Financial Services

Securitization

Course Outline
Introduction to Securitization
What is Securitization?
Need for Securitization
Products
Securitization Process
Benefits of Securitization
Securitization Case

Evolution of Securitization in India

Securitization Market in India
Regulations
Market Outlook

Introduction to Securitization

What is Securitization?
Pooling of relatively illiquid debt and packaging it into liquid
investible securities
Creation and issuance of debt securities, or bonds, whose payments
of principal and interest derive from cash flows generated by pools of
assets
Asset pools created by combining similar loans into pools; such as
loans with similar maturity, coupons.
Loans: Auto loans, home equity loans, student loans
Trade Receivables: Credit card receivables, Account receivables
Goal of all securitization transactions is to isolate the financial assets
supporting payments from its originators such that payments are
derived solely from the segregated pool of assets and not from the
originator of the assets.

Need for Securitization

The whole loan market was relatively illiquid; making it difficult for
lenders to sell loan portfolios both quickly and at an acceptable price
Trading whole loans also carried high transaction costs
Loan portfolios are exposed to interest rate risk, credit risk,
concentration risk

Introduction to Securitization

Securitized Products: Also known as pass thru

certificates (PTC) passes interest and principal
payments of the pool to the investors or holders of the
certificates
Mortgage-Backed Securities (MBS) - Securitized mortgages
Asset-Backed Securities (ABS) - Securitized non-mortgage
loans or assets with expected payment
Collateralized mortgage obligations (CMO): A more
complicated PTC. Another innovation of the structured
finance industry
Goal with CMOs was to address prepayment riskthe main obstacle
to expanding the demand for pass-thru.
Prepayment risk is the unexpected return of principal resulting from
consumers who refinance the mortgages (when interest rates fall)
Investors are often forced to reinvest the returned principal at a
lower return.
CMOs accommodate the preference of investors to lower prepayment
risk with classes of securities. The different bond classes are also
called tranches (a French word meaning slice).
Some tranches are subordinate to other tranches.

Introduction to Securitization

Investors in the subordinate tranche would first absorb the prepayment or

default loss first.
Securitization Process
Originator of Assets such as lenders, credit card companies sells assets to
SPV
SPV is legally separate from the company or lender, is the holder of the
assets. Set up specifically to purchase the originator's assets and act as a
conduit for the payment flows
Underwriters usually investment banks; serve as intermediaries between
the issuer (the SPV) and investors.
Gauge investor demand
Consult on how to structure (different tranches & pricing) the ABS and
MBS to attract different segments of the market.
Help determine whether to use their sales network to offer the
securities to the public or to place them privately.
Most importantly, underwriters assume the risk associated with buying
an issue of bonds in its entirety and reselling it to investors
Originators often act as a Servicer following the securitization by acting as
a servicerthe agent collecting regular loan or lease payments and
forwarding them to the SPV. Servicers are paid a fee for their work

Introduction to Securitization

Introduction to Securitization

Securitization Process (contd)

Credit Rating: Virtually all PTCs are rated by independent
rating agencies whose analyses is watched closely by
investors as a guide to the credit quality of the securities.
Higher credit ratings means the security is less risky and
translates into a lower interest rate for the originator as
investors do not demand the same risk premium. The
originator passes the savings on to the consumer in the
form of lower lending rates
Credit Enhancement: The securitization pool may need such
support to improve rating, build investor confidence and
improve funding costs. Serves as guarantees that investors
will receive the payments associated with the securities.
Increases credit quality of the security to increase likelihood
of buyers receiving payments
Internal enhancements: Subordinating one or more
tranche, or portion, of the securities issued. This practice
places the claims of one tranche over another. Any
defaults affecting the securities must be absorbed by a
subordinate tranche before the senior tranche is affected.

Introduction to Securitization

Over-collateralization: The amount of assets placed in a

securitization pool exceeds the principal amount of bonds
issued.
External credit enhancements: A surety bond or a letter of
credit from a financial institution guaranteeing the timely
repayment of principal and interest.

Dealers:
Are market makers and providers of liquidity
Supply and demand, Credit Rating can affect liquidity.

Benefits of Securitization
Aids Geographic Dispersion of Capital:
Traditionally, Banks have provided credit in the
areas where they accepted deposits. By
securitizing loans, however, the lender
generates capital for new loans that may come
from a different location

Introduction to Securitization
Efficient Allocation of Capital: Securitization also encourages
an efficient allocation of capital.
Investors demand higher interest rate from lower quality
asset pool and vice versa. The actual size of this yield
premium - the yield the securities pay in excess of similar
government securities - will depend on the credit quality
of the assets and the structure of the transaction.
This also amounts to customizing a security to investors
needs or risk tolerance levels
Reallocation of Risk Levels: By shifting the credit risk of the
securitized assets to investors, financial institutions can
reduce their own risk. As the risk level of an individual
institution declines, so does systemic risk, or the risk faced
by the financial system overall.
For Borrowers (or Debtors)
Lowers Borrowing Cost: The existence of a liquid secondary
market for loans increases the availability of capital lowering
borrowing costs for individuals as well as firms

Introduction to Securitization

For Lenders
Originators (Lenders or Creditors or Issuers)
When assets are securitized, the lenders receives the payment stream
as a lump sum rather than spread out over time. Financial institutions
that realize the full value of their loans immediately can turn around
and re-deploy that capital in the form of a new loan
Securitization also removes any interest rate risk associated with
mortgages off of their balance sheet
Diversifies credit risk away from loan originators to investors
Receiving servicing fees in addition to moving assets off the balance
sheet has a positive effect on ROA and demonstrates to investors a
more efficient use of capital. Removing loans from their balance sheet
can lower regulatory capital requirements, or the amount and type of
capital banks must hold given the size of their loan portfolio
Investors
Investors range from Individuals to pension funds, insurance companies,
institutional investors to mutual funds
Issuers can customize the coupon, maturity and seniority of a security
according to a particular investor's needs
Investors benefit from the legal segregation of the securitized assets.
The segregation protects the payment stream on the MBS and ABS from
a bankruptcy or insolvency of the originator

Securitization hits a brick wall in India

Securitization in India The Gold Rush
RBI tightens norms on securitization deals
MFI sector sees largest securitization transaction
Securitization deals likely to take a hit
De-jargoned Securitization
SKS Microfinance completes two securitization
transactions worth Rs 226 crore
Volume of securitization shrinks due to adverse
tax regime