Securitization, a process by which illiquid financial assets are transformed into tradable commodities, is one of the most significant innovations of the financial world. Having originated in 1970 in mortgage markets in the USA, securitization has already converted over $90 trillion worth of non-tradable assets into marketable securities. As a powerful tool of liquidity and risk management, securitization has had a tremendous impact on the welfare of the world economy. In mortgage markets in many countries it provides a cheaper source of financing, and thus promotes the demand for housing. In the banking sector, securitization is widely used for allocating capital more efficiently, transforming risk into a tradable security, and reducing the overall cost of capital. It has enabled developing countries to emerging market institutions to raise their sovereign ratings ceilings and thereby tap international capital markets for lower-rate financing.
Read More: The Concept of Securitization
The process of securitization typically characterized by the following steps:
- Identification Process: The lending financial institution either a bank or any other institution for that matter which decides to go in for securitization of its assets is called the ‘originator’. The originator might have got assets comprising of a variety of receivables like commercial mortgages, lease receivables, hire purchase receivables etc. The originator has to pick up a pool of assets of homogeneous nature, considering the maturities, interest rates involved frequency of repayments and marketability. This process of selecting a pool of loans and receivable from the asset portfolios for securitization is called ‘identification processes.
- Transfer Process: After the identification process is over the selected pool of assets are then ‘passed through’ to another institution which is ready to help the originator to convert those pools of assets onto securities. This institution is called special purpose vehicle (SPV) or the trust. The pass through transaction between the originator and the SPV is either by way of outright sale basis. This process of passing through the selected pool of assets by the originator to a SPV is called transfer process and once this transfer process is over the assets are removed from the balance sheet of the originator.
- Issue Process: After this process is over the SPV takes up the onerous task of converting these assets to various type of different maturities. On this basis SPV will issue securities to investors. The SPV actually splits the packages into individual securities of smaller values and they are sold to the investing public. The SPV gets itself reimbursed out of the sale proceeds. The securities issued by the SPV are called by different names like ‘Pay through Certificates’, ‘Pass through Certificates’. Interest only Certificate, Principal only Certificate. The securities are structured in such a way that the maturity of these securities may synchronies with the maturity of the securitized loans or receivables.
- Redemption Process: The redemption and payments of interest on these securities are facilitated by the collections by the SPV from the securitized assets. The task of collection of dues is generally entrusted to the originator or a special service agent can be appointed for this purpose. This agency paid certain commission for the collection service rendered. The servicing agent is responsible for collecting the principal and interest payments on assets pooled when due and he must pay a special attention to delinquent accounts. Usually the originator is appointed as the service. Thus under securitization the role of the originator gets reduced to that of the collection agent on behalf of SPV in case he is appointed as a collection agent. A pass through certificate may be either ‘with recourse’ to the originator or ‘without recourse’. The usual practice is to make it ‘without recourse’. Hence the holder of a pass through certificate has to look the SPV for payment of the principal and interest on the certificate held by him. Thus the main task of the SPV is to structure the deal raise proceeds by issuing pass through certificates and arrange for payment of interest and principal to the investors.
- Credit Rating Process: The passed through certificate have to be publicly issued, they required credit rating by a good credit rating agency so that they become more attractive and easily acceptable. Hence these certificates are rated at least by one credit rating agency at the end of process of securitization. The issues could also be guaranteed by external guarantor institutions like merchant bankers which would enhance the credit worthiness of the certificates and would be readily acceptable to investors. Of course this rating guarantee provides to the investor with regard to the timely payment of principal and interest by the SPV.