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Securitization
Securitization involves pooling financial assets like loans and converting them into marketable securities. Key players include originators who make the original loans, special purpose entities that purchase the loans and issue securities, credit rating agencies that rate the securities, underwriters that help issue the securities, trustees that ensure obligations are fulfilled, servicers that collect loan payments, and investors who purchase the securities. SPVs play an intermediary role by holding the pooled securities and allowing risk sharing. Banks securitize to diversify risk, generate liquid assets, extend their credit pool, and earn fee income, while investors can earn higher returns through a diversified portfolio. However, prepayments and floating rates may impact returns, and maintenance obligations and regulator concerns about under
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Securitization
- 2. Securitization of Loans Securitizationis the process of pooling and repackaging of homogeneous illiquid financial assets into marketable debt securities.
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- 4. Securitization Process Originator –An entity making loans to borrowers or having receivables from customers Issuer –The Special Purpose Entity/ Vehicle which buys assets from Originator and packages them into security for further sale Credit Rating Agency – Rates the Securities Investment Bank/underwriters : A body that is responsible for conducting the documentation work. Security Underwriter or Investment Banker Helps Issue Securities Trustee – Makes Sure that the Issuer Fulfills All Their Obligations Servicer- Collects Payments on the Securitized Loans Investor- The party to whom securities are sold .
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- 6. SPV AND ITSROLE It is a legal entity created to fulfill the narrow, specific or temporary objectives. i.e 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
- 7. WHY BANKS SECURITIZE Diversifiesa Bank’s Credit Risk Exposure Creates Liquid Assets Out of Illiquid Assets Transforms These Assets into New Sources of Capital Extends credit pool, More Geographically Diverse Loan Portfolio Reduces credit concentration Risk management by risk transfers Avoids interest rate risk Allows the Bank to Generate Fee Income
- 8. INVESTOR’s VIEW POINT ADVANTAGE Opportunityto 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. Floating rates can affect the return on securities. Maintenance obligations of the collateral
- 9. Types of SecuritizedAssets Residential Mortgages Home Equity Loans Automobile Loans Commercial Mortgages Small Business Administration Loans Credit Card Receivables Truck Leases Computer Leases
- 10. Regulator’s Concern AboutSecuritization Risk of Agreeing to Serve as Underwriter for Securities that Cannot be Sold Risk of Acting as Credit Enhancer and Underestimating Need for Loan Reserves Risk that Unqualified Trustees Will Fail to Protect Investors Risk of Loan Servicers Being Unable to Satisfactorily Monitor Loan Performance and Collect Monies Owed