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SECURITIZATION

Developed by Dr IKRAM CPA, PhD.


SECURITIZATION
• It stands for conversion of loans or loan
recoveries into marketable paper or securities by
SPV (Special Purpose Vehicle)
• By pooling assets, it diversifies and reduces risks
of the portfolio and, with additional credit
enhancement arrangement, can produce highly
creditworthy instruments to market.
• Isolating and efficiently allocating the risk.
• It is selling the rights to cash flow from loans etc .
Developed by Dr IKRAM CPA, PhD. 2
SECURITIZATION PROCESS
• Selection of assets by the Originator
• Packaging of pool of loans and advances (assets)
• Underwriting by underwriters.
• Assigning or selling to of assets to SPV in return for cash
• Conversion of the assets into divisible securities
• SPV sells them to investors through private stock market in return for cash
• Investors receive income and return of capital from the assets over the
life time of the securities
• The risk on the securities owned by investors is minimized as the
securities are collateralized by assets
• The difference between the rate of the borrowers and the return
promised to investors is the servicing fee for originator and the SPV .
• Assets to be securitized to be homogeneous in terms of underlying assets
,maturity period ,cash flow profile
Developed by Dr IKRAM CPA, PhD. 3
STRUCTURE OF SECURITIZATION

Developed by Dr IKRAM CPA, PhD. 4


PLAYERS INVOLVED IN
SECURITIZATION
1. Originator: An entity making loans to borrowers or having
receivables from customers
2. Special Purpose Vehicle: The entity which buys assets from
Originator and packages them into security for further sale
3. Investment Bank : A body that is responsible for conducting
the documentation work.
4. Credit Rating Agency: To provide value addition to security
5. Insurance Company / Underwriters: To provide cover
against redemption risk to investor and / or under-
subscription
6. Obligors: Company that gives debt to other company as a
result of borrowing.( debtor)
7. Investor: The party to whom securities are sold .
Developed by Dr IKRAM CPA, PhD. 5
SPV AND ITS ROLE
• It is a legal entity created to fulfill the narrow, specific
or temporary objectives. ie funding the assets.
• SPV are typically used by companies to isolate the
firm from financial risk and allow other investors to
share the risk.
• Intermediary
• Helps in the pooling process
• Holding of pooled securities as a repository
• Bankruptcy remote transfer

Developed by Dr IKRAM CPA, PhD. 6


WHY ORIGINATOR SECURITIZE
• Off-balance sheet financing – remove illiquid
assets.
• Improves capital structure
• Extends credit pool
• Reduces credit concentration
• Risk management by risk transfers
• Avoids interest rate risk
• Improves accounting profits

Developed by Dr IKRAM CPA, PhD. 7


INVESTOR VIEW POINT
ADVANTAGE
• Opportunity to potentially earn a higher rate of return .
• Opportunity to invest in a specific pool of high quality
credit-enhanced assets .
• Portfolio diversification .
DISADVANTAGE
• Prepayment by borrowers can lessen the earning through
interest.
• Currency interest rate fluctuations which affect the
floating rates on ABS.
• Maintenance obligations of the collateral are not met as
given in the prospectus.

Developed by Dr IKRAM CPA, PhD. 8


CATEGORY OF SECURITIZATION
• Assets backed securities :Those securities whose
income is derived from pool of underlying assets.
Example: payments from car loan, credit card.
• Mortgage backed securities: Mortgage loans are
purchased from banks and assembled into pools
which become securities.

• Credit debt obligation:


CBO: Those backed b corporate bonds.
CLO: Those backed by leveraged home loans.

Developed by Dr IKRAM CPA, PhD. 9


EXAMPLE OF SECURITIZATION IN INDIA
• First securitization deal in India between Citibank and GIC
Mutual Fund in 1991 for Rs 160 million.
• L&T raised Rs 4,090 mln through the securitization of future
lease rentals to raise capital for its power plant in 1999.
• Securitization of aircraft receivables by Jet Airways for Rs
16,000 mn in 2001 through offshore SPV.
• India’s largest securitization deal by ICICI bank of Rs 19,299
mn in 2007. The underlying asset pool was auto loan
receivables

Developed by Dr IKRAM CPA, PhD. 10


WHAT CAN BE SECURITIZED
All sorts of assets are securitized:
• Auto loans
• Student loans
• Mortgages
• Credit card receivables
• Lease payments
• Accounts receivable.

Developed by Dr IKRAM CPA, PhD. 11


BENEFITS TO FINANCIAL
ENVIRONMENT
• This bring the financial market and capital market together
and hence increase the power of capital market.
• The securitization reduces the risk for the creditor so it will
lead the lower cost of funding.
• Agency and intermediation cost is reduced.
• The rate of assets turnover in market increases. HFCs do
securitize due to this the volume of the resources increases.
• Component risk (credit ,liquidity, catastrophe) are segregated
and distributed to the market intermediaries which absorb
them and make market stable.

Developed by Dr IKRAM CPA, PhD. 12


The Subprime Mortgage Securitization Process
Warehouse
Lender Credit
(makes short term loans to Rating
Issuer for purchase of
mortgages) Agency

Requests loan

Mortgagor Bank/Financial Arranger/


Provides
Institution Loan sold
(Borrower) loan
Issuer
Loans pooled
(Originator) and sold to Trust

Makes loan
payments
Provides customer service SPV
to borrower
(Trust)
Servicer
(is employed by Trust to issues
collect loan payments etc.) Remits loan payments to Trust and securities
advances unpaid interest payments.

Investors

Adapted from: “Understanding the Securitization of Subprime Mortgage Credit’” Ashcraft and Schuermann, Federal Reserve Bank of
13
New York Staff Report 318, March 2008. Developed by Dr IKRAM CPA, PhD.
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