk off their balance sheets so as to meet capital ratio requirements.

Above all, it is the innovation of securitization teams at investment banks and law firms that is ensuring the continued growth of the securitization market. Charles Schorin at MSDW sums up this spirit of innovation: "You read the letter of the law, and then you try to get around it. That's the creativity of bankers." Sudden increases in securitized issuance generally indicate that lawyers and bankers have found a way round a law to reach more investors or avoid tax obstacles. 

Finding legal loopholes
Angela Clist, partner at Allen & Overy's securitization department, explains the importance of legal teams to securitization deals : "Lawyers are very much involved in the structuring of securitization deals. They are aware of where the obstacles to deals lie. For some deals you are issuing a new type of security, so it is essential to understand the different areas that are relevant for a deal, especially in terms of tax and banking law."

It is this technical manouevering round hampering legal or tax obstacles that it behind two record breaking deals in the last two months: Abbey National's Holmes Financing no. 2 and Citibank's CCIT no. 1.

Holmes Financing no. 2 is the second issue from Abbey National's master trust, Holmes Financing. It is the biggest European MBS ever. The deal uses a similar structure to the one used for Bank of Scotland's Mound Financing deal in April. The deal was revolutionary in its introduction of MBS with soft bullets.

The earlier problem with MBS was that their maturities tended to imitate the loans that covered them, which were amortized. This meant the bonds' redemptions were amortized too, which made it harder to sell them. Certain investors could not buy non-bullet securities, and even those that could were not fond of securities that could transform into cash without warning.

When Bank of Scotland approached Schroder Salomon Smith Barney (SSSB) to structure £1.7 billion in mortgage loans into a bond, it was this problem that the securitization team grappled with. The solution that SSSB and Allen & Overy came up with was the use of a master trust. Master trusts were first used for automobile loan securitization in the US, and then adopted recently by credit card companies for their issues. But the Bank of Scotland deal was the first deal to apply it to the MBS market. 

While previously, the mortgage loans were still held by the issuer, for the Bank of Scotland deal the loans were transferred to a master trust called Mound Financing. The trust holds a sufficient amount of loans for large tranches to be issued with soft bullets. The loans in a trust can be topped up with other loans if some should be repaid, and the trust can be used for different issues with different redemption-types and different maturities. 

Thus with the Mound Financing no. 1 deal, $6 billion was issued in three tranches with different maturities but all with soft bullet redemption. The other tranches were sterling denominated, one rated AAA of £285 million, one of £37.5 million rated A+ and one of £37.5 million rated BBB. All the tranches had a step up and call soft bullet redemption, which means if the notes are still outstanding at a certain date, they will get stepped up to a higher interest rate. The bond issuer could also choose to redeem any outstanding bonds at this time. In effect, the sterling bonds acted more like traditional MBS, and were priced accordingly. The AAA dollar denominated tranches were the real innovation. 

The master trust innovation was not possible in the UK before last year. As is often the case in securitization, the obstacle, and the solution, was legal. Under the provisions of Miras, the tax relief for mortgage interest payments set up under the 1983 budget, loans had to be beneficially owned by one entity. For the master trust to work, the trust had to be owned by two entities, as Clist explains: "For legal reasons it's better to have two beneficiaries. The cash flow also works more efficiently that way." When the government finally decided to remove Miras last year, it left the way open for trust deals such as Bank of Scotland's Mound Financing.

Abbey National sets new record
SSSB used the same structure for Abbey National's Holmes Financing no. 2 deal this month. The £2.4 billion MBS is the largest MBS ever, and it marks the first use of the trust structure for more than one issue. It is the second issue from the Holmes Financing master trust. The trust is called Holmes because Abbey National own 221b Baker Street, the home of the famous sleuth.

One of the most attractive features of the trust system for issuers is that once the structure is in place they have a ready-made legal and financial framework for further issuance. They can issue whichever type of maturity they want with different kinds of redemption, so as best to tap investor demand. Thus in the Holmes Financing no. 2 deal there are two big dollar tranches of $1 billion each, one with a 2004 maturity and one with a 2017 maturity. There is also a Eu500 million tranche with a 2040 maturity, and a £500 million tranche, also with a 2040 maturity. Each of these tranches has a rating, maturity and redemption type tailored to appeal to a particular sector of investor.

It is this ability to return to the market quickly and efficiently as opportunities arise that may well prove to be the main benefit of the master trust system, for issuers and investors. Matthew Froggat from the securitization team at CSFB, which co-managed the deal, says of the structure: "Overall funding costs are quite a lot lower than with traditional MBS. Because you're really giving the investors what they want, they are prepared to pay more. The fixed costs are slightly higher, at least initially, but that is easily covered by savings on funding costs."

A member of the syndication team at SSSB testifies to the pricing strength of the master trust security: "You can price at least five to seven basis points better with a deal like this. With the soft bullets, you've opened up a whole new investor base. It is a complicated deal, which is why there was a big roadshow for all three deals - the Mound Financing no. 1 and the Holmes Financing no. 1 and 2. There were also presentations made on Bloomberg, and we took the time to educate our bankers about the deal so they could go out and explain it to investors."

Froggat at CSFB says: "It is an incredibly complicated and expensive structure, and only really suitable for large and well-known companies. There was a lot of explaining to do to investors, but Abbey National has a strong reputation in Europe and the US." 

Meanwhile, SSB in the US has organized the structure for another record breaking ABS that uses the master trust system. Citibank issued a $2.25 billion credit card ABS in late October from its new master trust, called Citibank Credit Card Issuance Trust. The deal is believed to be the largest credit card securitization tranche ever. 

Reaching new investors
Like the European MBS deals, the size of Citibank's deal is a consequence of sophisticated legal manoeuvres enabling Citibank to reach a whole new base of investors. Here, the obstacle was a law by which in order to get off-balance sheet treatment for a master trust, the equity for it had to be owned by more than one party.

It is almost exactly the opposite law to that which hampered the MBS market in Europe. To comply with the law in the US, securitized bonds were structured as certificates. But certificates could be sold to just 100 investors. Moreover, even if the certificates behaved like securities, the fact they weren't disqualified them for purchase by pension funds.

The tiny but very significant loophole SSB has found through this is that by repackaging the master trust certificate in another trust, Citibank makes the new company, Citibank Credit Card Issuance Trust, act like a corporate borrower. The outcome of this is that its issues are no longer regarded as certificates, but as debt. 

This means that the new issues are no longer hampered by the 100 investors rule. And they are eligible for purchase by pensions funds under the Employee Retirement Income Security Act of 1974, which is the pot of gold at the end of the long, complicated process. 

Citibank can now reach a far larger investor base, and it can issue bigger bonds. The master trust also means that, like Abbey National and Bank of Scotland, Citibank can return easily and quickly to the market. Since the $2.25 billion deal in October, it has already issued a $750 million fixed-rate seven-year bond through the trust.

Lisa Capuano, director in charge of funding for Citibank's credit card securitization, says: "We can delink the subordinated and the senior debt in terms of timing of issuance and maturity. So for the $2.25 billion issue we already had the subordinated bonds in place, so we could launch the AAA senior debt when we wanted. As long as we have the subordinated debt already in place the timing is completely flexible. We can issue the subordinated BBB debt days, weeks or months in advance of the big issues, so we can take advantage of market opportunities when they arise."

The master trust structure has enabled Citibank and Abbey National to make their debt programme act like an MTN programme, with the capacity to issue at short notice, in small or large volumes, as often or as rarely as they want. David Basra, head of securitization at SSSB, and a key figure in the application of the master trust structure to European MBS, explains: "It's a living breathing programme. It answers the clients' needs. And it is cheaper for borrowers now because the technology has already been developed."

Both the Holmes and Citibank deals are likely to be copied by other companies, potentially in equally large deals. However, the trust structure, because of the initial cost and complication of setting it up, makes sense only for an issuer of the size and reputation of Citibank or Abbey National. Basra thinks it very likely that the structure will be used to securitize automobile loans in the UK, as it already is in the US. The securitization market is likely to continue growing rapidly as the European ABS market expands, and with markets as far apart as China and UAE showing interest in entering the MBS market, 2001 might just be the year for ABS.

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