Smaller retentions result in relief equal to the difference between
8 per cent and the retainer.
There are other considerations, however including the cost of fund-
ing such an arrangement. If the bank accessed low cost ﬁnancing then
the difference between the aggregate level achieved through the secur-
itization route is unattractive since even the most senior tranches are
typically sold at a premium to libor prevalent in the asset-backed
market. The alternative arrangement to participating loans is the syn-
thetic arrangement covered in great detail in Section 4.7.
4.11 Investor analysis
Construction of ﬁnancial securities
We now drill down into the ‘proﬁle’ and consider the assets that com-
prise the offering to the investors. A consideration of this base is vital to
originating the instruments and is another integral component of their
design. There is little beneﬁt in promoting a particularly efﬁcient struc-
ture which purportedly would enjoy a large valuation if the investor
demand for the individual components is low. To obviate the chances of
this, the structuring team would work closely with the organizations
origination and ﬁxed-income sales team to understand the nature of the
investor marketplace and which instruments would appeal.
214 Credit risk: from transaction to portfolio management
Figure 4.30 The liquidity within the structure.
We have described these entities as being an integral component of the bank. For
many commercial banks this is not the case and the service would be made available
from a partner bank.
The ﬁrst instrument is a middle dated annuity. This is a class of
security which pays out a constant stream of income. Each payment
can be thought of as being comprised of both interest and principal; to
begin with most of the payment will be interest but as the time to matur-
ity increases then more will be comprised of nominal. There is a for-
mula to calculate its value; this is displayed in the equation below:
where P is the principal amount and r is the annuity rate lasting for n
For example if we consider the ﬁrst tranche, which has a common
annual payment of $115 000 000 lasting for 15 years, r 4%:
This value is very approximate, and considerably overvalues, for reason
we postpone to a later discussion.
Annuities comprise two tranches of the structure. If we examine the
loan proﬁle we can infer why this was the case. The shape can be
approximately described by two distinct patterns. The ﬁrst part com-
prises payouts up to a maturity of about 2018; this is almost a hori-
zontal line. The second shape starts from 2018 and extends to 2023.
This is a downward sloping line and is caused by a heavy loan redemp-
tion schedule over this period.
As annuities produce a horizontal proﬁle they are a natural candidate
for the securitization of the payments until 2018. The question then
arises as to whether there will be sufﬁcient investor appetite for these
long dated instruments. The demand for the various tranches comes
from different sources of the investment community. Generally the prin-
cipal aim is to securitize as much as possible as high-investment grade.
This would then appeal to the large institutional investors who are usu-
ally only allowed through regulatory authorities to deal in such paper.
Further appeal would be anticipated from the retail marketplace.
The long dated annuities would be structured as investment grade
assets, and would ﬁnd a natural home within the pension funds that
P $1278 614 560.
P $115 000 000
(1 0.04) 1
0.04 (1 0.04)
(1 ) 1