About Securitization

Meaning of Securitization (Securitisation)

Securitization is a financial process that involves converting illiquid assets, such as loans or receivables, into liquid, tradable securities. This process enables financial institutions, such as banks or mortgage companies, to bundle these assets together and offer them to investors as securities.

Steps of Securitization

Step 1

Asset Pooling

Various financial assets, such as mortgages, car loans, leases, or credit card receivables, are grouped together into a pool via a tranche selection process.

Step 2

Special Purpose Vehicle (SPV)

These pooled assets are transferred to a separate legal entity known as an SPV to isolate the assets from the originator’s balance sheet.

Step 3

Structuring Securities (Optional)

The SPV then divides its securities into tranches (such as senior and junior tranches) based on different risk and return levels.

Step 4

Credit Enhancement (Optional)

These are used to make the securities more attractive for investors and can include overcollateralization, reserve funds, and guarantees.

Step 5

Obtain Credit Ratings (Optional)

These securities are then rated by credit rating agencies based on the quality of the securitized assets, the structure of the tranches, and any credit enhancements.

Step 6

Securities Issuance

The SPV sells the securities to investors, and the received funds are paid to originators for the assets. Payments to investors are generated by the cash flows from the underlying assets (i.e., loan repayments).

Step 7

Servicing the Assets

The originator collects payments from the assets and directs them to the SPV. The SPV then distributes the cashflow to investors based on the waterfall structure (i.e., senior tranches before junior tranches).

Step 8

Continuous Monitoring and Reporting

The originator will continue to monitor the performance of the assets and provide regular reports to investors on the status of the assets, cashflows, and any changes.

Step 9

Maturity or Termination

The underlying assets, via the SPV, will continue to generate cashflow for investors until the securities reach its final maturity date. The securitization transaction will then be completed, and the SPV may be dissolved.

Step 10

Asset Substitution (Optional)

Terminated assets within a securitized pool can be substituted and replaced by new and similar assets to maintain the integrity and and characteristics of the asset pool and tranches.

Purpose of Securitization

Why do financial institutions create securitized products?

Liquidity Creation

Securitization helps financial institutions convert illiquid assets into cash, which can be used for further lending or investment.

Risk Management (for Originators)

By selling the securitized assets, originators can reduce their exposure to potential risks.

Risk Management (for Investors)

By relying on multiple instances of the same asset, instead of simply one instance, investors can reduce risk as long as the instances are not correlated (i.e., life insurance vs. housing)

Capital Efficiency

This process enables originators to remove assets from their balance sheets, helping them meet regulatory capital requirements and free up capital for other uses.

Funding Diversification

Securitization provides access to broader funding by tapping into capital markets, reducing reliance on traditional deposit-based funding.

Interest Rate and Maturity Risk

Institutions can manage interest rate risk and enhance financial stability by better aligning assets and liabilities.

Supporting Economic Growth

By freeing up capital and increasing liquidity, institutions can increase their lending activities and boost market development through more investment opportunities.

Investor Benefits

Investors can better tailor their investments to their risk and return preferences with access to a more diverse range of securities.

Cost of Capital Reduction

Securitization lowers funding costs by selling high-quality, asset-backed securities, which can be a cheaper alternative to traditional funding methods.

Regulatory Arbitrage

Institutions can optimize for regulatory requirements such as capital reserve requirements by reducing assets from their balance sheets.

Market Liquidity Enhancement

By creating a steady supply of tradable securities, institutions can enhance market liquidity, facilitating easier buying and selling.

Find Out What Securitization Master Can Do For You

Asset Classes of Securitization

While there are many different asset classes in the securitization industry, these are some of the most common ones.

Mortgage-Related

Mortgage-Backed Securities (MBS)

Securities backed by a pool of residential and/or commercial mortgages.

Collateralized Mortgage Obligations (CMOs)

MBS divided into tranches, distributing cash flows to investors based on risk, return, and maturity.

Debt-Based

Asset-Backed Securities (ABS)

Backed by various types of loans, such as car loans, student loans, or credit card debt.

Traditional Collateralized Debt Obligations (CDOs)

Structured products backed by various debts, including bonds and loans, issued in tranches with different risks (Senior Note, B Note, Mezzanine Note, Equity Note in order of lowest to highest risk)

Collateralized Loan Obligations (CLOs)

CDOs backed by corporate loans, where investors receive returns based on interest and principal payments.

Collateralized Bond Obligations (CBOs)

Similar to CDOs but backed by high-yield corporate bonds, providing payments from bond interest and principal.

Synthetic/Derivative

Credit Default Swaps (CDS)

Transfers credit risk without selling or transferring underlying assets by guaranteeing loan if borrower defaults in exchange for regular premiums.

Business/Revenue-Based

Whole Business Securitization

Securitizing cash flows from an entire business or substantial operations, including franchise revenue or long-term contracts.

Future Flow Securitization

Securitizing expected future cash flows from operations, such as export contracts or telecommunications receivables.

Trade Receivables Securitization

Securitizing amounts owed by customers, providing immediate cash and transferring non-payment risk to investors.

Project Finance Securitization

Securitizing cash flows from specific projects, such as toll roads, with payments based on the revenue generated by the project.

Specialty

Catastrophe Bonds (Cat Bonds)

Insurance-linked securities (ILS) backed by insurance against catastrophic events, offering returns as long as specified events don’t occur.

Royalty Securitization

Securitizing future royalties from music, patents, or intellectual properties, with payments based on generated income.

Types of Securitization

Pass-Through Securitisation

Cashflows from underlying assets such as interest and principal payments are collected and directly transferred to investors via one tranche (or bond) class. Investors hence directly bear credit risk because they receive cashflows directly from the assets equally.

Pay-Through Securitisation

Cashflows from underlying assets are collected but transferred to institutional investors based on tranches/classes (senior/junior). A Special Purpose Vehicle (SPV) will represent these tranches via bonds or notes. Investors hence can better manage their individual risk.

Public Securitisation

This is usually pay-through securitization but offered to the general public. However, because this is offered to the public, this is a more liquid and tradable type of securitization that often has credit enhancements, ratings from credit agencies, and strict regulatory and disclosure requirements.

Examples of credit enhancements include overcollateralization, reserve accounts, or third-party guarantees. Examples of credit agencies include S&P, Moody’s, and Fitch.