Econ3210 - Securitization

Growth of securitization

Grow in emerging markets where large highly rated corporate entities and banks have used to turn future cash flow from hard currency export into current cash. Securities will become simpler as regulatory changes occur

Securitization process Step 1

Two steps The originator - identifies assets to remove from balance sheet and pool them into reference portfolio. Sells this asset pool to an issuer, such as SPV - special purpose vehicle.

Original purpose of securitization

Was to finance simple, self liquidating assets such as mortgages. But any asset with stable cash flow can be structured ino a reference portfolio.

Securitization process Step 2

issuer finances the acquisition of pooled assets by issuing trad-able, interest bearing securities, that are sold to capital market investors. Investors receive fixed or floating rate payments from a trustee account funded by the cash flows from the reference portfolio.

Backing of securities

securities can be backed by mortgages, sovereign loans, consumer credit, project finance, lease recievables, individualized lending agreements. e.g Asset backed security ABS. or Collateralized debt obligation CDO

Securitization

A process in which certain types of assets are pooled so that they can be repackaged as interest bearing securities. Interest and principal payments are passed through to purchasers of securities.

Allure of securitization 2

A company with B credit rating with AAA rated assets on books can raize AAA funds, Unlike conventional debt, securitization does not inflate companies liabilities, instead produces funds for future, without balance sheet growth

Issues of subprime

Compromising the incentives for originators to ensure minimum standards of prudent lending, risk management, investment

Reference Portfolio

Divided in to tranches, each with different level of risk and seniority Senior debt Mezzanine Junior debt - First loss position

Securitizaion 3

In most cases the originator services the loans in the portfolio, collects payments from original borrowers and passes them on - a servicing fee to the trustee, or SPV

Allure of securitization 3

Investors can get tailored risk return properties of tranches based on risk tolerance. Originators do not sell securities out right only the credit risk and keep legal title to benefit from differences of price acquired and price to sell to investors.

Securitization

Is an alternative , and diversified source of finance based on transfer of credit risk, from issuer to investor.

SPV

Is an entity set up usually by a financial institution, to purchase assets and realize their off balance sheet treatment for legal and accounting purposes.

Why do securitization

It is cheaper to raise money through securitzation and securitzied assets are less costly to hold for banks, because financial regulators have different standards for them than for assets that underpin them.

Issues with the structure

It was sensitivity was the problems of subprime mortgage. When repayment issues surface in junior tranches, lack of confidence spreads to holders of senior tranches. panic in sues and investors go to safer assets, resulting in fire sale of securitized debt.

Allure of securitization 1

New sources of funding - moving assets of balance sheets, or borrow against them to refinance. Reduces borrowing costs and lowers regulatory minimum capital requirements Assets detached from originators balance sheet and credit rating Can pool loans or leases into package to sell to issuer who converts to a tradable security (SPV)

Benefits

Originate and distribute approach broad economic benefits Spreading out credit exposures and diffusing risk concentrations and systemic vulnerabilities.