Gautami Nadarajan

A0141110J

Securitization refers to process of packaging individual loans and other debt instruments,
converting the package into a security and enhancing credit rating of securities to be sold to
third party investors. I see it as 5 stages, pooling assets, moving assets off balance sheets
to Special Purpose Vehicles (SPVs), SPVs enhancing the credit of the securities, tranching
and SPVs issuing tradable asset to investors. Each stage comes with different advantages
and disadvantages.
Pooling of assets is done according to demand in the market for the assets and the assets’
characteristics.
Moving assets off balance sheet must be done by a true sale done at arm’s length, which
transfers the rights of ownership to a SPV, which has to independent from the firm. By
selling the assets off at market value to an independent SPV, the assets will be bankruptcy-
remote, which allows assets to survive the bankruptcy of the seller. SPVs will the pool debt
with similar characteristics and decrease the default risk of the assets in the security,
increasing the possibility that investors will receive the rightful cashflows and increasing the
credit rating of the security than the underlying assets and even that of the originator.
Tranching is done by the SPV, where cash flows generated by underlying assets are sold to
third-party investors. This issuance of debt by dividing benefits and risks among investors on
a pro-rata basis.
SPVs will then issue rated securities to investors, either through a private offering or public
offering, to finance the purchase of the property by issuing Secondary Mortgage Market
(SMM) instruments such as redeemable preference shares to the investors. Private offerings
are issued to large institutional investors while the public offerings are issued to investors in
the open capital market. SPVs will then facilitate the “pay-through” of receivables from the
real estate to the investors.

Pros
Securitization provides developers with numerous benefits. Developers require large
amounts of capital to fund their developments. Although developers can use 100% of their
own equity, it would cause a low Internal Rate of Return, which indicates low profitability of a
potential investment.
Developers have access to a wide range of equity and debt funding options that are
available constantly in the SMM. Equity can be obtained from mortgage-backed securities
and Real Estate Investment Trusts, where investors can purchase ownership rights and
potentially gain capital gains. Debt can be obtained from the SMM. Due to the large number
of investors in the SMM with different risk appetites, the different tranches can be priced to
decrease borrowing costs as much as possible and more funds can be raised by
developers. Investors will get a constant stream of revenue in the form of coupon payments
for their investments. Developers can further increase debt raised by tranching risks into
coupon payments from principal amortization and interest payments, based on a future
expected cashflow. The presence of the SMM increases competition for debt that was
previously solely provided for by financial institutions, lowering the borrowing costs and
obtaining competitive borrowing costs and terms from the national and international capital
market and SMM. By investing lesser equity, securing long-term productive capital at low
borrowing costs, developers will be able to earn higher IRR and increase profitability of
development.
Securitization also increases the liquidity of a lumpy and illiquid investment. Future
cashflows that have not emerged, are uncertain and are not available for spending, can be
securitized. Once these future cashflows have been securitized, the cash is immediately
available to be spent or invested in the development. Also, once securitized, the level of
profits will be locked in for the developer and the risk of profit not emerging is passed on
from the developer to the investors who bought securities in the SPV. Not only that,
developers will be protected from floating interest rate risks and high interest rates, which is
 Gautami Nadarajan
A0141110J

due to the tight liquidity in the debt market, and also the rising costs of originating a loan. As
such, developers will be able to diversify financing risk.
For developers in Singapore, originators have the buy-back option. Developers can buy-
back the development from the SPV after three years of originating the security, at 65% to
75% of the prevailing market value. By doing so, developers will be able to retain any price
appreciation of the development.
Securitization allows off-the-balance-sheet transactions which allows liquidity to be injected
into the company of the developer. This liquidity can be used to reduce the gearing of the
developer with heavy borrowing liability. It can also be used to free up capital that had been
invested in low-yield properties, which can be re-invested in other development activities,
improving the yields and efficient use of capital.

Cons
Securitization involves credit rating agencies to rate the credit of a securitized asset. If the
credit rating agency does not do its job properly and issues a higher rating for the
development than it is worth, the developer will have to pay a higher coupon payment to the
investors, which decreasing the IRR and profitability of the developer.
Also, securitization can be expensive due to numerous costs, such as management and
system costs, legal fees, underwriting fees, rating fees and ongoing administration. It also
requires large scale structuring. As such, it may not be cost-efficient for small and medium
developers to securitize their developments.

Although developers have large equity reserves required to fund their developments,
securitization is preferred since it decreases amount of equity invested and increases the
leverage effects, increasing the Internal Rate of Return on the equity invested in their
developments and lowers the cost of borrowing. I agree that securitization is a cost-efficient
way for developers to raise funds.

References
Sing, T. F. (2000, October 4). Securitizing Real Estate – A Primer on the New Financial Instrument [Press
release]. Retrieved October 28, 2018, from
http://www.rst.nus.edu.sg/staff/singtienfoo/Property%20Review%20-
%20Securitizing%20Real%20Estate2.pdf