This is a project to create an open source library of smart contracts for common securitization structures such as subordination, overcollateralization, and directed cashflows.

The benefits of having openly available standard smart contracts are:

Avoid duplicate modeling of the same securitization structures by issuers, trustees, rating agencies, and analytic services
Avoid modeling discrepancies between the different parties
Create greater confidence in using these structures when they adhere to open standards
Reduce the costs for issuing of securities with automated smart contracts using standard structures
Open up market for more types of transactions using these structures

How It Works

Smart contracts will automatically make payments, or "distributions" to different classes of securities based on payments received from a pool of assets, or "underlying assets," according to pre-set rules, also known as the "waterfall." The underlying assets may be loans, receivables, or other securities, and they could have different cashflows: Some may be fully amortizing, others interest only, balloons, or bullet loans. They may also have different default, recovery, and prepayment rates. The smart contract will aggregate the cashflows for all the underlying assets and distribute them to the securities according to the waterfall rules.

The smart contracts will take these parameters for the underlying assets:

Unpaid Principal Balance (UPB)
Note rate
Amortization type - level payment or interest only.
Amortization term
Maturity term - could be used to model interest only or balloon loans.
Prepayment rate - amount of prepaid principal, as a percentage of the UPB.
Default rate - amount of defaulted principal, as a percentage of the UPB.
Recovery rate - amount of the defaulted principal recovered, as a precentage of the default rate.
Yield maintenance - payment received as part of yield maintenance penalties the borrowers paid to prepay their loans.

Examples:

	Residential Mortgage	Consumer Loan (Auto)	Commercial Mortgage
Unpaid Principal Balance	$1,000,000	$20,000	$10,000,000
Note Rate	3.5%	14.99%	4.25%
Amortization Type	Level Payment	Level Payment	Level Payment
Amortization Term	30 years	7 years	30 years
Maturity Term	30 years (ie fully amortizing)	7 years (fully amortizing)	10 years (balloon payment)
Prepayment Rate	1% per month	2% per month	0.5% per month
Default Rate	0.05% per month	2% per month	0.05% per month
Recovery Rate	70%	20%	70%
Yield Maintenance	None	None	5%

Using these parameters, smart contracts could be implemented for the following standard waterfall rules:

Subordination

With subordination, subordinated classes absorb the losses from defaults while the senior classes receive all the cashflows until they are paid off, and then the next layer of senior classes start to receive cashflows, until they are either paid off or their principal balance has been reduced to zero due to defaults. This structure is commonly used with larger balance loans such as residential and commercial mortgages.

An example of the structure would be:

Class	Principal	Interest
A-1	$70,000,000	2%
A-2	$20,000,000	2.5%
B	$5,000,000	5.5%
C	$5,000,000	15%

Interest payments received are allocated to A-1 and A-2 class at the same time based on their relative balances, then to class B, then to class C.

Principal payments, prepayments, and recovery from defaults are allocated to A-1, then A-2, then to B, then to C.

Realized losses reduce the outstanding balance of class C, then class B, then A-1 and A-2 at the same time based on their relative balances.

Overcollateralization

With overcollateralization, the amount of securities issued is less than the UPB of the underlying assets. The ratio of underlying assets to securities is the Overcollateralization ratio. It starts at an initial level, such as 110%, and may be targeted to stay at the same level or rise over time to a higher ratio, such as 125%. As the securities pay down from regular principal payments, prepayments, and recovery from losses, the issuer is expected to contribute more assets to maintain the Overcollateralization ratio at the targeted level. If the issuer does not or cannot contribute more assets, then all the received payments go to pay down the assets as quickly as possible in an "early amortization" event. This structure is more common with consumer assets, such as auto loans or credit cards, where the balances are relatively small and the terms of the loan short.

Example:

Underlying assets: $100,000,000 of auto loans with average rate of 14.99% and average term of 7 years

Securities: $80,000,000 fully-amortizing note with rate of 2.5% and term of 5 years

Overcollateralization: Issuer must maintain ratio of underlying assets to securities of 125%, or all cashflows from underlying assets are used to pay down the principal of the securitized note. This will cause the maturity of the note to shorten significantly.

Credit Enhanced Power Purchase Agreement

The underlying asset is a long-term power purchase agreement (PPA) for renewable energy whose credit is enhanced by a third party. When the renewable energy system, such as solar panels, wind farm, or storage batteries, generates energy, the PPA requires the buyer of the energy, or "offtaker", to pay for the energy produced. If the offtaker does not make the purchase, then a third party providing credit enhancement makes the payment, up to a maximum amount. If, however, the system fails to generate energy as expected originally, then a different third party would be responsible. This allows the technology and credit risks to be placed separately, for example with the original technology vendor and with a social impact or credit investor.

Borrower Shared Credit Enhancement

In a twist on the overcollateralization structure, as the Overcollateralization amount builds over time and the credit risk to the securities investor falls, the note rate for borrower or borrowers could fall as well. This would encourage borrowers to make payments by lowering their payments.

Analytical Validation

Verification of the smart contracts will be based on the cashflows allocated to each class under different prepayment and default/recovery scenarios. As long as the cashflows generated agree with expectations or standards, the smart contracts can be considered correct.

Other measures such as yield, spread, option value calculations are dependent on specific models and therefore should not be part of the standard smart contracts.

Browser not supported