UMB is among the newest and most active trustees serving the asset-backed security (ABS) industry. There are two main trustee functions in an ABS structure: indenture trustee and underlying trustee. In a pair of brief, non-technical posts, we’ll share just what those roles entail. This one focuses on the indenture trustee role—why it exists and how we serve clients.
Let’s start by establishing a hypothetical ABS structure, a widget loan deal. Say the securitization consists of $100,000,000 of widget loans transacted by a non-bank lender. We’ll call that firm Finance Co.
Finance Co. works with an underwriter to determine a pool of loans to securitize. The underwriter brings the newly created securities to market, and investors (noteholders) purchase interests—meaning the bonds that are now secured by the cash flows generated as borrowers repay their widget loans over time.
Now, after the deal has come to market and borrowers are making payments, how does the money get to investors? That’s where the intuitive need for a trustee comes into play.
Here’s how it works, in a nutshell
- Each calendar day, a subset of borrowers pays their widget loan. Say it’s the first day of the month, and Finance Co., in its role as a servicer, receives a total of $100,000 in loan payments.
- Finance Co. transfers the funds into a trust account at the indenture trustee. (Note this means the indenture trustee has banking powers. In the case of UMB, the specific entity serving as indenture trustee is UMB Bank, n.a.)
- Over the course of the month, assets in the trust account accumulate as Finance Co. makes additional transfers into the account.
- At the end of the month, Finance Co. sends the indenture trustee a waterfall report breaking down how much of those accumulated transfers was principal repayment and how much was interest.
- The indenture trustee then uses the waterfall report to make required movements within the trust and reserve account—and to pay principal and interest to the investors.
- The P&I payments due to the investors are made manually or through the Depository Trust Company (DTC).
Ultimately, the role of the indenture is to ensure transactions are processed correctly and noteholders receive payments on the due dates. Deal participants rely on the credibility of the indenture trustee to give them confidence this will happen in the appropriate way.
Another way the credibility of the indenture trustee comes into play is in a related role called backup servicer. Noteholders want to know that if Finance Co. were unable to continue collecting loan payments—for whatever reason—some other entity will step in to do so.
What is a backup servicer?
In its role of backup servicer, UMB contracts with multiple third-party companies to be on standby just in case there were a need. UMB’s role is as the responsible party to make sure everything goes smoothly should there be a need.
Backup servicing is one of several closely related functions, often associated with the more technically narrow indenture trustee function. Here is a more complete list, with brief notes:
- Owner trustee – Holds ownership of the trust that has a secured interest in the loans
- DTC Settlement Agent – Settles the notes on behalf of a placement agent with DTC
- Collateral Agent – Safeguards and processes borrower’s funds held as collateral
- Escrow Agent – Safeguards and processes funds held in escrow until a closing occurs
- Verification Agent – Verifies certain items on an electronic loan file
- Document Custody – Holds custody of an electronic loan file
- Paying agent and registrar – Pays the investors or lenders (paying agent) and holds a list of the investors or lenders (registrar)
- Account bank – Opens and holds the trust account on behalf of the borrower
- Cash management – Moves the funds received and investing the funds on behalf of the borrower
- Calculation and tax agent – If needed, prepares the waterfall on behalf of the servicer
- Backup servicer – If needed, recalculates the servicer report and is prepared to step in for the primary servicer if needed
In a follow-up post, we’ll cover the role of underlying trustee, which will also provide an opportunity to outline a typical securitization structure—meaning how the several legally distinct entities relate to each other with respect to ownership, payment flows and more.
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