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FINANCIAL INSTITUTION

SECURITIZATION
FINAL TERM REPORT

(15th April 2010)

GROUP MEMBERS:

SYED MOHSIN HASSAN-_______

FAIZAN-_______

ANNAM ZAHID-_______

ANAM TALPUR-_______
SUBMITTED TO:
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TALHA-_______
SHARIQUE AYUBI

Table of Contents
FINANCIAL INSTITUTION..............................................................................................1
(15th April 2010).................................................................................................................1
GROUP MEMBERS:..........................................................................................................1
SYED MOHSIN HASSAN-_______..................................................................................1
FAIZAN-_______................................................................................................................1
ANNAM ZAHID-_______..................................................................................................1
Table of Contents.................................................................................................................2
.............................................................................................................................................3
SECURITIZATION.............................................................................................................4
INTRODUCTION...............................................................................................................4
DEFINTIONS......................................................................................................................4
WHAT IS SECURITIZATION?.........................................................................................5
ASSET-BACKED SECURITIZATION MARKET IN PAKISTAN..................................5
HISTORY............................................................................................................................6
TYPES OF SECURITIZATION.........................................................................................7
MORTGAGE-BACKED SECURITY.................................................................................7
COMMERCIAL MORTGAGE-BACKED SECURITIES.................................................8
COLLATERALIZED DEBT OBLIGATIONS ..................................................................8
ASSET BACKED SECURITIES .......................................................................................8
SPECIAL STRUCTURES OF SECURITIZATION...........................................................9
Master trust..........................................................................................................................9
Issuance trust........................................................................................................................9
Grantor trust.......................................................................................................................10
Owner trust.........................................................................................................................10
MAJOR PLAYERS...........................................................................................................10
PROCESS OF SECURITIZATION..................................................................................12
PROCESS OF ASSET BACKED SECURITIZATION ..................................................13
WHY DO ISSUERS NEED SECURITIZATION? ..........................................................14
REASONS TO SECURITIZE RECEIVABLES...............................................................14
WHY DO INVESTORS INVEST IN ASSET-BACKED SECURITIES? ......................15
Credit risk...........................................................................................................................15
Liquidity risk......................................................................................................................16
Financial Guarantee...........................................................................................................16
FEATURES OF ASSET BACKED SECURITIZATION.................................................16
Credit enhancement and trenching.....................................................................................16
AMORTIZED AND NON-AMORTIZED ASSETS........................................................18
FIXED VS FLOATING RATE.........................................................................................19
ADVANTAGES TO ISSUER...........................................................................................19
ADVANTAGES TO ORIGINATOR................................................................................20
ADVANTAGES TO INVESTORS...................................................................................20
DISADVANTAGES TO ISSUER.....................................................................................21
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DISADVANTAGES TO THE ORIGINATOR.................................................................21

DISADVANTAGES TO INVESTOR...............................................................................21
STRICT RULES AND REGULATIONS (REGULATED BY SECP).............................22
TRANSACTIONS.............................................................................................................26
TELECOM SECTOR (PAKTEL LIMITED) ...................................................................26
THE LEASING SECTOR.................................................................................................30
REAL ESTATE SECTOR ................................................................................................31
PETROLEUM SECTOR...................................................................................................33
PAKISTAN INTERNATIONAL AIRLINES...................................................................35
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SECURITIZATION
INTRODUCTION
Securitization is one of the most significant innovations in the global capital
markets during the last fifteen years. It has substantially enhanced the efficiency of
assets and liabilities by individuals and corporations.

DEFINTIONS
Standard & Poor’s, 2000

Asset-Backed Securitization is one of the most exciting areas of application of

securitization, particularly from emerging market countries. Securitization is the
conversion of receivables and cash flow generated from a collection (pool) of financial
assets such as (mortgage loans, auto loans, credit card receivables and other assets
including present or future receivables) into securities that are backed by these assets. In
other words, securitization is the “pooling of homogenous, financial, cash-flow
producing, illiquid assets and issuing claims on those assets in the form of marketable
securities.”

It is the process of aggregating similar instruments, such as loans or mortgages, into a

negotiable security.

The process of securitizing assets; the conversion of loans into securities, usually in order
to sell them on to other investors. The principal and interest on the debt underlying the
security is paid to the investors on a regular basis, though the method varies based on the
type of security.

The idea of asset backed securitization is to create a capital market product. It results in
the creation of a "security", which is a marketable product. Asset Backed Securities
(ABS) is considered both a fixed income and a derivative instrument. Asset Backed
Securities (ABS) qualify as a fixed income instrument because they generate a coupon
income (not necessarily fixed) periodically, and qualify as a derivative, since they are a
derived instrument from a plain vanilla instrument (a straightforward financial
instrument such as a standard fixed-interest product with no sophisticated add-ons) being
the underlying pool of assets.

Asset Backed Securitization is the issuance of a debt instrument backed by a revenue

producing asset of the issuing company. Asset securitization involves producing bearer
asset-backed securities usually Term Finance Certificates in Pakistan, which can be
freely traded and which are secured by a portfolio of receivables. In order to ensure
marketability, the instrument must have general acceptability as a store of value; hence,
the security is generally either rated by credit rating agencies, or is guaranteed by an
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independent guarantor. Further, to ensure liquidity, the instrument is generally prepared

in homogenous lots as if it is a case of securitization of future receivables, the assets with
the same maturity will be pooled and taken up for the asset backed securities.

WHAT IS SECURITIZATION?
Securitization is a structured finance process that distributes risk by aggregating debt
instruments in a pool, then issues new securities backed by the pool. The term
"securitization" is derived from the fact that the form of financial instruments used to
obtain funds from the investors are securities. As a portfolio risk backed by amortizing
cash flows - and unlike general corporate debt - the credit quality of securitized debt is
non-stationary due to changes in volatility that are time- and structure-dependent. If the
transaction is properly structured and the pool performs as expected, the credit risk of all
tranches of structured debt improves; if improperly structured, the affected tranches will
experience dramatic credit deterioration and loss. All assets can be securitized so long as
they are associated with cash flow. Hence, the securities which are the outcome of
securitization processes are termed asset-backed securities (ABS). From this perspective,
securitization could also be defined as a financial process leading to an issue of an ABS.

ASSET-BACKED SECURITIZATION MARKET IN

PAKISTAN
Asset-Backed Securitization (ABS) was previously governed by a bare law till 1999. The
only significant securitization transaction in Pakistan before the guidelines and rules of
Securities and Exchange Commission of Pakistan was in 1997, the securitization of net
settlement receivables by Pakistan Telecom. Pakistan Telecom in the country's overseas
telephony monopoly and net settlement receivables arise when there are inward calls into
Pakistan. Pakistan Telecom, like most of the emerging Asian countries, would normally
have such remittances as the inward calls by Pakistani residents abroad would exceed
those outward calls, leading to a net settlement receivable. 6 international carriers such as
AT&T who were expected to pay to Pakistan Telecom entered into notice-of-assignment
agreements agreeing to pay into the collection account in favor of the SPV.
Thereafter, the guidelines and rules have been designed by the Securities and Exchange
Commission of Pakistan in 1999 for the establishment of Special Purpose Vehicle (SPV)
to carry out the Asset-backed Securitization in Pakistan. Banks and Development
Financial Institutions (DFIs’) were attractive to participate in the Securitization by
having their own Special Purpose Vehicle (SPV). In this regard, State Bank of Pakistan
has received requests from a number of financial institutions desirous of performing
various roles in assets securitization transactions through special purpose vehicle. These
requests have been considered in consultation with concerned quarters and it has been
decided that banks/DFIs can participate in assets securitization through SPV. These
guidelines limit (cap) the total exposure of a bank/DFI towards securities issued by a
Special Purpose Vehicle (SPV) at 5% of its own paid up capital or 15% of the total value
of the Asset-Backed Securitization (ABS) issued by the Special Purpose Vehicle (SPV)
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— which ever is less. Further, the aggregate exposure on account of Asset-Backed

Securitization is limited to 20% of the total paid up capital of the bank/DFI. This will
encourage banks/DFIs to

(a) Invest in and sell-down these Asset-Backed Securities, i.e. to churn their Asset
Backed Securities portfolio to stay within the 20% cap and to

(b) Actively trade in Asset Backed Securities to develop a secondary market, rather than
to simply purchase these Asset Backed Securities and hold them till maturity.

HISTORY
"Asset securitization began with the structured financing of mortgage pools in the 1970s.
For decades before that, banks were essentially portfolio lenders; they held loans until
they matured or were paid off. These loans were funded principally by deposits, and
sometimes by debt, which was a direct obligation of the bank (rather than a claim on
specific assets). But after World War II, depository institutions simply could not keep
pace with the rising demand for housing credit. Banks, as well as other financial
intermediaries sensing a market opportunity, sought ways of increasing the sources of
mortgage funding. To attract investors, investment bankers eventually developed an
investment vehicle that isolated defined mortgage pools, segmented the credit risk, and
structured the cash flows from the underlying loans. Although it took several years to
develop efficient mortgage securitization structures, loan originators quickly realized the
process was readily transferable to other types of loans as well."

February 1970, the U.S. Department of Housing and Urban Development created the
transaction using a mortgage-backed security. The Government National Mortgage
Association sold securities backed by a portfolio of mortgage loans.
To facilitate the securitization of non-mortgage assets, businesses substituted private
credit enhancements. First, they over-collateralized pools of assets; shortly thereafter,
they improved third-party and structural enhancements. In 1985, securitization techniques
that had been developed in the mortgage market were applied for the first time to a class
of non-mortgage assets — automobile loans. A pool of assets second only to mortgages in
volume, auto loans were a good match for structured finance; their maturities,
considerably shorter than those of mortgages, made the timing of cash flows more
predictable, and their long statistical histories of performance gave investors confidence.
This early auto loan deal was a $60 million securitization originated by Marine Midland
Bank and securitized in 1985 by the Certificate for Automobile Receivables Trust

The first significant bank credit card sale came to market in 1986 with a private
placement of $50 million of outstanding bank card loans. This transaction demonstrated
to investors that, if the yields were high enough, loan pools could support asset sales with
higher expected losses and administrative costs than was true within the mortgage
market. Sales of this type — with no contractual obligation by the seller to provide
recourse — allowed banks to receive sales treatment for accounting and regulatory
purposes (easing balance sheet and capital constraints), while at the same time allowing
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them to retain origination and servicing fees. After the success of this initial transaction,
investors grew to accept credit card receivables as collateral, and banks developed
structures to normalize the cash flows.

Starting in the 1990s with some earlier private transactions, securitization technology was
applied to a number of sectors of the reinsurance and insurance markets including life and
catastrophe. This activity grew to nearly $15bn of issuance in 2006 following the
disruptions in the underlying markets caused by Hurricane Katrina and Regulation XXX.
Key areas of activity in the broad area of Alternative Risk Transfer include catastrophe
bonds, Life Insurance Securitization and Reinsurance Sidecars .

The first public securitization of Community Reinvestment Act(CRA) loans started in

1997.

As estimated by the Bond Market Association, in the United States, total amount
outstanding at the end of 2004 at $1.8 trillion. This amount is about 8 percent of total
outstanding bond market debt ($23.6 trillion), about 33 percent of mortgage-related debt
($5.5 trillion), and about 39 percent of corporate debt ($4.7 trillion) in the United States.
In nominal terms, over the last ten years, (1995-2004,) ABS amount outstanding has
grown about 19 percent annually, with mortgage-related debt and corporate debt each
growing at about 9 percent. Gross public issuance of asset-backed securities remains
strong, setting new records in many years. In 2004, issuance was at an all-time record of
about $0.9 trillion.

TYPES OF SECURITIZATION

• MORTGAGE-BACKED SECURITY
A mortgage-backed security (MBS) is an asset-backed security or debt
obligation that represents a claim on the cash flows from mortgage loans, most
commonly on residential property.
First, mortgage loans are purchased from banks, mortgage companies, and other
originators. Then, these loans are assembled into pools. This is done by government
agencies, government-sponsored enterprises, and private entities. Mortgage-backed
securities represent claims on the principal and payments on the loans in the pool,
through a process known as Securitization. These securities are usually sold as bonds, but
financial innovation has created a variety of securities that derive their ultimate value
from mortgage pools.
Most MBS's are issued by the Government National Mortgage Association (Ginnie Mae),
a U.S. government agency, or the Federal National Mortgage Association (Fannie Mae)
and the Federal Home Loan Mortgage Corporation (Freddie Mac), U.S. government-
sponsored enterprises. Ginnie Mae, backed by the full faith and credit of the U.S.
government, guarantees that investors receive timely payments. Fannie Mae and Freddie
Mac also provide certain guarantees and, while not backed by the full faith and credit of
the U.S. government, have special authority to borrow from the U.S. Treasury. Some
private institutions, such as brokerage firms, banks, and homebuilders, also securitize
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mortgages, known as "private-label" mortgage securities.

Residential mortgages in the United States have the option to pay more than the required
monthly payment (curtailment) or to pay off the loan in its entirety (prepayment).
Because curtailment and prepayment affect the remaining loan principal, the monthly
cash flow of an MBS is not known in advance, and therefore presents an additional risk
to MBS investors.

• COMMERCIAL MORTGAGE-BACKED SECURITIES

Commercial mortgage-backed securities (CMBS) are secured by commercial and
multifamily properties (such as apartment buildings, retail or office properties, hotels,
schools, industrial properties and other commercial sites). The properties of these loans
vary, with longer-term loans (5 years or longer) often being at fixed interest rates and
having restrictions on prepayment, while shorter-term loans (1–3 years) are usually at
variable rates and freely pre-payable.

• COLLATERALIZED DEBT OBLIGATIONS

Collateralized debt obligations (CDOs) are a type of structured asset-backed
security (ABS) whose value and payments are derived from a portfolio of fixed-income
underlying assets. CDOs securities are split into different risk classes, or tranches,
whereby "senior" tranches are considered the safest securities. Interest and principal
payments are made in order of seniority, so that junior tranches offer higher coupon
payments (and interest rates) or lower prices to compensate for additional default risk.
A few academics, analysts and investors such as Warren Buffett and the IMF's former
chief economist Raghuram Rajan warned that CDOs, other ABSs and other derivatives
spread risk and uncertainty about the value of the underlying assets more widely, rather
than reduce risk through diversification. Following the onset of the 2007-2008 credit
crunch, this view has gained substantial credibility. Credit rating agencies failed to
adequately account for large risks (like a nationwide collapse of housing values) when
rating CDOs and other ABSs.
Many CDOs are valued on a mark to market basis and thus have experienced substantial
write-downs on the balance sheet as their market value has collapsed.

• ASSET BACKED SECURITIES

Asset Backed Securities a process whereby any SPV raises funds by issue of
Term Finance Certificates (TFCs) or any other instruments with the approval of the
Commission (SECP), for such purpose and uses such funds by making payment to the
Originator and through such process acquires the title, property or right in the receivables
or other assets in the form of actionable claims"
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SPECIAL STRUCTURES OF SECURITIZATION

Master trust
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.
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.

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 card-backed securities.
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Grantor trust
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.

Owner trust
In an 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.

MAJOR PLAYERS
The major "players" in the securitization game, all of whom require legal representation
to some degree, are as follows (this terminology is typical, but different terms are used;
for example the "originator" is often referred to as the "issuer" or "seller"):

Originator - This is the entity on whose books the assets to be

securitised exist. It is the prime mover of the deal i.e. it sets up the necessary
structures to execute the deal. It sells the assets on its books and receives the
funds generated from such sale. In a true sale, the Originator transfers both the
legal and the beneficial interest in the assets to the SPV.

Issuer - The issuer also known as the SPV is the entity, which would
typically buy the assets (to be securitised) from the Originator. The SPV is
typically a low-capitalised entity with narrowly defined purposes and
activities, and usually has independent trustees/directors. As one of the main
objectives of securitisation is to remove the assets from the balance sheet of
the Originator, the SPV plays a very important role inas much as it holds the
assets in its books and makes the upfront payment for them to the Originator.

Trustees - usually a bank or other entity authorized to act in such capacity. The
Trustee, appointed pursuant to a Trust Agreement, holds the Receivables, receives
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payments on the Receivables and makes payments to the Securityholders. In many

structures there are two Trustees. It accepts the responsibility for overseeing that all the
parties to
the securitisation deal perform in accordance with the securitisation trust agreement.

Investors - the ultimate purchasers of the Securities. Usually banks, FI’s,insurance

companies, retirement funds and other "qualified investors." In some cases, the Securities
are purchased directly from the Issuer, but more commonly the Securities are issued to
the Originator and then sold to the Investors, or in the case of an underwriting, to the
Underwriters.

Underwriters/Placement Agents - the brokers, investment banks or

banks that sell or place the Securities in a public offering or private placement. The
Underwriters/Placement Agents usually play the principal role in structuring the
transaction, it also works with the Originator and helps in structuring deals.

Rating Agencies - The rating process would assess the strength of the cash flow
and the mechanism designed to ensure full and timely payment by the process of
selection of loans of appropriate credit quality, the extent of credit and liquidity support
provided and the strength of the legal framework. For.eg.Moody's, S&P, Fitch IBCA and
Duff & Phelps.

Servicer - the entity that actually deals with the Receivables on a day to day basis,
collecting the Receivables and transferring funds to accounts controlled by the Trustees.
In most transactions the Originator acts as Servicer.
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PROCESS OF SECURITIZATION
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PROCESS OF ASSET BACKED SECURITIZATION

The process of creating asset backed securities is discussed in the following points:

1. The Company sells its products and services on credit and this becomes the trade
receivables or account receivables in the balance sheet of the company.

2. Out of these receivables, the originator pools certain receivables together on the basis
of maturity and risk structures and sells these to a securitization company known as
Special Purpose Vehicle (SPV) or Special Purpose Entity (SPV).

3. The securitization company makes payment (consideration) to the originator for the
receivables purchased.

4. These receivables are converted into a pool of securities by the securitization

company for the purpose of issuing Pass Through or Pay through Certificates (PTCs).

5. These Pay Through or Pass Through Certificates are then rated by Credit Rating
Agencies e.g. Pakistan Credit Rating Agencies (PACRA), JCR-VIS Credit Rating
Co. Ltd.

6. The Pay Through or Pass Through Certificates are sold to individual investors or
Qualified Institutional Buyers.

7. The Collection of receivables from debtors is obtained by Company itself in case of

Pass Through Certificates and by Securitization Company in case of Pay Through
Certificates. If collection is made by the Company then it is under obligation to pass
on the money to the securitization company.

8. The securitization company then, makes payment to the investors.

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WHY DO ISSUERS NEED SECURITIZATION?

The need for cash is to grow and expand the business. Raising equity and borrowing
through debt is difficult, expensive and can distort the financial leverage of a company.
Equity and bonds are two 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 (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. Besides this the originator
of asset-backed securitization may benefit in the following manners:

• Securitization mainly results in receivables being replaced by cash thereby improving

the liquidity position.

• It removes the assets from the balance sheet of the originator, thus liberating capital
for other uses, and enabling restructuring of the balance sheet by reducing large
exposures.

• It facilitates better asset liability management by reducing market risks resulting from
interest rate mismatches. The process also enables the issuer to recycle assets more
frequently and thereby improve earning.

• Finally, transparency may be improved since securitization results in identifiable

assets in the balance sheet.

REASONS TO SECURITIZE RECEIVABLES

Probably the most common reason to securitize receivables is to efficiently raise cash.
Enhancing working capital is especially important for companies with long sales cycles
and terms of sale. Given that receivables are typically the largest single asset category on
the balance sheet, it is a natural choice for monetization. The securitization process
Generally provides companies broader access to capital at a lower all-in-cost of funds.
This is especially true for companies whose creditworthiness is weaker than their
Customers. In such instances there exists a credit arbitrage. A well-structured
securitization can achieve an investment grade rating even for a selling company that is
not investment grade rated. Through standardized underwriting, robust servicing, credit
insurance and appropriate structuring, a company can intends to further broaden the
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opportunities for mid-sized companies to bootstrap their access and resulting

efficiencies. Achieving balance sheet management objectives can be an additional reason
a company chooses to securitize their receivables. Sale treatment can be achieved with
the resulting opportunity to de-leverage through the use of proceeds to redeem
outstanding debt. Compliance with debt or loan covenants can be fostered through
improvements in certain balance sheet ratios and metrics, including: days sales
outstanding (DSO), “quick” ratio, return-on-assets (ROA) and debt-to-equity ratio.

WHY DO INVESTORS INVEST IN ASSET-BACKED

SECURITIES?

These the reasons the investors prefer to invest in asset-backed securities:

• Securitization creates instruments with differing maturities, risks, coupons, which

is appealing to investors. Securitization is a structured financial instrument i.e.
tailored to the risk-return and maturity needs of investors, rather than a simple
claim against an entity or asset.

• Asset-Backed Securitization offers a yield higher than instruments with

comparable risk. This is due to the credit worthiness of the instruments (usually
AAA rated) and the credit enhancement features.

• Asset-Backed Securitization offers a predictable cash-flow. Investors buy Asset-

Backed Securities with confidence that payments will occur at specified dates in
the future.

• Asset-Backed Securities are secured by the underlying assets; therefore they offer
significant protection against downgrades by rating agencies to the issuer.
• It provides an opportunity to the investors to diversify their investment portfolio
by investing in these asset backed securities.

Credit risk
It arises from the possibility that the issuer of an ABS, usually a special purpose vehicle,
may default on its liabilities. Since the SPV is normally structured to have no assets or
business other than holding the securitized assets, the principal focus is on the cash flow
from the assets themselves. The most important possibility to be considered is default by
the underlying borrowers, such as the car owners in the case of automobile loan
securitization. While a small but predictable loan loss ratio is manageable, the rating
agencies must carefully analyze the variations in default and delinquency rates and
evaluates any factors that might trigger an escalation in defaults.
Since the SPV is normally structured to have no assets or business other than holding the
securitized assets, the principal focus is on the cash flow from the assets themselves.
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Liquidity risk
It is the possibility of a cash shortfall at times when interest or principal payments are
due. If the individual obligors behind the underlying loans are late with their payments,
cash flow to the SPV may be insufficient for it to make interest and principal payments
in full and on time to investors. The cash flow from the underlying assets to the investors
should be structured -- and, if necessary, supplemented -- in such a way that no such
shortfall will occur.

Financial Guarantee
Many asset- backed securities are guaranteed, to remove the burden of analysis from the
investor. Rather than having to conduct a detailed analysis of a complex structure, many
investors prefer to rely on a top-rated, specialized financial institution whose only
business -- and livelihood -- depends upon maintaining its top rating through extremely
prudent credit policies.

FEATURES OF ASSET BACKED SECURITIZATION

Credit enhancement and trenching
Unlike conventional corporate bonds which are unsecured, securities generated in a
securitization deal are "credit enhanced," meaning their credit quality is increased above
that of the originator's unsecured debt or underlying asset pool. This increases the
likelihood that the investors will receive cash flows to which they are entitled, and thus
causes the securities to have a higher credit rating than the originator. Some
securitizations use external credit enhancement provided by third parties, such as surety
bonds and parental guarantees (although this may introduce a conflict of interest).
Individual securities are often split into tranches, or categorized into varying degrees of
subordination. Each tranche has a different level of credit protection or risk exposure than
another: there is generally a senior (“A”) class of securities and one or more junior
subordinated (“B,” “C,” etc.) classes that function as protective layers for the “A” class.
The senior classes have first claim on the cash that the SPV receives, and the more junior
classes only start receiving repayment after the more senior classes have repaid. Because
of the cascading effect between classes, this arrangement is often referred to as a cash
flow waterfall. In the event that the underlying asset pool becomes insufficient to make
payments on the securities (e.g. when loans default within a portfolio of loan claims), the
loss is absorbed first by the subordinated tranches, and the upper-level tranches remain
unaffected until the losses exceed the entire amount of the subordinated tranches. The
senior securities are typically AAA rated, signifying a lower risk, while the lower-credit
quality subordinated classes receive a lower credit rating, signifying a higher risk. [11]
The most junior class (often called the equity class) is the most exposed to payment risk.
In some cases, this is a special type of instrument which is retained by the originator as a
potential profit flow. In some cases the equity class receives no coupon (either fixed or
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floating), but only the residual cash flow (if any) after all the other classes have been
paid.
There may also be a special class which absorbs early repayments in the underlying
assets. This is often the case where the underlying assets are mortgages which, in
essence, are repaid every time the property is sold. Since any early repayment is passed
on to this class, it means the other investors have a more predictable cash flow.
If the underlying assets are mortgages or loans, there are usually two separate
"waterfalls" because the principal and interest receipts can be easily allocated and
matched. But if the assets are income-based transactions such as rental deals it is not
possible to differentiate so easily between how much of the revenue is income and how
much principal repayment. In this case all the income is used to pay the cash flows due
on the bonds as those cash flows become due.
Credit enhancements affect credit risk by providing more or less protection to promised
cash flows for a security. Additional protection can help a security achieve a higher
rating, lower protection can help create new securities with differently desired risks, and
these differential protections can help place a security on more attractive terms.
In addition to subordination, credit may be enhanced through:

 External Features:
 A Corporate/ Thrid Party Guarantees
 A letter of credit from a bank
 Bond Insurance
 Internal Features
 Over collateralization
 Reserve Funds
- Cash reserve funds
- Excess servicing spread accounts

• A reserve or spread account, in which funds remaining after expenses such as

principal and interest payments, charge-offs and other fees have been paid-off are
accumulated, and can be used when SPE expenses are greater than its income.
• Cash reserve funds are straight deposits of cash generated from issuance proceeds.
• Excess servicing spread accounts involve the allocation of excess spread or cash
into a separate reserve account after paying out the net coupon, servicing fee and
all other expenses on a monthly basis. For example:
Suppose that, Gross weighted average coupon is 8% and other servicing fees are .
25% so the net weighted average coupon is 7.25%. Therefore, the excess spread
would be (8-.7.25-.25= 0.5%).
• Third-party insurance, or guarantees of principal and interest payments on the
securities.
• Over-collateralization, usually by using finance income to pay off principal on
some securities before principal on the corresponding share of collateral is
collected.
 18

• Cash funding or a cash collateral account, generally consisting of short-term,

highly rated investments purchased either from the seller's own funds, or from
funds borrowed from third parties that can be used to make up shortfalls in
promised cash flows.
• A third-party letter of credit or corporate guarantee.
• A back-up servicer for the loans. Discounted receivables for the pool.

AMORTIZED AND NON-AMORTIZED ASSETS

Most ABS issues are AAA rated, because they are secured by collateral or have credit
enhancements. Asset-backed securities are diverse, with different yields, maturities,
collateral, and credit ratings.
ABSs can also be classified according to the type of payments made: amortizing and
nonamortizing. Amortizing payments (aka liquidating loans) are used to pay off loans
for a specific amount, whereas nonamortizing payments (aka revolving loans) are
usually payments made on a revolving line of credit. Mortgages and auto loans are
familiar examples of amortizing loans, whereas credit cards represent the most common
type of revolving account. ABSs based on amortizing payments pay both principal and
interest to investors in each payment, whereas ABSs based on revolving loans pay only
interest for a specified amount of time, then pay only principal during the final phase
before the final maturity date.
Because the cash flow of the underlying assets is uncertain, asset-backed securities are
sold assuming an average maturity rather than giving a guaranteed maturity date.
Early amortization events (aka payout events, early calls) are events that will shorten
the lifetime of the ABS, if there is any danger that the investors will not be fully paid.
These payouts based on triggers are generally required by the credit rating agencies for an
investment-grade rating.
Early amortization triggers include:
• insufficient payments by the underlying borrowers;
• insufficient excess spread;
• rise in default rate above a specified level;
• bankruptcy of sponsor or servicer.
Once triggered, the revolving, controlled-amortization, or accumulation period ends, and
all money received from the underlying assets is used to return the principal to the ABS
investors. The trigger and its sequel are irrevocable—everyone is paid regardless of the
expected maturity date. Because income is received from the underlying assets monthly,
payments to investors are monthly until everyone is paid in full.
 19

FIXED VS FLOATING RATE

There are fixed and floating rate asset backed securities. Floating-rate are typically
created where the underlying pool of loans or receivables pay a floating rate. The most
common are securities backed by credit card receivables, home equity line of credit
receivables, closed-end home equity loans with and adjustable rate, student loans and
trade receivables. Fixed rate as the name suggests are the ones which have a fixed rate.
They can also be used to create a structure that has one or more floating-rate tranches.
For example, there are closed-end home equity loans with a fixed rate that can be pooled
to create a structure with floating-rate tranches.

ADVANTAGES TO ISSUER
1. Reduces funding costs: Through securitization, a company rated BB but with AAA
worthy cash flow would be able to borrow at possibly AAA rates. This is the number one
reason to securitize a cash flow and can have tremendous impacts on borrowing costs.
The difference between BB debt and AAA debt can be multiple hundreds of basis points.
For example, Moody's downgraded Ford Motor Credit's rating in January 2002, but
senior automobile backed securities, issued by Ford Motor Credit in January 2002 and
April 2002, continue to be rated AAA because of the strength of the underlying collateral
and other credit enhancements.

2. Reduces asset-liability mismatch: "Depending on the structure chosen, securitization

can offer perfect matched funding by eliminating funding exposure in terms of both
duration and pricing basis."[13] Essentially, in most banks and finance companies, the
liability book or the funding is from borrowings. This often comes at a high cost.
Securitization allows such banks and finance companies to create a self-funded asset
book.

3. Lower capital requirements: Some firms, due to legal, regulatory, or other reasons,
have a limit or range that their leverage is allowed to be. By securitizing some of their
assets, which qualifies as a sale for accounting purposes, these firms will be able to lessen
the equity on their balance sheets while maintaining the "earning power" of the asset.

4. Locking in profits: For a given block of business, the total profits have not yet
emerged and thus remain uncertain. Once the block has been securitized, the level of
profits has now been locked in for that company, thus the risk of profit not emerging, or
the benefit of super-profits, has now been passed on.
 20

ADVANTAGES TO ORIGINATOR
The Securitization structure is intended to provide significant advantages to Originators,
such as:

1. Balance sheet management, lower cost of funds and access to additional funding
sources.

2. The Originator does not have to wait until it receives payment of the receivables to
obtain funds to continue its business and generate new Receivables.

3. There is usually a significant spread between the interest paid on the Securities and the
interest earned on the Receivables. Ultimately, the Originator receives the benefit of the
spread. In addition, the Originator usually acts as Servicer and receives a fee for its
services.

4. Better utilization of resources and capital.

5. Improved financial ratios

ADVANTAGES TO INVESTORS
1. Opportunity to potentially earn a higher rate of return (on a risk-adjusted basis)
Opportunity to invest in a specific pool of high quality credit-enhanced assets: Due
to the stringent requirements for corporations (for example) to attain high ratings, there is
a dearth of highly rated entities that exist. Securitizations, however, allow for the creation
of large quantities of AAA, AA or A rated bonds, and risk averse institutional investors,
or investors that are required to invest in only highly rated assets, have access to a larger
pool of investment options.

2. Portfolio diversification: Depending on the securitization, hedge funds as well as

other institutional investors tend to like investing in bonds created through Securitizations
because they may be uncorrelated to their other bonds and securities.

3. Isolation of credit risk from the parent entity: Since the assets that are securitized
are isolated (at least in theory) from the assets of the originating entity, under
securitization it may be possible for the securitization to receive a higher credit rating
than the "parent," because the underlying risks are different. For example, a small bank
may be considered more risky than the mortgage loans it makes to its customers; were the
 21

mortgage loans to remain with the bank, the borrowers may effectively be paying higher
interest (or, just as likely, the bank would be paying higher interest to its creditors, and
hence less profitable).

DISADVANTAGES TO ISSUER
1. May reduce portfolio quality: If the AAA risks, for example, are being securitized
out, this would leave a materially worse quality of residual risk.
Costs: Securitizations are expensive due to management and system costs, legal fees,
underwriting fees, rating fees and ongoing administration. An allowance for unforeseen
costs is usually essential in securitizations, especially if it is an atypical securitization.

2. Size limitations: Securitizations often require large scale structuring, and thus may not
be cost-efficient for small and medium transactions.

3. Risks: Since securitization is a structured transaction, it may include par structures as

well as credit enhancements that are subject to risks of impairment, such as prepayment,
as well as credit loss, especially for structures where there are some retained strips.

DISADVANTAGES TO THE ORIGINATOR

1. Securitization has some disadvantages for originators significantly initial transaction
and on-going compliance costs.

2. Reduced control by the Originator of the assets sold to the SPE.

DISADVANTAGES TO INVESTOR
1. Credit/default: Default risk is generally accepted as a borrower’s inability to meet
interest payment obligations on time. For ABS, default may occur when maintenance
obligations on the underlying collateral are not sufficiently met as detailed in its
prospectus. A key indicator of a particular security’s default risk is its credit rating.
Different tranches within the ABS are rated differently, with senior classes of most issues
receiving the highest rating, and subordinated classes receiving correspondingly lower
credit ratings.
However, the credit crisis of 2007-2008 has exposed a potential flaw in the securitization
process - loan originators retain no residual risk for the loans they make, but collect
substantial fees on loan issuance and securitization, which doesn't encourage
improvement of underwriting standards.

2. Prepayment/reinvestment/early amortization: The majority of revolving ABS are

subject to some degree of early amortization risk. The risk stems from specific early
amortization events or payout events that cause the security to be paid off prematurely.
 22

Typically, payout events include insufficient payments from the underlying borrowers,
insufficient excess Fixed Income Sectors: Asset-Backed Securities spread, a rise in the
default rate on the underlying loans above a specified level, a decrease in credit
enhancements below a specific level, and bankruptcy on the part of the sponsor or
servicer.

3. Currency interest rate fluctuations: Like all fixed income securities, the prices of
fixed rate ABS move in response to changes in interest rates. Fluctuations in interest rates
affect floating rate ABS prices less than fixed rate securities, as the index against which
the ABS rate adjusts will reflect interest rate changes in the economy. Furthermore,
interest rate changes may affect the prepayment rates on underlying loans that back some
types of ABS, which can affect yields. Home equity loans tend to be the most sensitive to
changes in interest rates, while auto loans, student loans, and credit cards are generally
less sensitive to interest rates.

4. Moral hazard: Investors usually rely on the deal manager to price the securitizations’
underlying assets. If the manager earns fees based on performance, there may be a
temptation to mark up the prices of the portfolio assets. Conflicts of interest can also arise
with senior note holders when the manager has a claim on the deal's excess spread.[14]
Servicer risk: The transfer or collection of payments may be delayed or reduced if the
servicer becomes insolvent. This risk is mitigated by having a backup servicer involved
in the transaction.

STRICT RULES AND REGULATIONS (REGULATED

BY SECP)
Assets Securitization through Special Purpose Vehicle (SPV)
State Bank of Pakistan has received requests from a number of financial institutions
desirous of performing various roles in assets securitization transactions through special
purpose vehicle. These requests have been considered in consultation with concerned
quarters and it has been decided that banks/DFIs can participate in assets securitization
through SPV. However, in doing so and performing various roles in assets securitization
through this mode, they shall adhere to the guidelines prescribed below:

General Guidelines
2.
Banks/DFIs participating in a securitization transaction in any capacity shall
ensure that:
i) they do not own any share capital in the SPV
ii) the SPV and the ABS (Assets Backed Securities) issued by it do not carry the
same or similar name as that of the bank/DFI. SPV shall not include the name of
the bank/DFI in its name or imply any connection with the bank/DFI, for
example, by using a symbol closely associated with the bank/DFI.
iii) all reasonable steps are taken to ensure that investors are informed in writing that
their obligations to the SPV and investors in the ABS of the SPV are limited to
the extent expressed in their written agreement with SPV.
 23

iv) all transactions between them and SPV are conducted at arms length and are
market based.

Arranger/Structuring Agent
3.
The financial institution in this role may structure the transaction keeping in view
the requirements of the originator, the market appetite, internal and external credit
enhancement, quality of receivables, etc. Banks/DFIs performing this role shall ensure
that:
i) their legal advisers are satisfied that the terms of the asset securitization issue
protect them from any liability to investors in the scheme or the vehicle
ii) any offering circular contains a highly visible, unequivocal statement that the
banks/DFIs, serving in this capacity, do not stand behind the issue or the vehicle
and will not make good any loss in the portfolio.
iii) a fee at least at market terms and conditions is charged for the services performed.

Administrator/Trustee/Servicing Agent
4.
The role envisages collection of the assigned/purchased receivables, defraying
them to investors and taking appropriate enforcement actions when necessary to ensure
their payment. The banks/DFIs performing this role shall comply with the following
guidelines:
i) The bank/DFI should have clearly defined process flow and roles and
responsibilities of personnel needed to carry out these activities.
ii) There should be a written contract/agreement between the bank/DFI, originator
and SPV specifying the services to be provided as also other functions
antecedental and ancillary there to.

iii) The written contract/agreement shall specifically state that the bank/DFI is under
no obligation to remit funds to the SPV or the investors in the ABS unless and
until they are received from the obligor.
iv) The banks/DFIs shall ensure that any offering circular precisely mentions a highly
visible, prominent and unequivocal statement that serving in this capacity, they do
not stand behind the issue or the SPV and will not make good any losses in the
portfolio.
v) The bank/DFI shall place in record the written opinions from its legal advisers
that the terms of agreement protect it from any liability to investors in the
securitization transaction or the SPV (except normal contractual obligations
relating to its role as servicing agent).
vi) The bank/DFI may receive a performance-related payment (or benefit from any
surplus income generated
1
), in addition to its base fee, provided the same is on
market terms and conditions and any performance-related payment does not
commit it to any additional obligation. Such payment shall be recognized for
profit and loss purposes only after it has been irrevocably received.
 24

Investor
5.
The conditions prescribed under Prudential Regulation IV & V and NBFIs Rules
7 & 8 are relaxed only in cases where banks/DFIs desire to invest in marketable ABS
representing distinct, identifiable and recurring cash flows, issued by SPVs established
under Asset Backed Securitization Rules 1999 and duly registered with Securities and
Exchange Commission of Pakistan. They will, however, adhere to the guidelines
indicated below:
i) The banks/DFIs holding Asset Backed Securities (ABS) have risk exposure to
these underlying ABS assets. While determining total exposure under PR-I/NFBI
Rule 9 to any particular obligor, they shall therefore take into consideration the
exposure against the ABS assets of that particular obligor.
ii) The banks/DFIs shall invest in only those ABS, which are listed on the Stock
Exchange and have a minimum credit rating of A or equivalent from a Credit
Rating Agency approved by SBP or an international credit rating agency viz.
Standard & Poor, Moody or Fitch.
iii) Total exposure of a bank/DFI towards ABS issued by a SPV shall not exceed 5%
of its own paid up capital or 15% of the total value of the ABS issued by a SPV
which ever is less. Further, the aggregate exposure on account of ABS shall not
exceed 20% of the total paid up capital of the bank/DFI. (This will encourage
banks/DFIs to (a) invest in and sell-down these ABS, i.e. to churn their ABS
portfolio to stay within the 20% cap and to (b) actively trade in ABS to develop a
secondary market, rather than to simply purchase these ABS and hold them till
maturity)
iv) For Capital Adequacy purposes, the banks holding ABS shall treat them at par
with investment in TFCs and accordingly apply the risk weights prescribed by
State Bank.
v) The banks/DFIs will not invest in ABS in cases where originator/the company
setting up the SPV is defaulter of any financial institution. For this purpose,
banks/DFIs shall obtain report from CIB of State Bank before making investment
decisions.

Originator
6.
The banks/DFIs under this role would act as supplier of the assets/receivables that
are securitized. In this respect they shall comply with the following guidelines:
i) The banks/DFIs can securitize their assets relating to lease financing (with
acknowledged assignment of lease rental proceeds), mortgage financing and toll
1 This refers to any surplus income generated by the underlying assets of the SPV after
meeting all payment
obligations of the securities issued, operating costs of the SPV, and/or losses or bad debts
on the underlying assets.
financing (for infrastructure developmental projects). Other assets may be
securitized by banks with prior approval of State Bank, on a case to case basis.
ii) The securitizing bank/DFI shall ensure that there are no impediments (contractual
 25

or otherwise) that prevent the transfer of the assets, or the rights in relation to such
assets, to an SPV and all the necessary consents have been obtained. The transfer
of the assets should not contravene the terms and conditions of any underlying
agreement governing the assets.
iii) The securitizing bank/DFI must have legal and accounting opinions on record to
the effect that it has retained no liability for the loans so securitized.
iv) The securitizing bank/DFI must ensure that it is not obliged to support any losses
suffered by investors in the ABS issued by the SPV.
v) The assets should be transferred at fair value. A fixed amount of consideration
for the securitized assets must be received not later than the time of the transfer of
the assets.
vi) The securitizing bank/DFI shall have no obligation to repurchase any securitized
asset at any time.
vii) The transfer of assets must comply with the true sale criteria, which at a minimum
should have the following characteristics:
a. The underlying assets must have been isolated from an originator i.e., put
beyond the reach of the originator and its creditors even in receivership or
bankruptcy.
b. The risk that a transfer of assets by an originator to an SPV might be re-
characterized as a financing transaction rather than a sale of assets be
completely eliminated. In this regard, the originator must effectively
transfer all rights and obligations in the underlying assets to the SPV and
should not retain any residual beneficial interest in the underlying assets.
c. An originator must not hold any equity stake, directly or indirectly, in an
SPV. In addition, the originator must not be in a position to exercise
effective control over the decisions of the SPV in relation to the
securitization transaction. The originator thus should not have any
director, officer or employee on the board of the SPV
d. An SPV must have no recourse to an originator for losses arising from
those assets.
e. Where an originator is also the Administrator/Trustee, the services must
be provided on an arms length basis and on market terms and conditions.
viii) Investors must be clearly informed in the offering circular that the ABS they
invest in do not represent deposits or constitute other liabilities of the securitizing
bank/DFI and the securitizing bank/DFI does not in any way stand behind the
value or performance of the ABS issued by the SPV or of the assets held by the
SPV.
ix) Investors must be informed that their holdings of ABS are subject to investment
risk, including repayments or interest rate risks, possible delays in repayments and
loss of income, principal invested, etc.
x) The securitizing bank/DFI shall not support any loss arising from the
securitization transaction or by investors involved in it. It will also not bear any
of the recurring expenses of the transaction.
xi) The securitizing bank/DFI shall not underwrite or invest in the ABS issued by the
SPV.
 26

Underwriter
7. Banks/DFIs can underwrite the ABS issued by an SPV, however, its share should not
exceed 5% of its own paid up capital or 15% of total value of the ABS which ever is less.

Provider of Fund Based/Non-Fund Based Facilities

8. Banks/DFIs are not allowed to extend any fund based facility (for instance, temporary
liquidity support) to the SPV or provide any non-fund based facility (like credit
enhancement support in the form of stand-by letter of credit or guarantee) to the ABS.
However, in the following circumstances, banks/DFIs may allow fund based facility

(temporary liquidity support) to the SPV or provide non-fund based facility (credit
enhancement support in the form of stand-by letter of credit or guarantee) to the ABS:
i)
Where the facilities are fully secured against the guarantee of an International Ist
Class Bank rated at least A or equivalent by a recognized credit rating agency viz.
Standard & Poor, Moody or Fitch.
ii)
Where facilities are fully secured against cash or near cash collateral under
perfected lien of the bank after taking into account the margin requirements as
prescribed by State Bank of Pakistan. Cash or near cash collateral for the purpose
of this clause shall mean the bank deposits, deposit certificates and Government
Securities.
9. In addition to these guidelines, banks/DFIs desirous of participating in the assets
securitization transactions should formulate policies and develop controls, checks and
balances to effectively manage the associated risks.
10. State Bank of Pakistan will closely monitor the market developments and review the
guidelines, as and when necessary, to meet the needs of the market, while ensuring
prudent conduct of securitization transactions by banks/DFIs.

TRANSACTIONS
TELECOM SECTOR (PAKTEL LIMITED)

Special Purpose Vehicle:

Securetel-SPV Limited.

Originator:
Paktel Limited.

The SECP has granted registration to Securetel-SPV Limited, a wholly owned

subsidiary of United Executors and Trustees Limited, to operate as a Special Purpose
Vehicle under the Companies (Asset Backed Securitization) Rules, 1999. Securetel
 27

envisages mobilization of funds for Paktel Limited -a local cellular telecom- by issuing
TFCs. Of the total sum of Rs840 million, TFCs worth Rs640 million would be offered as
pre-IPO and Rs200 million in IPO. The TFC is rated "A" (single A) by PACRA, is for 3
year tenor and carries profit at SBP discount rates plus 200 bps with a cap of 16 per cent
and floor of 12 per cent for the first year and 11.5 per cent for the last two years. United
Bank Limited has acted as consultant for the ABS transaction. This securitization would
enable Paktel to replace its short-term foreign currency debt with medium-term local
currency debt. Considering the fall of the greenback following 9/11, the transaction
would improve Paktel's liquidity position by reducing foreign exchange losses.
Securetel purchased a portion of Paktel’s receivables and issued ABS notes in March
2003. Paktel in turn expects to utilize the proceeds in retiring partly its existing loans of
United Bank Limited of Rs750 million and Pak Kuwait Investment Company's Rs240
million. Nearly 99 per cent shares in Paktel are held by the Luxembourg based Millicom
International Cellular S.A, which is a fairly large holding company with 18 cellular
operations in 17 countries. Another major player, Orascom Telecom is also expected to
assign its nationwide receivables to a foreign bank in Pakistan.
Analysts at IP Securities (Pakistan) said that with the falling rate of returns on National
Savings Schemes (NSS) and Government Securities for the general public and financial
institutions, investment avenues were falling short and the facilitation of innovative
instruments was needed. Paktel had suffered huge exchange losses till the financial year

2001, due to foreign currency borrowings, a significant portion of which had been paid
off through internal cash generation and short-term loans. This had led to high reliance
on short-term borrowings. Paktel had therefore decided to issue medium term securitized
TFCs to rationalize its capital structure and to correct imbalance in asset liability
maturity profile.
The analyst noted that Paktel had suffered huge exchange losses till the financial year
2001, due to foreign currency borrowings, a significant portion of which had been paid
off through internal cash generation and short-term loans. This had led to high reliance
on short-term borrowings. Paktel had therefore decided to issue medium term securitized
TFCs to rationalize its capital structure and to correct imbalance in asset liability
maturity profile.
The 'mitigants' part of the Prospectus listed among others the following: The purpose of
securitization was to segregate the operational performance of a company from its
financial performance. The risk was on the operational performance of Paktel rather than
on its financial performance; the investment by the TFC holders would be in securities
issued by SPV and not in Paktel. Thus the TFC holders would not largely be dependent
on the financial performance of Paktel; the transaction was a future flow transaction,
because it was not backed by cash flows generated by an existing pool of assets, but
rather by cash flows from assets that would be generated in the future.
The prospectus noted that the future flow transactions were dependent on the ability of
the company to produce a good or provide a service, and thus derived their strengths
from segregating its performance from the overall financial profile of the company. By
separating operational from financial performance such transactions offered a less risky
investment alternative.
According to other details noted in the prospectus, of the total sum of Rs840 million,
 28

TFCs worth Rs640 million would be offered as pre-IPO and Rs200 million in IPO. The
TFC is rated "A" (single A) by PACRA, is for 3 year tenor and carries profit at SBP
discount rate plus 200 bps with a cap of 16 per cent and floor of 12 per cent for the first
year and 11.5 per cent for the last two years.

WORLDCALL PAYPHONES LIMITED:

The telecom sector itself has seen substantial activity in structured finance. WorldCALL
Payphones Limited is one of Pakistan's fastest growing telecom companies, with an
installed base of over 5,000 smart card payphones throughout Pakistan. WorldCALL
needed to raise Rs. 345 million in new equity financing to fund a major expansion plan,
including 8,000 additional card phones and a proposed wireless local loop network
supporting 50,000 additional phones. Following the unsuccessful attempts of another
securities firm to effect the offering and reopen the Pakistani IPO market, after a dry
spell of over two years, WorldCALL appointed AKD Securities as its financial advisor
to raise the necessary funds.
Realizing the potential upside for well funded private companies in Pakistan's
increasingly deregulated telecom sector, AKD underwrote the offering. After leading a
Rs. 195 million pre-IPO placement with institutional investors, AKD generated demand
for the IPO and as a result WorldCALL's Rs. 150 million IPO was heavily
oversubscribed and the company received the funds necessary for it to continue on its
growth trajectory.
 29

PAKISTAN TELECOMMUNICATIONS LTD.

Net Settlement Securitization

In 1997, Fitch rated a securitization of Pakistan Telecommunications Ltd.’s (PTCL) net

settlement receipts. The receivables in this type of transaction are the net amounts
generated by tariffs that one company owes to another for the use of its
telecommunication infrastructure when completing international calls. These tariffs arise
when individuals in a developed country (e.g., the United States, Japan or Germany)
make calls into an emerging-market country (e.g., Chile, Pakistan or Peru). Although the
developed-market company, MCI, for example, is originating the call and collecting the
revenues from the individual in the developed country, MCI must use PTCL’s
infrastructure to complete the call. PTCL allows MCI to use its infrastructure but charges
the company a fee for each minute of use. Similar fees are charged to PTCL when calls
originate in Pakistan and go to MCI’s market. There is a net amount in favor of PTCL,
because the volume of originating calls tends to be much higher in the United States than
Pakistan. It was these international net payments that were securitized in the PTCL
transaction. A key factor to this transaction was that the international carriers, such as
MCI, signed notice and acknowledgement agreements (N&As) that legally obligated
them to remit payments into the offshore collection account that is used to pay investors.
This structure mitigates certain sovereign risks, such as transfer and convertibility and
sovereign redirection. Due to this structure, Fitch initially rated the transaction ‘BBB–’.
This rating meant the transaction had a lower probability of default compared to that of
the sovereign. Additionally, Fitch rated the transaction above PTCL’s local currency
rating due to the company’s monopoly status in the local market and the high ratio of net
settlements in favor of Pakistan. Furthermore, the company is fully supported by the
government since it is 88% state owned. Rating the transaction above the local currency
rating of PTCL and the sovereign signifies that Fitch believes the net settlement cash
flows would continue to pay offshore investors, even during a default on local creditors.
From 1998–2001, Pakistan’s and PTCL’s credit quality deteriorated. Due to the decline
in credit quality and an increased risk of cash flow disruption, Fitch downgraded the
transaction first in June 1998 to ‘BB+’ and then again in October 1999 to ‘BB’.
Additional concerns included the drastic declines in net settlement tariffs.

The company obtained funds aggregating US $ 250 million against securitization of its
future international receivables relating to certain carriers. Under the arrangements, these
carriers have irrevocably assigned the company's future receivables to a Trust set up for
this purpose for the tenor of the facility. The cash flows arising from these receivables
are paid to the company by the Trust after deducting there from the repayment of
principal and return that investors in the Securitization Trust are to receive and retaining
a cash margin as a default cushion. Interest is payable quarterly at 8.42% per annum.
 30

THE LEASING SECTOR

(PAKISTAN INDUSTRIAL LEASING CORPORATION)

In June 2002, the specialized Companies Division of the SECP processed the
registration of First Securitization Trust as the first special purpose vehicle under the
Companies (Asset Backed Securitization) Rules, 1999. This trust has been set up to raise
funds for Pakistan Industrial Leasing Corporation Limited (PILCORP) up to rupees one
hundred million through issuance of debt instruments against the Securitization of
PILCORP's lease receivables. The said transaction was arranged by Aqeel Karim Dhedi
Securities (Pvt) Limited (AKD) and Orix Investment Bank Limited to provide funds to
PILCORP for retiring its debt obligations. In emerging markets like Pakistan, where
volatile economic cycles and sudden shocks are translated on the asset portfolio,
protection against deteriorating credit quality is very important. This unstable nature of
Pakistan’s economy has highlighted the importance of a strong capital base which can
provide protection against unanticipated losses. Furthermore, substantial capital provides
a leasing concern with greater flexibility to leverage its balance sheet. On the other hand,
for leasing companies in developed markets, deterioration in the asset quality usually
occurs over the long run, thus enabling them to increase general reserves/provisioning
against potential losses over a period of time. A serious issue plaguing the leasing sector
is the high rate of non-performing leases and loans (NPLs), a situation that can be
attributed primarily to the inadequacy of risk assessment procedures and, to a lesser
degree, limited industrial growth that has led to sectoral concentration. Leasing across a
spectrum of industries reduces the risk of impairment in the asset quality. Strict credit
policies and continuous monitoring of the portfolio are looked upon favorably by credit
rating companies and accounts are reviewed closely to establish a company's exposure in
each sector, which if exceeds 20% of Net Investment in Leases (NIL) prompts a further
examination. Similarly, a drag on ratings may occur if exposure to a single client exceeds
15% of total equity. SECP is paying increasing attention to this factor and has recently
proposed an amendment in the rules that govern the leasing sector by restricting
exposure to a single party to 30% of unimpaired capital and reserves instead of the
earlier limit of 20% of NIL.
 31

REAL ESTATE SECTOR

(ASSOCIATED CONSTRUCTORS LIMITED)

Nature of Transaction
Future flow securitization of receivables arising from a construction project

Issue Amount:
Rs. 100m
Tenor:
30 months

Placement Type:
Private

Originator & Servicer:

Associated Constructors Limited

Primary Obligator:
Pakistan Defense Officers’ Housing Authority.

SPV Trustee:
Crescent Leasing Corporation Limited

Investor Trustee:
First Dawood Investment Bank Limited

Overview of the Originator

ACL was incorporated in 1966 as an unlisted public company engaged in the business of
civil engineering and construction and has completed multifarious projects including
construction of power and industrial plants, road and bridges, transmission, lines, oil and
gas field development, salinity control etc.
 32

Transaction Summary:
The proposed ABS Certificates amounting to Rs. 100m will be issued by Development
Securitization Trust (DST), a Special Purpose Vehicle (SPV) formed under the Asset
Backed Securitization Rules 1999. The issue is securitized against designated future flow
receivables arising from the contract for six towers of Creek Vistas Towers in the Creek
City Project being executed by Associated Constructors Limited (ACL), the originator.
The contract agreement of the project is with the Pakistan Defense Officers’ Housing
Authority (DHA). The proceeds of sales of receivables will be utilized by ACL in the
purchase of specialized construction equipment for the project.
Future receivables, i.e. 40% of the originator’s present and future receivables based upon
the contract excluding the receivables that have already been realized prior to the closing

date, are expected to amount to around Rs. 477.72m. They will be routed through a
collection account to be maintained by the SPV trustee from which deductions will be
made for payments to the investors. A reserve fund equivalent to one installment will
also be created initially from the proceeds of the certificates. It may be increased to two
installments by the SPV Trustee if for two consecutive months project gross cash flows
fall short materially from the Projected Service Schedule provided by ACL. An exclusive
charge on the equipment being bought by ACL will form the security against
performance risk. The ABS Certificates will have a tenor of 30 months including three
months initial grace period on principal and interest payments. Debt servicing will be in
quarterly installments with nine equal principal repayments at a rate of KIBOR + 4%
with a floor of 7.50% and no cap.
Rating Rationale:
The rating of the ABS Certificates is based on the quality of receivables, the structure of
the transaction and the credit quality of ACL. In the absence of a potential backup
servicer, cash flow generation is dependant upon the performance of the originator in
carrying out the contract. The assigned cash flows are projected to provide over-
collateralization of over 4.0x to debt servicing requirements to cover the risk of both time
and cost overrun. Where cost considerations are considered, ACL is of the view that it
will benefit from the subsequent reduction in prices of non-pass through items. Presence
of a reserve fund is an additional source of comfort. ACL possesses diverse and vast
experience in carrying out construction activities. Our meetings with their past customers
also established that they enjoy a sound reputation in terms of quality and reliability.
However this is the first time they are venturing into a residential project of this
magnitude. Currently, this is the sole major project in which they are involved. ACL
operates at a very low debt leverage level in view of erratic cash flows associated with
the construction business and has been assigned entity ratings of BBB-/ A-3.
 33

PETROLEUM SECTOR
(ORIENT PETROLEUM INC. – PAKISTAN BRANCH)

Nature of Transaction
Securitization of future receivables i.e. proceeds of sale of gas and condensate production
of designated fields of Orient Petroleum Inc.-Pakistan Branch.

Issue Amount:
Rs. 1 billion + 500 million green shoe option.

Tenor:
5 Years

Originator & Servicer:

Orient Petroleum Inc. Pakistan Branch.

Primary Obligator:
National Refinery Limited.
Pakistan Refinery Limited.
Sui Southern Gas Company Limited.

Trustee:
To be decided

Overview of the Originator

Orient Petroleum Inc. is incorporated in the state of California, United States of America,
with the Head office in Houston, Texas and a branch office in Islamabad. The Pakistan
branch in engaged in exploration, drilling, production and sale of petroleum, natural gas
and LPG. The company was taken over by Hashoo Group in 1995. It is joint venture
operator in the North Porwar, Soan, Ratana, Mirpur Khas and Khipro Petroleum
Concession blocks and is a partner in non operated Meher Block of Petronas Carigali and
Sinjhoro Block of OGDCL where recently six discoveries were made.
 34

Transaction Summary:
The proposed TFCs of Rs. 1,000 m with Rs 500m green shoe option will be issued by
Naimat Basal Oil & Gas securitization Company Limited (NBSC), a Special Purpose
Vehicle for a tenor of five years. These are backed by the US dollar denominated future
receivables, with a cap of Rs 2,041 billion, arising from the sale of upto 0.52 MMBO of
condensate and 38.80 BSCF of gas from three producing fields i.e. naimat Basal, Siraj
South and Ali, where Orient Petroleum Inc. – Pakistan branch (OPI) is operator.

Suibsequent to the early well testing currently underway, the Government of Pakistan
will assueme the role of the primary buyer of the production of the designated fields.
GOP will in turn assign this production to National Refinery Limited and Pakistan
Refinery Limited (condensate) and Sui Southern Gas Company Limited (gas). These
companies will make direct payments into the collection account to be operated
exclusively by NBSC for monthly debt servicing and for meeting its administration
expenses. A reserve fund equivalent to three installments principal and interest payment
will also be maintained. It may increased on NBSC’s discretion to a maximum of six
instrallments equivalent payments, if for two consecutive months the production in the
fields falls below the “Projected Production Schedule” (PPS) provided by OPI by 15% or
more.
Debt servicing will be in monthly installments with 3% of the principal to be redeemed
in six months and remaining 97% in 54 equal monthly installments at a coupon rate of
Average Ask Rate of six months Karachi Interbank Offer rate + 2.5% with a floor of
7.50% and a cap of 13.00%. The TFCs will be listed on the Karachi Stock Exchange.

Rating Rationale:
The ratings are based on the quality of receivables, the structure of the transaction and
the credit quality of OPI as servicer and originator.
• The bankruptcy remote nature of NBSC arising from its legal status as an SPV
with limited scope of operations and true sale of assigned future receivables to
NBSC.
• The projected cash flows fro the assigned producing fields provide over
collateralization of around 3.0x to debt servicing requirements to cover the risk of
adverse fluctuations in production level, price and the exchange rate. Also the
projections have been based on very conservative price assumptions.
• Presence of reserve fund.
• Assured market for gas and condensate production due to the limited market
supply and strategic importance of the product.
• The quality of the receivables has been assured with good track record of
performance of the buyers.
• If OPI is unable to continue production for any reason, there is high probability
that the GoP will assign a Back up operator to ensure steady production flows
due to the strategic nature of the asset.
• OPI is involved in exploration and production activities in Pakistan and operates
with a sound technical team. It has substantial proven recoverable reserves which
are expected to generate strong cash flow stream during the next ten years. OPI’s
medium to long term entity rating is A (single A) while short term rating is A-1.
 35

PAKISTAN INTERNATIONAL AIRLINES

Pakistan International Airlines has struck a deal with Citibank for securitization of
domestic aviation future flows but the transaction has not been successfully executed.
The sources at Pakistan International Airlines have not revealed the information due to
the secrecy regarding the events.
However, it is concluded that all the other securitization transactions have been carried
out successfully and satisfactorily which shows its strong status in the Pakistani market.