EXAMPLE OF AN ACTUAL STRUCTURED FINANCE TRANSACTION

EXAMPLE OF AN ACTUAL STRUCTURED FINANCE TRANSACTION

We conclude this chapter with an actual structured finance transac- tion—Caterpillar Financial Asset Trust 1997-A. Caterpillar Financial Asset Trust 1997-A is the special purpose vehicle and is referred to in the prospectus as the “Issuer” and the “Trust.”

The collateral (i.e., financial assets) for the transaction is a pool of fixed-rate retail installment sales contracts that are secured by new and used machinery manufactured primarily by Caterpillar Inc. The retail installment sales contracts were originated by the Caterpillar Financial Funding Corporation, a wholly-owned subsidiary of Caterpillar Finan- cial Services Corporation. Caterpillar Financial Services Corporation is a wholly-owned subsidiary of Caterpillar Inc. Because Caterpillar Financial Funding Corporation sold the retail installment sales contracts to Caterpillar Financial Asset Trust 1997-A, Caterpillar Financial Funding Corporation is referred to in the prospectus as the “Seller.”

The prospectus states that:

“THE NOTES REPRESENT OBLIGATIONS OF THE ISSUER ONLY AND DO NOT REPRESENT OBLIGA- TIONS OF OR INTERESTS IN CATERPILLAR FINAN- CIAL FUNDING CORPORATION, CATERPILLAR FINANCIAL SERVICES CORPORATION, CATERPIL- LAR INC. OR ANY OF THEIR RESPECTIVE AFFILI- ATES.”

This is the key feature of a structured financing—the separation of the collateral from the creditors of Caterpillar Inc.

The servicer of the retail installment sales contracts is Caterpillar Financial Services Corporation, a wholly-owned finance subsidiary of Cat- erpillar Inc. and is referred to as the “Servicer” in the prospectus. For ser- vicing the collateral, Caterpillar Financial Services Corporation receives a servicing fee of 100 basis points of the outstanding loan balance.

The securities were issued on May 19, 1997 and had a par value of $337,970,000. In the prospectus the securities were referred to as “asset-

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backed notes.” The structure was as follows. There were four rated bond classes:

Par Value

Class A-1 $88,000,000 Class A-2 $128,000,000 Class A-3 $108,100,000 Class B

$13,870,000 This is a senior-subordinate structure. The senior classes in this

transaction are Class A-1, Class A-2, and Class A-3. The subordinate class is Class B. The senior classes are paid off in sequence—first Class A-1 is paid principal until it is paid off its entire balance, then Class A-2 starts receiving principal payments until it is paid off entirely, and then finally Class A-3 is paid off. Class B begins receiving principal payments after Class A-3 is paid off. Any losses on the collateral are realized by Class B. If the losses exceed $13,870,000 (the par value of Class B) plus the losses that can be absorbed by the reserve account (discussed later), the senior classes absorb the loss on a pro rata basis.

Consequently, credit enhancement for the senior classes is provided by the subordinate class, Class B. Additional credit enhancement was provided by a reserve fund of $7,799,325. This initial reserve account is provided by the Seller via a deposit of that amount. The Seller receives a note for this amount.

Over time, as losses on the collateral are realized, the amount of the reserve fund would decline if there is no mechanism to prevent this from occurring. To prevent this, the structure provides for a “specified reserve account balance” to be maintained. In the Caterpillar Financial Asset Trust 1997-A, the specified reserve account balance must be equal to the (1) lesser of the principal balance of the outstanding asset-backed notes in the structure and (2) $7,799,325 (the amount of the initial reserve account balance). If there is a shortfall in the specified reserve account balance in a month, any payments from the collateral that exceed the interest payments to all the classes, the servicing fee, and administrative fees are deposited into the reserve fund until the shortfall is eliminated.

In the Caterpillar Inc. 2001 10-K filing with the SEC, the following is noted regarding securitized receivables:

“When finance receivables are securitized, we retain inter- est in the form of interest-only strips, servicing rights, cash reserve accounts, and subordinate certificates.”

Borrowing Via Structured Finance Transactions

It should be clear what all of forms of the retained interest are. The interest-only strips are what we described earlier in this chapter. The servicing rights are the value of the servicing fee of 1% of the outstand- ing pool balance not only for the Caterpillar Financial Asset Trust 1997-

A discussed above, but all of its structured finance transactions to date. The cash reserve account is the amount remaining in the reserve fund ($7,799,325 in the structure discussed less any reserves used). Subordi- nate certificates are any certificates retained by Caterpillar in a struc- tured financing because they are not sold to investors.

As explained earlier in this chapter, the value for the interest-only strips must be calculated. In the 10-K report, it is explained that this is done as follows for the securitized receivables:

“Gains or losses on the securitization are dependent upon the purchase price being allocated between the carrying value of the securitized receivables and the retained inter- ests based upon their relative fair value. We estimate fair value based on the present value of future expected cash flows using key assumptions for credit losses, prepayment speeds, . . . and discount rates. . .”

In our discussion of the value of the interest-only strips, we explained why these assumptions are important.