Securitisation, Securitization

Securitization is the process of pooling various types of assets and using them as collateral to issue securities. The structured finance process allows the issuer access to greater funding for fresh investments by packaging its illiquid or less liquid assets as securities. Securitization involves issuance of bonds, issuance of pass through securities or collateralized mortgage obligations to investors.[br] 

Securitization is the process of pooling various types of assets and using them as collateral to issue securities. The structured finance process allows the issuer access to greater funding for fresh investments by packaging its illiquid or less liquid assets as securities. Securitization involves issuance of bonds, issuance of pass through securities or collateralized mortgage obligations to investors.[br] 

Purpose of Securitization

Securitization is generally undertaken by a company planning to raise funds, restructure debt or adjust its finances. While traditional funding options such as issuance of equity dilute ownership and debt are quite costly, securitization allows a company to use some of its illiquid assets to raise funds.

 

Securitization not only frees up the capital tied up in these assets but also allows the issuer to sell them at a higher price. Home loans, auto loans, student loans and credit card receivables are the most common type of assets used as collateral to issue securities.

 

Process of Securitization

The process of securitization is conducted through a Special Purpose Vehicle (SPV) or a trust specially created for the purpose. The assets of the originator are transferred to the SPV or Trust in case of a sale, transfer, partial sale or part funding, depending on the terms agreed. In a sale, the originating company is allowed to remove the transferred assets from its balance sheet. In a financing deal, the assets are considered to remain the property of the originator.[br]

 

The SPV, or the trust, then uses the assets purchased as collateral to issue securiteis to investors and the cash flows from the assets are used to pay off the interest and the principal to the holders of the securities. The performance of these securities is totally dependant on the assets backing them. These securities can be issued on a fixed rate or floating rate basis and are generally rated by reputed rating agencies on the risk they carry. In some cases, third party guarantees are used to enhance the credit rating of a security.

 

Securities backed by assets are often split into tranches representing varying degrees of subordination. Each level of security represents different level of credit protection or risk exposure and the senior classes have the first claim on cash flows received by the SPV.