| Abstract: | A securitization transaction creates a new set of analytical challenges for both investors in the asset backed securities (ABS) and for holders of the debt and equity of the sponsor. This article argues that investors can gain insights into the risk and expected rewards of both ABS and the sponsoring corporation's securities by focusing on the excess cash flow (or "residual interest") that is expected to be generated by the ABS trust. The value of this residual interest is recognized as a one-time gain by the sponsoring lender in the period the ABS transaction is closed. Because the assumptions used to calculate this gain should represent management's best estimates as to the performance of the loan pool, comprehensive analysis of the gain-on-sale calculation can provide both corporate and ABS investors with significant insight into the level of risk in the securities they own. It also offers a tool for determining whether the expected returns justify the risks. |
