Securitization

Securitization is the process whereby certain types of assets are pooled for repackaging into marketable, interest-bearing securities. The interest and principal payments from the assets are passed through to the purchasers of the securities.

Securitization process

In its most basic form, the process is carried out in two steps. In the first step, an entity with loans or other interest-bearing assets—the originator— decides to segregate such assets by removing them from its balance sheet. These assets are pooled into a reference portfolio. The originator then sells the portfolio to an issuer, usually embodied in a special purpose vehicle (SPV)—a body set up specifically to purchase and hold the assets and assume their risks while managing their rewards, for legal and accounting purposes. In the second step, the issuer finances the purchase of the pooled assets by issuing and selling tradable, interest-bearing securities to capital market investors. In return for their holdings of such securities, the investors receive fixed or floating rate payments from a trustee account fed by the cash flows generated by the reference portfolio. Typically, the originator services the loans pooled in the portfolio, collects interest from the original borrowers, and passes the funds—against a servicing fee—to the SPV or the trustee.

Main types

Securitization is the process of monetizing financial assets (existing or arising in the future) so that the risks of underlying assets (such as credit risk, prepayment risk, interest rate risk, and liquidity risk) would mainly depend on principal repayment and interest payment on the securities, rather than on the performance of a business or venture.

In terms of composition, securitization is typically classified as cash securitization and synthetic securitization. Other types include existing asset securitization, future flow securitization, etc.

From the perspective of term or time span, the so-called term securitization is classified as short-term securitization and long-term securitization. Term securitization is defined as a type of securitization (a structured finance technique) that provides long-term funding for a loan receivables initially securitized (converted into securities) through the corresponding facilities (warehouse receipts). In these transactions, a pool of loan receivables is sold to a bankruptcy-remote, special purpose entity (SPE) that, in turn, transfers the receivables to a securitization trust. The securitization trust issues and sells asset-backed securities (ABSs), secured or otherwise backed by the underlying receivables, and then the proceeds from the sale of the issued securities are used to finance the securitized receivables.

• short-term securitization: it involves asset-backed commercial papers (ABCP) or structured investment vehicles (SIVs). ABCP is a money market tool that can be used to tap into short-term financing on a roll- over basis. SIVs are used for refinancing of long-term assets with short-term liabilities in order to capitalized on credit spread differences. Normally the securitisation vehicle acquire the relevant reference assets through a true sale, receiving the beneficial rights to the underlying assets. However, an Originator could buy protection through credit derivatives instead of selling the assets (synthetic)
• long-term securitization: a category of term securitization in which the underlying assets have long term maturities. Long term securitization involve mortgage backed securitizations (commercial or real estate), asset backed or collateralized debt obligations (with loan or bond obligations as underlying).