Securitization

An Overview
Objectives

 Concept
 Securitization structure
 Credit enhancement methods
 Securitization market in India
Concept
 Securitization is the process of pooling and
repackaging of homogeneous illiquid
financial assets into marketable securities
that can be sold to investors.
 The systematic process , where loans and
other receivables are pooled, packaged,
rated and sold in the market in the form of
asset backed securities
Concept
 The pooled financial assets and the
underlying cash flow are used to create
guarantees for securities that are offered on
retail to institutional investors.
 For example, a Finance Company can
securitize its housing loan portfolios into
financial instruments with fixed return which is
based on the maturity profile of the housing
loans.
Concept
 If the Company has Rs 200 crore worth of
housing loan, and is due to earn 11% on
them, it can securitize these loans into
financial instruments with 10% return with
safeguards against defaults.
 The Principal and the interest repayment
on the securitized instruments are met from
the financial assets which are securitized.
Concept

 In the Securitization process, the illiquid

financial assets are transferred into a more
liquid form of assets and are distributed to a
broad range of investors through the capital
market.
 Securitization is backed by a wide variety of
assets such as vehicles, construction
equipment, real estate and personal loans
Securitization – Parties involved
 Primary parties

i) The Originator

ii ) Special Purpose Vehicle

iii ) The Investor

Securitization – Parties involved

 Secondary Parties:
i ) The Obligor
ii ) Credit rating agency
iii ) Administrator
iv) Trustee
v ) Structurer
Assets to be securitized
 Any pool of assets that has clearly defined
predictable cash flows with historical
Information on payments, default and loss
pattern, documentation and nature of loan.
Any form of loan receivables like housing loans,
consumer loans, vehicles loans, lease rental,
credit card receivables, government
receivables, trade receivables could be
Securitized.
Essential Characteristics for Assets
to be securitized
 Assets should have consistent cash flows
 Default rate should be low
 Principal should be totally amortized at
maturity.
 Underlying collateral should be marketable
 There should be diverse obligators so that
the risk is diversified
 Underlying assets should have standard
documentation
Securitization – The Process
 Securitization of assets involve following
major steps:
i) Transfer of Assets
ii ) Issue of Securities
iii ) Servicing of securities
Transfer of Assets
The Originator or the lending institution has to
identify the receivables to be securitized.
The receivables are segregated into baskets or
pools, based on the type of credit, geographical
area and mortgage pattern.
Mortgage pledges, are aggregated into pools
of assets of similar nature in term of payment
pattern and documentation.
Identifies pools of assets are then transferred
to the SPV as follows:
Transfer of Assets

Methods of transfer:
i ) Novation
ii ) Assignment
iii ) Sub participation
Documentation
 Legal agreements are required to define the rights
and obligations of the originator , SPV and the
investor.
A transfer agreement is made between the originator
and SPV covering the sale of existing
receivables, an obligation of the originator to
repurchase at breach of warrant etc.
An administration agreement is signed between the
originator and the SPV covering the administration
fees, liability for acts and omissions etc.
Security trust deed is made to create security in the
favor of the investor over the SPV ‘s assets.
Issue of Securities
After acquiring the assets, SPV comes out
with securities.
The securities issued may be pass through
certificates, pay through certificates ,interest
only or principal only stripped structures and
asset based commercial papers.
The maturity of the issued securities is
structured to match the maturity of the
securitized loans.
Issue of securities
Issued securities are credit rated or are
guaranteed by an external institution to
enhance the marketability. While rating the
pass through securities, rating agencies
normally focus on the asset quality of the loan
pool.
Getting guarantee or underwriting the issue
provides credit enhancement, i.e. a sense of
confidence regarding timely payment of the
Interest and principal is instilled by credit rating and
Enhancement.
Servicing of securities
Repayment of the securitized loan and bill
received by the originator are passed on to the
SPV. This facilitates the servicing of securities
to the investors.
Sometimes special agents are appointed for
collection of dues from the obligors, on a
commission basis. The originator may be
appointed as a servicer. i.e as a collection
Agent under securitization. Pass through
Certificate holders hold SPV responsible for payment
Of their principal and interest.
Credit enhancement
As such, the investors seek additional security
in the form of credit enhancement.
Securitized instruments with credit
enhancement get a high level of credit rating
and marketability of the instrument is made
easier .
Types of Credit Enhancement
External Credit enhancement:
a) Insurance
b ) Third Party guarantee,
c ) Letter of credit
Internal Credit Enhancement:
a) Credit trenching (Senior/sub-ordinate)
b ) Over collateralization
c ) Cash collateral
d ) Spread account
e ) Triggered amortization
Structure of Securities
Structure of the securities vary from one
another in accounting technique and legal
standing.
Types of Structure of Securities:
i) Pass through certificates
ii ) Pay through certificates
iii ) Preferred Stock certificates
Types of Securitization
Securities issued by the SPV are backed by :
 Assets backed securities,
 Mortgage backed securities,
 Corporate Debts
 Future Flows
Credit Enhancement

The term refers to the various methods used to

reallocate the risks.
Generally, the investors of securitized
instruments have a direct exposure to the
performance of the underlying asset or
mortgage and have limited or no recourse to
the originator.
The loss to the investors may vary in frequency.
severity and timing depending on the asset
Characteristics, origination and administration.
Factoring and Securitization
Factoring:
 Book debts of mfg and trading companies
 Trade debts and receivables
 Short term in nature
 Securities are not issued on the basis of
loans receivables
 Collection work is carried out by factor,
 Entire credit risk is passed( in case of without
recourse)
Securitization
 Mainly associated with financial companies
 Deals with loans and receivables of hire
purchase and financial services,
 Medium and long term in future,
 Securities are issued on the basis of
underlying assets,
 Collection work is carried out by the
administrator or the originator,
 A part of the risk is absorbed by the originator
Securitized securities and convential
securities
 Securitization is packaging of a pool of financial assets into
marketable securities.
 Conventional securities like bonds and debentures are different
from this in nature, structure and source of repayment
 Securitized instruments are derivatives of
the traditional debts- the receivables ,The instrument
is highly secured with underlying assets and guarantees
 Bonds or debentures are long term promissory notes for raising
long term capital. They may be secured or unsecured.
 Securitized securities can be structured to
achieve a desired level of risk and rating but this is not feasible
in the case of traditional securities.
Securitized Securities and Convential
Securities
In securitization, the source of repayment is the
pool of assets and the SPV pays the investors.
The earning power and profitability of the
issuing company is the source of payment for
debts and bonds
Effect of Securitization on Balance
Sheet
1) Capital Relief:
Securitization provides capital relief. FI and
banks are required to maintain CRAR . In
Securitization ,assets are taken off from the
Balance Sheet and CRAR is not required to
be maintained to that extent. The Cost of
Capital coverage for the assets in question
is eliminated since the assets are removed
from the balance sheet.
Effect of Securitization on Balance
Sheet
Income Statement Effect:
a ) Recognizing profits
b ) Timing of income
c ) Low cost of funds
d ) Impact on financial ratio
Benefits of Securitization
Securitization offers a number of advantages
To the seller, investor and the debt markets.
Securitization increases the number of debt
Instruments in the market for the financial
System. It also widens the market by attracting
new players on account of availability of
superior assets.
Benefits of Securitization
 To Originator:
i) Improves liquidity
ii ) Better Asset Liability Management
iii ) No Opportunity cost of capital
iv )Improves transparency
v ) Provides market access
vi ) Low cost funding
Benefits of Securitization
 For Investors
a ) More avenues
b ) Credit enhancement provides good quality
assets,
c ) Reduces risks
d ) The prevalence of secondary market offers
liquidity
e ) Better financial management
Securitization in India
i ) Nature of Securitization : Asset based
securitization funds are preferred to the
securitization of receivables
2) Beneficiaries : FI, Banks, NBFc using
truck/auto pools
3 ) Structure: Mostly transfer of beneficial interest in
assets and not legal title.
4 ) Market: Two way quotes required to create
liquidity and develop market.
Securitization in India
5 ) Raising of Funds: Only restricted to QIBs
and not to retail investors,
6 ) The Problem of Stamp Duty: Issue of
Securities attracts stamp duty which is
an obstacle.
7 ) Requirement of registration of immovable
property
Legal Framework
All securitization transactions are based on
General laws like Transfer of Property Act,
Contract Act and Indian Trust Act.
Absence of a specific statutory law governing
The rights of parties affect investors perception
about such transactions
Conclusion

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