Loan Securitization
Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.
Table of Contents
Beginning of Loan Securitization
Loan securitization is the process of pooling various types of receivables, including mortgage loans and credit card receivables, and using them as collateral to issue securities. This structured finance process enables the originators of various types of loans to reduce their risk and adjust their finances. Home loans, auto loans, student loans and credit card receivables are the most common type of loans used as collateral to issue securities.[br]
Beginning of Loan Securitization
Traditionally, banks and lending institutions held loans till their maturity or until the time they were paid off. These loans were funded by deposits and direct loans (which were not backed by any type of assets). However, the rising demand for credit forced these banks to search for alternate funding options. Securities backed by mortgage loans were the first ones to be issued in February 1970. Securitization techniques used in the housing loan segment were successfully adopted in the case of automobile loans in 1985. The process was then emulated in the case of credit card receivables and student loans. Over the past several years, loan securitization has been successfully utilized in the case of Community Reinvestment ACT (CRA) loans, which were targeted at low and moderate income borrowers, equipment leases and even small business loans.
Process of Loan Securitization
The process of loan securitization is conducted through a Special Purpose Vehicle (SPV) or a trust specially created for the purpose. The loan receivables of the originator are transferred to the SPV or the Trust, which then uses the assets purchased as collateral to issue securities to investors. The interest and principal payments received from the borrowers are used to pay off the interest on the securities. The performance of the securities is totally dependent on the assets backing them. Securities backed by assets are often split into tranches representing varying degrees of subordination. Each level of security represents a different level of credit protection or risk exposure, and the senior classes have the first claim on cash flows received by the SPV.[br]
Loan securitizations are often structured as sequential bonds, wherein the first tranche receives all the principal payments until it is retired; then the second tranche begins to receive principal, and so forth. Another type of structure used in loan securitization is the pro rata bond structure, wherein each tranche is paid a proportionate share of the principal throughout the life of the security.