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Financial Services(MBA2F07)

UNIT-III

Securitization

Course Coordinator: Dr. Saboohi Nasim

FMS&R, AMU

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Basic Concept

Process of Securitization

Parties to Securitization

Securitized Financial Instruments

Credit Enhancement & Credit Rating

Benefits of Securitization

Securitization in IndiaRegulatory Framework

Securitization(syllabus coverage)

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Basics of Securitization

Securitization is a recent financial

innovation that has brought aboutrevolutionary changes in the

financial world

It is used as a financial strategy to

increase liquidity and accelerate thedevelopment of the financial

markets.

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What is Securitization?

Securitization is a process of

conversion of receivables

(illiquid assets)

into marketable securities

that can be

traded in the financial

markets

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Basics of Securitization

Receivables refer to expected streams of

cash flows: include financial assets like loansand advances, sundry debts, etc..

Cash flow streams are packaged into poolsof homogenous assets (housing loans of

similar maturity) or homogenous cash flows

(credit card receivables) that act as collateral

to the securities issued.

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Basic Rationale for Securitization..

Allows the organization to recycle thefunds much earlier it could otherwise.

Distribution of Credit Risk- involved in

the financial assets- among all the

investors who have subscribed to thesecuritized financial instruments.

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Scope of Securitization

Scope of Securitization has extended to cover any

predictable cash flow stream arising out of normal businesstransactions.

The asset or cash flow streams that can be securitized

include:

Auto loans

Auto leases, Aircraft leases, Computer leases

Commercial loans

Consumer loans

Real state loans

Home loans

Credit card receivables , etc

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Types of Securitization

Based on the financial asset backing, the

securitization process are of three types:

1. Mortgage- backed Securitization: mortgage

loans are converted into marketable securities

1. Asset- backed Securitization: Sundry debtors

converted into marketable securities

1. Cash-Flows Securitization: Cash flow streams

(credit card receivables) converted into

marketable securities

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The Securitization Process

Steps in securitization:

1. Identification of assets or cash flows that can bepooled for securitization Originator: organization that goes in for

securitization

Obligor: Borrowers/customers who owe moneyto the originator

2. The identified assets or cash flows are pooled and

then pass through another institution called

Special Purpose Vehicle (SPV): SPV is formed

exclusively to deal with the securitization

3. SPV splits the pooled cash flow into securities

offered for subscription in the market

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The Securitization Process.

Transfer of Assets by Originator to the SPV: Three

Modes:1. Novation: refers to the substitution of an SPV for

the originator under an agreement: all rights of

the originator passes off to the SPV: requires the

consent of the debtors

2. Assignment: consent of the debtors not required

3. Sub-participation: originator remains the lender;

SPV deposits some %age of money in the

originators account

h

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The Securitization Process.

Other Modes of Transfer:

Sale of the receivables by the Originator to anintermediate SPV: originator gets the receivables

off from its balance sheet to book a profit/loss

for accounting purpose

Sale of the receivables by the Originator to an

SPV that aggregates receivables from multiple

originators: Different forms of receivables areaggregated from various originators to create

large pools in order to reduce costs.

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Parties Involved in the Securitization Process.

Originator

Obligor

The SPV

InvestorsAdministrators

Credit Rating Agencies

StructurerUnderwriter/Placement Agents

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Schematic Diagram of the Securitization Process.

Originator

SPV

SpecialPurpose

Vehicle

Investor

Structurer

Obligor

Administrator

Credit rating agency

Receiving funds for

receivables sold

Sale of debts/receivables

Receiving proceeds for

Sale of securities

Issue of Securities

Loans &

advances

Payment of interest

& principal

(Receivables)

Underwriters, Placement

Agents..

S i i d Fi i l I i h

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Securitized Financial Instruments in the

Securitization Process.

Pass Through Certificates(PTC)-is a conduit

through which cash flows from the debtors

are passed on to the holders of theinstrument

Pay Through Securities(PTS)-SPV issue

securities backed by the general credit of the

SPV(SPV free to restructure cash flow..)

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Credit Risks in Securitization

Credit Risk: arises out of non payment of underlying

loans by obligors

Delinquency Risk: Temporary delays in the payment

of underlying loans by obligors

Pre-Payment Risk: High prepayments of the loans by

obligors may disrupt the cash flow

Commingling Risk: arises when the funds which

belong to the investors are temporarily used by the

originator or servicer for its own operations

C dit E h t & C dit R ti

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Credit Enhancement & Credit RatingSecuritization might require credit enhancement to

reduce overall credit risk.

Credit risk in securitization include: default risk;Delinquency risk; pre-payment risk; commingling risk.

Credit enhancement occurs when the securitized financial

instruments credit quality is increased above that of theunderlying receivables pool.

Variety of Credit Enhancement techniques: external/Internal

Credit rating of securitization is the rating of thesecuritized financial instrument at a particular creditenhancement

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Major Benefits of the Securitization

Converts illiquid assets/NPA into liquid assets(originator)

Built in risk reduction mechanism

Flexible means of financing

Once securitized, NPAs removed from the BS of the

originator, thus enhancing capital adequacy ratio

Cash inflows arising from the sale of illiquid assets can be

used for repayments of borrowings of the originator,

resulting in better debt-equity ratio.

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Major Benefits of the Securitization

Helps orgns. to diversify their funding base

Allows orgns. to focus on their core business by

selling off NPAs to SPVs

Leads to reallocation of risk in planned &

transparent manner

Securitized fin. instruments tradable in the

secondary market; widening & deepening of fin.

Markets.

Securitization in India

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Securitization in IndiaA relatively new concept in India1990s

Originated in USAextended to non-mortgage debts in

1980s

Trillions of dollars of the market value of global

securitization

First deal in India structured in 1991 between ICICI and

Citibank. A sum of 150 mn INR was raised by Citibank in

which Citibank acted as an agent of ICICI for the issue ofPTCs

Asset backed Securitization has grown substantially

Regulatory Framework for Securitization

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Regulatory Framework for Securitization

No specific regulatory framework until recently

Securitization and Reconstruction of Financial assets

and enforcement of Security Interests Act,

2002(SARFAESI Act, 2002)-legal framework for

securitization of assets

RBI Guidelines and Directions, 2003

Registration mandatory securitization businessShall not raise money by way of deposits

To frame policy within 90 days of registration

with approval of board; etc.

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For details refer to the

reference/study material

providedThanx!