Securitization is a process by which the financial assets of a business are transformed into securities. Financial assets of a business comprise of Loans given, Credit card balances, hire purchase receivables, mortgage backed receivables, accounts receivables on trade etc. One may get confused between factoring and debt securitization. Factoring also involves transfer of the financial assets but they are not transformed into securities.
In a securitization process, first of all, the financial assets are packaged together which is called as ‘asset pool’. Later on, securities are issued on the basis of this asset pool. This is a type of recycling of funds. The only condition here is that the package of assets which are pooled together must be those which generate steady cash flows.
Following is the description of the securitization process in brief:
(a) Origination: The originator gives loans to different classes of borrowers. The borrowers undertake to repay these loans in equated monthly installments which comprise of principal and interest. These installments which are receivables constitute the financial assets for the originator.
(b) Securitization function: A special purpose entity (SPE) is established. All the cash generating financial assets of the originator are pooled up together and transferred to the SPE. Such transferred financial assets are called as securitized assets. The originator retains certain rights towards these assets which are called as retained assets.
(c) Financing: The SPE issues certain classes of securities also called as debt securities to various investors. The investors are generally the insurance companies, mutual funds etc. These securities are issues through various merchant bankers.
Following are some of the prominent features of Securitization:
(a) Spread: The originator earns profits from the interest rate gap (spread). This gap is the difference in the interest rates available between interest rates on secured assets (interest received from borrowers) and the interest paid to investors.
(b) Advance receivables: The originator may agree to securitize certain receivables which are not existing at the time of securitization but will get generated in the future. Such advance receivables are estimated and the purchase consideration for the same is received by the originator in advance.
(c) Recourse: The investor in the securities cannot seek recourse from the originator if the originator does not receive cash flows from the asset pool. In other words, the investors bear the credit risk since the originator is obliged to pay to the investors only if he gets his dues from the original borrowers. However, the originator generally has the right to sue the borrowers.
(d) Servicing: The originator continues to collect the amounts due from the borrowers with or without servicing fees for the same,
Following are some of the advantages of securitization to the originator:
(a) Off-balance sheet financing is possible. The balance sheet does not get clogged with several loans, yet all the benefits of financing are available.
(b) The asset pool, though generate cash, are somewhat illiquid. Securitization process helps to convert illiquid assets into liquid portfolio.
(c) The credit rating of the Originator enhances considerably.
Better balance sheet management becomes possible.
Posts by SpeakBindas Editorial Team.