Present by

Vivekananda Suaro, EPGP-07-097

Management of
Financial
Institutions
Disadvantages of Securitization
Presented to

PROF. PANKAJ BAAG, IIM KOZHIKODE

Disadvantages of Securitization

The securitization process involves four basic steps. In the first step, a company, known as
the originator, picks a portfolio of assets that it wishes to sell, or remove from its balance
sheet. The originator is often a financial institution that aims to get rid of assets, such as
loans and mortgages. In the second step, the "reference portfolio" is transferred to a special
purpose vehicle, or SPV, for legal and tax reasons. The SPV then issues interest-bearing
securities, such as mortgage-backed securities, which are used to fund the acquisition of the
assets. In the final step, investors are paid over the life of the deal from the cash flows
generated by the portfolio assets. Investors can choose from a wide range of securitization
investments, including prime and subprime mortgages, home equity loans, auto loans and
credit card receivables.
Disadvantages for Issuers
One of the biggest drawbacks for issuers is that it's far more complicated to structure a
securitization than to structure traditional types of debt, such as a bank loan or a vanilla
corporate bond. In addition, the transactions may not always lead to off-balance-sheet
treatment, reducing the benefit to financial institutions.
Disadvantages for Investors
Many investors flock to securitizations because of their "AAA" credit ratings, meaning that
one or more credit agencies, such as Moody's, believe that investors will not lose their
money with these investments. These high ratings are made possible through a combination
of features, such as bond insurance, letters of credit and senior-subordinate credit
structures. Investors also appreciate the diversification that securitization can bring to their
portfolios. However, it's not all sunshine, as certain securitizations carry prepayment risk
the chance that the deal's cash flows accelerate from expectations. For example, a pool of
mortgages might prepay from refinancing, returning money to investors in a lower interest
rate environment. In addition, some deals simply flop, such as the mortgage-backed
securities that soured during the 2007 financial crisis.

Like

every financial structure, a securitization structure also can have his

disadvantages, such as:

The synchronisation of the interest generated by the pool and the interest paid to
the investors is a very arduous and tedious process.

The transfer of mortgages may be difficult for legal, regulatory or tax reasons. The
complexity of the transaction requires a very highly sophisticated documentation,

VIVEKANANDA SUARO EPGP-07-097

MANAGEMENT OF FINANCIAL INSTITUTIONS

PAGE 1

Disadvantages of Securitization

which covers every potential risk. The numerous participants and opinions as well
as the voluminous documentation are very time consuming and costly.

VIVEKANANDA SUARO EPGP-07-097

MANAGEMENT OF FINANCIAL INSTITUTIONS

PAGE 2