Types of Securitization Structures

Through securitization process, debts are factored and discounted in a structured and sophisticated manner which allows for the availability of funds and the repayment of the debt obligations through the creation of an insolvency remote vehicle which is separate, distinct and independent of the Originator.

Securitization structures are most appropriate for a company that seeks financing but is unable to tap funding sources for the desired tenor and funding cost because of its perceived credit risk. In general, any asset class with relatively predictable cash flows can be securitized. The Special Purpose Vehicle (SPV)¹ re-designs the type of bonds to be issued depending on the deal structure. The broad types of securitization structures include:

  1. Cash vs. Synthetic Structures: Most transactions world over follow the cash structure in which the originator sells assets and receives cash instead. In a synthetic transaction, the seller keeps his title and investment on the assets unaffected. In other words, he does not sell assets for cash but merely transfers risks/rewards relating to the asset by entering into a derivative transaction. When securities are issued by the SPV, they carry such embedded derivative. Synthetic securitization is gaining popularity in Europe and Asia.
  2. True Sale vs. Secured Loan Structures: The true sale structure involves sale of a specific pool of assets where the originator transfers both the legal and the beneficial interest in the assets. In a secured loan structure, the originator takes a loan similar to any secured lending. Investor rights in this case are protected by creating a fixed and a floating charge over the undertaking of the originator in favor of a security trustee. The assets are generic assets of the originator and the trustee is empowered to take possession of the assets at times of certain trigger events to prevent the assets from being burdened any further. The use of secured loan structure depends on the legal provisions of the country concerned. The secured loan structure is more popular in the UK.
  3. Pass Through vs. Collateral Structure: In a pass through structure², the SPV issues participation certificates that enable investors to take a direct exposure on the performance of the securitized assets. Investors are serviced as and when cash is actually generated by the underlying assets. Risks like delay/disruptions in cash flows is mitigated via credit enhancement. (As investors do not have recourse to the Originator, they seek comfort through credit enhancement methods by which risks intrinsic to the transaction are re-allocated.) Pass through structure is the most basic and simplest way of securitization in mortgage markets. In a collateral structure (also known as pay through structure), the SPV retains the assets to be securitized with it and gives investors only a charge against the securitized assets. The SPV issues debt that is collateralized by the assets that are transferred by the originator. This is also referred to as the Pay through structure and popularly known as collateralised mortgage obligations (CMO).
  4. Discreet Trust vs. Master Trust: Discreet trust implies one SPV for a single identified pool of assets where investors participate in the cash flow of the pool. In the creation of a master trust, the Originator sets up a large fund in which large pools of receivables are transferred, much larger than the size of the funding raised by investors. Several security issuances can be created from this fund either concurrently or consecutively. The master trust serves as a tool to create disparities between the repayment structures and the tenure of the securities and assets in the pool. Master trusts are increasingly becoming the preferred mode of securitisation as a result of their flexibility.
  5. Conduit vs. Standalone Transactions: In conduit transactions, the purchaser or conduit sources the assets from multiple originators and securitizes the assets by issuing asset-backed commercial paper³. Since commercial papers of short term duration, it becomes necessary for the conduit to avail of short term or bridge financing from banks. In standalone transactions, the conduit purchases the assets from a single originator. In this case the conduit issues securities of a maturity matching the maturity of the underlying asset pool.

Notes:

  1. The investor’s return in securitization transaction should depend purely on the securitized cash flows and should be insulated from the financial risks associated with the originator. Hence, it is necessary to have legal separation of these assets from the estate of the originator. This is achieved by means of sale of the assets to Special Purpose Vehicle (SPV). The SPV is set up solely for the purpose of the securitization transaction and does not engage in any other business activity. The SPV does not borrow or lend any money and hence cannot go bankrupt. Most SPV follow a set of pre-determined activities clearly identified by the securitization documents. Without the flexibility of taking any management decision. This mode of structuring the transaction ensures that securitized assets become bankruptcy remote from the originator.
  2. In case of pass through certificates payments to investors depend upon the cash flow from the assets backing such certificates. In other words as and when cash (principal and interest) is received from the original borrower by the SPV it is passed on to the holders of certificates at regular intervals and the entire principal is returned with the retirement of the assets packed in the pool. Thus, pass through have a single maturity structure and the tenure of these certificates is matched with the life of the securitized assets.
  3. This type of structure is mostly prevalent in mortgage backed securities. Under Asset-based commercial papers structure, the SPV purchases portfolio of mortgages from different sources (various lending institution) and they are combined into a single group on the basis of interest rate, maturity dates and underlying collaterals. They are then transferred to a Trust which in turn issued mortgage backed certificate to the investors. These certificates are issued against the combined principal value of the mortgages and they are also short term instrument. Each certificate is entitled to participate in the cash flow from underlying mortgages to his investments in the certificates.

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