DEBT SECURITIZATION

DEBT SECURITISATION

DEBT

SECURITISATION

What is Debt?

What is Securitization?
Securitization is the process by which financial assets such as loan receivable, mortgage backed receivable, credit card balances, and hirepurchase debtors, lease receivable, trade debtors, etc. are transformed into securities. Securitization is a process of pooling and repackaging homogeneous illiquid financial assets into marketable securities that can be sold to investors. Securitization is the process by which financial assets are transformed into securities. Since through Securitization, the illiquid financial assets or debtors are converted into Securities, it can also be called as Debt or Asset Securitization. Definition:Securitisations nothing but liquifying assets comprising loans and receivables of an institution through systematic issuance of financial instruments. Securitisation helps them to recycle funds at a reasonable cost and with less credit risk As from the risk management point of view , the lending financial institutions have to absorb the entire credit risk by holding the credit outstanding in their own portfolio. Securitisation offers a good scope for risk

diversification The entire transaction relating to securitisation is carried out on the asset side of balance sheet

What can be securitized:

auto loans student loans mortgages credit card receivables lease payments accounts receivable corporate or sovereign debt, etc. All assets generating stable and predictable cash flows can be taken up for securitization. In practice however, much of the securitised paper issued have underlying periodic cash flows secured through contracts defining cash flow volumes, yield and timing. In this respect, securitization of auto loans, credit card receivables, computer leases, unsecured consumer loans, residential and commercial mortgages, franchise/royalty payments, and other receivables relating to telecom, trade, toll road and future export have gained prominence. 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. However, to make reasonable estimates of the credit quality and payment speed of the securitised paper, it would be essential to analyse the historical data on portfolio performance over some reasonable length of time.

Parties in a Securitization Transaction

Securitization programs usually involve several participants, each carrying out a specialist function, such as, creating and analysing the asset pool, administration, credit rating, accounting, legal negotiation, etc. These include:

 The Originator also interchangeably referred to as the Seller is the entity whose receivable portfolio forms the basis for Security issuance, Obligor, is an entity, which has received a loan giving rise to the financial assets that is securitized by the Originator. Special Purpose Vehicle (SPV), which as the issuer of the Security ensures adequate distancing of the instrument from the originator, The Servicer, who bears all administrative responsibilities relating to the securitization transaction, The Trustee or the Investor Representative, who act in a fiduciary capacity safeguarding the interests of investors in the Security, The Credit Rating Agency, which provides an objective estimate of the credit risk in the securitization transaction by assigning a well-defined credit rating, The Regulators, whose principal concerns relate to capital adequacy, liquidity, and credit quality of the Security, and balance sheet treatment of the transaction, Service providers, such as Credit Enhancers and Liquidity Providers, and, Investors, more important than all the aforementioned are the investors in the securitised paper. Investors are the ultimate judges of any securitization effort.

Securitization Process
Origination Process : The process of a selecting a pool of loans and receivables from the asset portfolios for securitisation is also called Identification Process. Pooling Process: Similar loans or receivables are clubbed together to create an underlying pool of assets. Originator has to pick up from various assets which includes homogeneous nature , considering the maturities , interest rates involved and marketability. Issuing Process : The 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. This process is also known as Transfer process.

Structuring Process: SPV converts these assets in various types of maturity. SPV splits individual securities of smaller values and they are sold to investing public. They are structured in such a way that the maturity of these securities may synchronise with the maturities of the securitised loans. Various types such as: Pay through certificates, Pass through Certificates , Interest only certificates , Principal only certificate.

Credit Enhancement Process: It is an arrangement which is designed to protect the holder of the securities issued by an SPE from losses and / or cash flow mismatches arising from shortfall, or delay in collection from securitized assets. The arrangement often involve one or more of the following: Over collaterisation, assets in excess of the securitized assets. Recourse obligation accepted by the Originator. Third party guarantee, i.e., a guarantee normally extended by Merchant Bankers. Structuring of the instruments into senior and subordinated securities. Independent credit rating of the securitised paper from a well known credit rating agency.

Documentation process: In documentation lies the heart of all securitization. It is legal framework, which govern and provide fundamental to securities transactions. It clearly defines legal obligations and recourse available to various aspect of securitisation such as: Legality of the transaction, Bankruptcy remoteness of the issuer from the originator, Payment schedules,

Redemption clauses, Duties and responsibilities of various parties, Claim of Investors Recourse Available

Administration Process : Formal demarcation of duties and responsibilities and proper administration of different functions relating to securitised assets, such as: payment servicing managing relationship with the final obligors Collection of dues Redemption and payments of interest and principal Settlement of claims and grievances