Fachhochschule für Oekonomie & Management

Essen

Bachelor Thesis

Bachelor of Arts (International Management)

7th Semester

Topic:

ABS-

Structures, Markets, Threats and Opportunities

How the Subprime Crisis influences German Banks

With the example of IKB

Author:

Nadine Lobnig

Submission Date:

7th March 2008

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Table of Contents

TABLE OF CONTENTS I

LIST OF ABBREVIATIONS IV

LIST OF FIGURES VI

LIST OF TABLES VII

1

INTRODUCTION 1

1.1

Preface 1

1.2

Research Objective 1

1.3

Research Methodology 2

1.4

Organization of the Thesis 2

2

PORTFOLIO THEORY BY HARRY M. MARKOWITZ 4

2.1

Definition of a Portfolio 4

2.2

Portfolio Analysis 4

2.3

Uncertainty within a Portfolio 4

2.4

Relation of Securities within a Portfolio 5

2.5

Objectives of Markowitz′ Portfolio Analysis 6

2.6

Further Portfolio Theories 6

2.6.1

Capital Asset Pricing Model (CAPM) 6

2.6.2

Arbitrage Pricing Theory (APT) 7

2.7

Critical Appraisal 8

3

ASSET-BACKED SECURITIES 10

3.1

Definition of Asset Backed Securities as a Term 10

3.2

Historical Development of ABS as a Financial Tool 10

3.3

Basic Structure of an ABS Transaction 12

3.4

Asset-Backed Commercial Paper (ABCP) Program 14

3.5

Types of ABS 16

3.5.1

Mortgage-Backed Securities 16

3.5.2

Collateralized Debt Obligations 17

3.5.3

Borrowers Characteristics 18

3.6

Cash Flow Structures 19

3.6.1

Pass-Through Structure 19

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3.6.2

Pay-Through Structure 20

3.7

Importance of Rating 21

3.7.1

Definition of Rating 21

3.7.2

Function of Rating for Investors 22

3.7.3

Rating- Systems and ­Symbols 23

3.8

Credit Risks while Investing in ABS 24

3.8.1

Asset Risks 25

3.8.2

Structural Risks 26

3.9

Credit Enhancement Methods 27

3.9.1

Internal Enhancement 28

3.9.1.1

Subordination 28

3.9.1.2

Overcollateralization 29

3.9.1.3 Spread

Accounts 29

3.9.2

External Enhancement 30

3.9.2.1

Pool Insurance 30

3.9.2.2

Letters of Credit 31

3.9.2.3

Liquidity Facilities 31

3.10

Critical Appraisal 32

4

US SUBPRIME CRISIS 34

4.1

History of the Subprime Market 34

4.2

History of the Subprime Crisis 35

4.3

Reasons for the US Subprime Crisis 39

4.3.1

Factors in the US 40

4.3.2

Factors beyond the US Boundaries 41

4.3.3

Rating Agencies as a Further Factor 42

4.4

Regulations for German Banks Concerning the Subprime Crisis 44

4.5

Effects on Further ABS Vehicles 46

4.6

Critical Appraisal 49

5

DEUTSCHE INDUSTRIEBANK AG (IKB) 51

5.1 About

IKB 51

5.2

History and Development of Deutsche Industriebank AG 51

5.2.1

Bank for Industry Obligations (Bafio) 51

5.2.2

Reorganization of Bafio 52

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5.2.3

Deutsche Industriebank 52

5.2.4

Industriekreditbank AG (IKB) 53

5.2.5

Deutsche Industriebank AG 53

5.3

Influence of the Subprime Crisis on IKB 53

5.3.1

Overview on IKB′s Crisis 55

5.3.2

IKB′s Management Failures 57

5.3.3

IKB and Rhineland Funding 59

5.3.4

Effects on IKB′s Customers 62

5.3.5

Reorientation for IKB 63

5.3.6

Current Developments for IKB 64

6

CONCLUSION 67

6.1

Findings 67

6.2

Recommendation and Outlook 68

BIBLIOGRAPHY VIII

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- IV -

List of Abbreviations

AAA

The highest rating symbol

ABS

Asset-Backed Securities

APT

Arbitrage-Pricing-Theory

BaFin

Bundesanstalt für Finanzdienstleistungsaufsicht

Bafio

Bank für deutsche Industrieobligationen

BAKred

Bundesaufsichtsamt für das Kreditwesen

CAPM

Capital-Asset-Pricing-Model

CEO

Chief Executive Officer

Cf.

Confer to; Compare

CMO

Collateralized Mortgage Obligations

EBIT

Earnings before Interest and Taxes

etc.

Et cetera; and other similar things ; and so on

EUR

Euro

FDIC

Federal Deposit Insurance Corporation

FHA

The Federal Housing Administration

GNMA

Government National Mortgage Association

i.e.

Id est. (lat.); that means

IKB

Deutsche Industriebank AG

IOSCO

International Organization of Securities Commissions

KfW

Kreditanstalt für Wiederaufbau

KWG

Kreditwesengesetz

MBS

Mortgage Backed Securities

p.

Page

pp.

Pages

PwC

Pricewaterhouse Coopers

S&P

Standard & Poor′s

SIV

Structured Investment Vehicle

SPV

Special Purpose Vehicle

URL

uniform resource locator

USA

United States of America

USD

United-States-Dollar

VA

The Veterans Administration

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- V -

vs.

Versus

w.p.

without page

w.y.

without year

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List of Figures

Figure 1: Basic Structure of an ABS Transaction 13

Figure 2: Basic Structure of an ABCP Program 15

Figure 3: Calculation of the Excess Spread 30

Figure 4: Announced and Estimated Losses of Banks 39

Figure 5: An Overview of the IKB Crisis 57

Figure 6: Strategy of Rhineland Funding 60

Figure 7: IKB′s Shareholder′s Structure 65

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List of Tables

Table 1: Comparison of the Rating Symbols of the Well-Known Rating Agencies 23

Table 2: Example for Credit Enhancement by Subordination 29

Table 3: Contingent Liabilities of IKB 61

Table 4: Liabilities of IKB 61

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ABS ­ Structures, Markets, Opportunities and Threats

1

1

Introduction

1.1

Preface

The general view once was that the financial system has become more stable because

risks mainly lay not within the banks balance sheets, but with the investors and further

parties involved when structuring and selling structured products such as asset-backed

securities.1 As a result of the re-evaluation of subprime loans and other asset-backed

securities structures as the speculative bubble busted in summer 2007, a clear increase

in the risk aversion has been observable during the past few months. This, in turn, has

caused problems in the interbank market since refinancing costs have increased

enormously, so that not only banks are being affected by the breakdown in the US

subprime mortgages.2

In addition, it can be assumed that due to the subprime market breakdown and loans

given to hedge funds plus their own investments in credit products, risks have found

their way back in the banks balance sheets. Recently, there has been talk of an

upcoming recession.3 Only time will tell how the financial markets will continue to

react on the consequences of the subprime crisis.

1.2

Research Objective

Basically asset-backed securities were thought to carry little or almost no risk while

simultaneously bringing in a high return. They were supposed to transform risky assets

into riskless ones without minimizing the return.4

In connection with high ratings there may be the question of which risks should actually

be considered when investing in asset-backed securities. Furthermore, it needs to be

discovered how possible problems can affect the economic performance of a company.

The objective of this paper is to reveal the difficulties in evaluating and handling the

investments in asset-backed securities of German financial institutes, using the example

1

Cf. Brost, M. et al. (2007), p. 19.

2

Cf. Fischermann, T. et al. (2007), p. 27.

3

Cf. Gerth, M. (2007), p. 86.

4

Cf. Gundlach, M., Lehrbass, F. (2004), p. 311.

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