SECURITIZATION

Pooling and repackaging of homogeneous illiquid financial assets into marketable securities that can be sold to investors, is known as securitization

Parties in securitization: generally 3 parties, namely1.originator: any financial institution or other entity, which has decided to adopt securitization and sell its assets 2. special purpose vehicle: usually a trust which converts receivables into seurities. 3. The investor: MF, pension fund, insurance company, PF, etc buying securities from SPV

 Other parties are: 4.The obligor: original borrower on whose integrity success of securitization depends. 5. Credit rating agency: rates originator and underlying assets of securities. 6. Administrator: receiving and paying agent who receives payments from obligor and gives to SPV. contd

7. Trustee: ensure that all parties meet their obligations 8. Structurer: works with originator to comply with all legal, taxation, procedural requirements and structuring whole deal.

Assets to be securitized: any loan like housing loan, leasing rentals, consumer loans, credit card loans, govt receivables, etc which have Consistent cash flow Default rate is low Principal amortizable on maturity. Underlying collateral liquid Diverse obligators to diffuse risk Standard documentation of underlying asset.

Process of securitization
Mainly includes transfer of assets, issue of securities, servicing of securities. 1. Transfer of assets: to SPV thru any of the following methods Novation (new loan agreement b/w borrower and SPV, old cancelled) Assignment (statutory with legal & beneficial rights or equitable with beneficial rights)

 Sub-participation- (not a transfer of loan, payments received from borrower are transferred to buyer by the lender or originator) Documentation: rights and obligations of all parties are defined.

2. Issue of securities: maturity of securities is matched with securitized loans, rated or guaranteed or underwritten by some agency. 3. Servicing of securities: repayment of securitized loan passed on to SPV, which then pays to investors on maturity.

Stages involved
1. Identification process: Originator picks pool of homogeneous assets for securitization. 2. Transfer process: Selected pool of assets transferred (passed through) to SPV/ trust by outright sale. Assets are removed from B/S.

 3. Issue process: SPV converts these assets into securities of various maturities. Securities sold to investing public. SPV gets reimbursed from sale of securities. maturity of securities synchronized with maturity of underlying assets.

4. Redemption Process: Securities (principle & interest)are redeemed from collection of securitized assets. Collections are made by originator or servicing agent. SPV makes payment to holders of securities (pass through certificates, etc) on maturity.

 5. Credit Rating Process: Securities are to be rated by at least one agency for their credibility. For a better rating normally securities are guaranteed by some merchant banker or other financial institution. Rating increases Investors confidence regarding liquidity/marketability of these securities.

6. Role of merchant banker: Often act as SPV Help in timing, pricing and underwriting of issue. Help in meeting all legal/tax/accounting and other regulatory requirements. Merchant bankers association increases investors confidence.

7. Role of other parties: Other parties may be original borrowers (obligors) and prospective investors. Success of securitization depends on timely repayment by obligors. Prospective investors are buyers of securities wiling to purchase pass through certificates.

Structure for securitization/types of securities

1. Pass through certificates: issued to investors, against pooled assets and undivided interest cash flows received from underlying assets are passed through to investors. Tenure of PTCs is matched with life of securitized assets. PTCs have single maturity structure. Investors have no charge against underlying assets.

2.Pay through certificates: Multiple maturity structure depending on maturity of underlying assets Secured debt instruments of different maturity in response to investors demand. Offered at a discount to face value. Like deep discount bonds.

3. Preferred stock certificates: issued by subsidiary company against trade debts/ consumer receivables of parent company. Subsidiary company issues S.T. securities against them with guarantee from merchant banker. 4.Stripped structures: structured as interest only or principal only securities. Borrowers make early payment if market interest falls. Investors in principle only gain by getting early payment, but interest only investors lose interest.

5. Asset based commercial paper: SPV purchases portfolio of mortgages from lending institutions, combine into single group on the basis of interest rate, maturity and underlying collateral. Then transfers them to trust which, in turn, issues mortgaged backed papers (CPs) of S.T. duration. Investors participate in cash flows from underlying mortgages to the extent of investment in certificates.

Benefits of securitization
1. Additional source of fund/liquidity for originator. 2. Greater profitability due to high liquidity and fees when originator acts as receiving and paying agent. 3.Enhancement in capital adequacy ratio by removal of assets from balance sheet. 4.Spreading of credit risk by sharing responsibility with several parties. contd..

5. Lower cost of funding due to higher credit rating of asset backed securities than the rating of company as a whole. 6. Provision of Multiple instruments for investors. 7. Safer investment and higher return to investors. 8. Capital formation by preventing idle capital.

Causes of unpopularity in india

1. New concept, benefits not much known 2. Heavy stamp duty and registration fees on assignment of illiquid& non performing assets to SPVs. 3. Cumbersome transfer procedure to SPVs. Difficulty in assignment of debt to third party. Transfer of Property Act needs amendment. 4. Lack of standardised loan document creates pooling difficult for SPVs.

5. Inadequate credit rating facilities. 6. Absence of proper accounting procedure for securitized assets. 7. Absence of proper guidelines for securitization.