Securitization
SECURITIZATION
Financial Engineering
UBS Chandigarh
By : RISHI MALHOTRA
By:ByRishi
: Rishi Malhotra
Malhotra
Securitization
Scheme of the presentation Securitization Defined
Securitization defined
Securitization of debt, or asset securitization as is more
What can be securitized? often referred to, is a process by which identified pools of
receivables, which are usually illiquid on their own, are
Parties in securitization
transformed into marketable securities through suitable
Securitization process repackaging of cash flows that they generate.
Types of securitization
Securitization is a structured finance process that
Why securitization?
distributes risk by aggregating assets in a pool (often by
selling assets to a special purpose entity), then issuing
Why not securitization? new securities backed by the assets and their cash flows.
The securities are sold to investors who share the risk and
reward from those assets.
The process through which an issuer creates a financial
instrument by combining other financial assets and then
marketing different tiers of the repackaged instruments to
investors. The process can encompass any type of
financial asset and promotes liquidity in the marketplace.
By: Rishi Malhotra
Securitization
Scheme of the presentation What can be Securitized?
Securitization defined
What can be securitized? In concept, all assets generating stable and predictable
cash flows can be taken up for securitization.
Parties in securitization
Securitization process Auto loans
Credit card receivables
Types of securitization Computer leases
Unsecured consumer loans
Why securitization?
Residential and commercial mortgages
Why not securitization?
Franchise/Royalty payments
Other receivables relating to telecom, trade, toll road and
future export.
Typically, asset portfolios that are relatively homogeneous
with regard to credit, maturity and interest rate risk could
be pooled together to create a securitization structure.
By: Rishi Malhotra
Securitization
Scheme of the presentation Parties in a Securitization Transaction
Securitization defined
The Originator – also interchangeably referred to as
What can be securitized?
the Seller – is the entity whose receivable portfolio forms
the basis for ABS issuance.
Parties in securitization
• Special Purpose Vehicle (SPV), which as the
Securitization process
issuer of the ABS ensures adequate distancing of the
Types of securitization instrument from the originator.
Why securitization? • The Servicer, who bears all administrative
responsibilities relating to the securitization transaction.
Why not securitization?
• The Trustee or the Investor Representative,
who act in a fiduciary capacity safeguarding the interests
of investors in the ABS.
•The Credit Rating Agency, which provides an
objective estimate of the credit risk in the securitization
transaction by assigning a well-defined credit rating.
pool auditors, et al.
By: Rishi Malhotra
Securitization
Scheme of the presentation Parties in a Securitization Transaction
Securitization defined
•The Regulators, whose principal concerns relate to
What can be securitized?
capital adequacy, liquidity, and credit quality of the ABS,
Parties in securitization and balance sheet treatment of the transaction.
Securitization process • Service providers such as Credit Enhancers and
Types of securitization
Liquidity Providers.
Why securitization? • Specialist functionaries such as legal and tax
counsels, accounting firms, pool auditors, et al.
Why not securitization?
•Investors are the ultimate judges of any
securitization Effort more important than all the
aforementioned are the investors in the securitised
paper.
By: Rishi Malhotra
Securitization
Scheme of the presentation Securitization Process
Securitization defined
What can be securitized?
Parties in securitization
Securitization process
Types of securitization
Why securitization?
Why not securitization?
By: Rishi Malhotra
Securitization
Scheme of the presentation
Securitization Process
Securitization defined
What can be securitized?
1. Creation of asset pool and its sale
Parties in securitization The originator/seller (of assets) creates a pool of
assets and executes a legal “true sale” of the same
Securitization process
to a special purpose vehicle (SPV). An SPV in such
Types of securitization cases is either a trust or a company.
Why securitization?
2. Issuance of the securitised paper
Why not securitization?
This activity is usually performed by the SPV. Design of
the instrument however would be based on the nature of
interest that investors would have on the asset pool. In the
case of pass-through issuances, the investors will have a
direct ownership interest in the underlying assets, while
pay-throughs are debt issued by the SPV secured by the
assets and their cash flows.
By: Rishi Malhotra
Securitization
Scheme of the presentation Securitization Process
Securitization defined 3. Credit Risk
It must be made abundantly clear at the very outset that
What can be securitized?
the accretions on the asset-backed security, i.e., interest,
Parties in securitization amortisation and redemption payments, are entirely
dependent on the performance of the pooled assets, and
Securitization process will have nothing to do with the credit of the originator.
Types of securitization
4. Pool Selection
The process of selecting assets to build a securitization
Why securitization? pool would take into careful consideration, loan
characteristics that are important from a cash flow, legal,
Why not securitization? and credit points of view, such as type of asset, minimum
and maximum loan size, rate, maturity and concentration
limits (geographic, single-borrower, etc.).
5. Administration
Formal delineation of duties and responsibilities relating to
administration of securitised assets, including payment
servicing and managing relationship with the final obligors
must be spelt out clearly through a contractual agreement
with the entity who would perform those functions.
By: Rishi Malhotra
Securitization
Scheme of the presentation Securitization Process
Securitization defined
In addition, the following features are often included as
What can be securitized?
part of a securitization transaction:
Parties in securitization
• Credit enhancement to support timely payments of
Securitization process interest and principal and to handle delinquencies.
Types of securitization
• Independent credit rating of the securitised paper
Why securitization? from a well known credit rating agency.
Why not securitization? • Providing liquidity support to investors, such as
appointment of market makers.
By: Rishi Malhotra
Securitization
Scheme of the presentation Types of Securitization
Securitization defined
What can be securitized? Asset backed securities (ABS)
Financial security backed by a loan, lease or receivables
Parties in securitization
against assets other than real estate and mortgage-
Securitization process
backed securities.
An ABS is essentially the same thing as a mortgage-
Types of securitization backed security, except that the securities backing it are
assets such as
Why securitization? •Auto loans
•Credit card receivables
Why not securitization?
•Student loans
•company's receivables
•royalties
By: Rishi Malhotra
Securitization
Scheme of the presentation Types of Securitization
Securitization defined
What can be securitized?
Mortgage backed securities (MBS)
A type of asset-backed security that is secured by
Parties in securitization a mortgage or collection of mortgages.
Furthermore, the mortgage must have originated from a
Securitization process regulated and authorized financial institution.
When you invest in a mortgage-backed security you are
Types of securitization
essentially lending money to a home buyer or business.
Why securitization?
Mortgage-backed security sub-types include:
Why not securitization? •Residential mortgage-backed security (RMBS) - a pass-
through MBS backed by mortgages on residential property.
•Commercial mortgage-backed security (CMBS) - a
pass-through MBS backed by mortgages on commercial
property.
•Collateralized mortgage obligation (CMO) - a more
complex MBS in which the mortgages are ordered into
tranches by some quality (such as repayment time), with
each tranche sold as a separate security.
By: Rishi Malhotra
Securitization
Scheme of the presentation Types of Securitization
Securitization defined
What can be securitized? •Stripped mortgage-backed securities (SMBS): Each
mortgage payment is partly used to pay down the loan's
Parties in securitization
principal and partly used to pay the interest on it. These
Securitization process
two components can be separated to create SMBS's, of
which there are two subtypes:
Types of securitization
1.Interest-only stripped mortgage-backed
Why securitization? securities (IO) - a bond with cash flows backed by the
interest component of property owner's mortgage
Why not securitization?
payments.
2.Principal-only stripped mortgage-backed
securities (PO) - a bond with cash flows backed by the
principal repayment component of property owner's
mortgage payments.
By: Rishi Malhotra
Securitization
Scheme of the presentation Types of Securitization
Securitization defined
Collateralized debt obligations(CDO)
What can be securitized?
Parties in securitization
They are a type of structured asset-backed security (ABS)
whose value and payments are derived from a portfolio of
Securitization process fixed-income underlying assets. CDOs securities are split
into different risk classes, or tranches, whereby "senior"
Types of securitization
tranches are considered the safest securities.
Why securitization?
Types based on the underlying asset:
Why not securitization? •Collateralized loan obligations (CLOs) -- CDOs backed
primarily by leveraged bank loans.
•Collateralized bond obligations (CBOs) -- CDOs
backed primarily by leveraged fixed income securities.
•Collateralized synthetic obligations (CSOs) -- CDOs
backed primarily by credit derivatives.
•Structured finance CDOs (SFCDOs) -- CDOs backed
primarily by structured products (such as asset-backed
securities and mortgage-backed securities)
By: Rishi Malhotra
Securitization
Scheme of the presentation Why Securitization ?
Securitization defined
Advantages to issuer:
What can be securitized?
Efficient funding
Parties in securitization
Lower Cost
Securitization process
Alternative investor base
Issuer’s credit rating becomes
Types of securitization irrelevant
Why securitization? Reduces asset liability mismatch
Why not securitization? Lower capital requirements
Locking in profits
Transfer risks (credit, liquidity, prepayment,
reinvestment, asset concentration)
Balance sheet management
Improves capital utilization
Releases capital
By: Rishi Malhotra
Securitization
Scheme of the presentation Why Securitization ?
Securitization defined
What can be securitized? Benefits to consumers-borrowers
Parties in securitization
Lower cost of funds.
Securitization process
Increased array of credit contracts.
Types of securitization
Competitive rates of terms nationally
Why securitization?
and locally.
Why not securitization?
Funds available consistently
By: Rishi Malhotra
Securitization
Scheme of the presentation Why Securitization ?
Securitization defined
What can be securitized? Benefits to investors
Parties in securitization
Low event risk
Securitization process
Higher yields for lower/similar risk
Types of securitization
Structured issuances: Create instruments to match
Why securitization? investment objectives
Why not securitization? Secondary Market Liquidity
Enhanced diversification
By: Rishi Malhotra
Securitization
Scheme of the presentation Why Not Securitization ?
Securitization defined
Disadvantages to issuer:
What can be securitized? 1. Costs
2. Size limitation
Parties in securitization
3. Risks
Securitization process
Risks to investors:
Types of securitization
1. Liquidity risk :
Why securitization?
• Credit default
Why not securitization? 2. Event risk
• Prepayment/reinvestment/early amortization
• Currency interest rate fluctuations
3. Contractual agreements
• Moral hazard
By: Rishi Malhotra
Securitization
Scheme of the presentation Securitization – Indian context
Securitization defined •First deal in India between Citibank and GIC Mutual Fund, in
1990 for Rs. 160 million.
What can be securitized?
•Securitisation of cash flow of high value customers of
Parties in securitization
Rajasthan State Industrial and Development Corporation in
Securitization process 1994-95, structured by SBI cap.
Types of securitization •Securitisation of overdue payments of UP government to
HUDCO by issue of tax-free bonds worth Rs. 500 million
Why securitization?
Why not securitization?
•Securitisation of Sales Tax deferrals by Government Of
Maharashtra in August 2001 for Rs. 1500 million with a green
Securitization- Indian context shoe option of Rs. 75 million.
•First deal in power sector by Karnataka Electricity Board for
receivables worth Rs. 1940 million and placed them with
HUDCO.
•Mega securitisation deal of Jet Airways for Rs. 16000 million
through offshore SPVs.
By: Rishi Malhotra
Securitization
Scheme of the presentation Securitization – win-win for all
Securitization defined
What can be securitized?
Originators
–Churn higher returns on lower capital base
Parties in securitization
•Investors
Securitization process
–Can invest in low-risk rated home loans paper
Types of securitization
without hassles of origination/ servicing.
Why securitization? •Financial system as a whole
–Expertise of Specialists helps maintain quality of
Why not securitization? underlying assets and reduces ALM mismatches.
Securitization- Indian context
•Home Loan Customers
–Access to cheaper fund
By: Rishi Malhotra
Securitization
References
[1] What SEBs Owe - Out standing dues to central utilities,
http://www.indiapoweronline.com/Scripts/GNT006C1.ASP?ArtID=450&CatID
=1&SecID=14
[2] P.P. Vora (2001), “NHB - Promoting A Sound, Healthy, Viable And
Efficient Housing Finance System”, http://www.shilpabichitra.com/v039.htm
[3] Modak, Anand, (2001), “Securitization - A boon for Investors and
Borrowers, Investime, September 2001”,
http://www.valuemoney.com/new/sec.pdf
[4] Ghosh, T P, “Innovations in asset-backed securities”,
http://www.financialexpress.com/fe/daily/19990331/fex31002.html
[5] Standard and Poor, “Global CBO/CLO Criteria”,
http://www.standardandpoors.com/ResourceCenter/RatingsCriteria/Structure
dFinance/articles/pdf/globalcboclo99.pdf
[6] Notes from http://www.vinodkothari.com
By: Rishi Malhotra
Securitization
Thank you
By:ByRishi
: Rishi Malhotra
Malhotra
