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Introduction
Securitization is simple terms means the conversion of existing or future cash in-flows of any person into tradable security, which then may be sold in the market. The cash inflow from financial assets such as mortgage loans, automobile loans, trade receivables, credit card receivables, fare collections become the security, against which, borrowings are made.
What is Securitization?
Securitization is the packaging of a pool of financial assets into marketable securities. Typically relatively illiquid assets are converted into securities. The aim behind a securitization structure is to serve the risk of originator insolvency from the risk of the asset/ receivable performance, allowing the investor to rely on the asset risk rather the general corporate credit risk of an originator.
Securitisation How?
Homogeneous Loans (assets) are pooled together by Co. A The Pool is sold to SPV (Special Purpose Vehicle) SPV makes payment to Co. A at a Discount
SPV issues the pool certificate to Co. B collecting the sale proceeds and promising to pay Co. B installment and the interest regularly for a given period of time
SPV collects the payment from borrowers passes on the proceeds to Co. B after deducting its service charges
Stripped Securities:
Under this, the securities are classified as interest only (IO) securities or Principal Only securities; IO holders are paid back out of interest only and PO security holders are paid out of principal repayments only. These securities are highly volatile in nature and are least preferred by the investors. PO securities increase in value when interest rates go down because it becomes lucrative to prepay existing mortgages and undertake fresh loans at lower interest rates.
The investment banker either underwrites the securities for public offering or privately places them. It is also involved in structuring the issue to see that the issue meets all legal, regulatory, accounting and tax requirements. The credit enhancer provides the required amount of credit enhancement to reduce the overall credit risk of a security issue. The Rating agencies assign rating to the asset banked securities issue.
Loan repayments
Transfer of assets
Servicer
Issuer SPL
Credit Support
Payment for securities
Issue securities
Investors
A positive interest rate spread which is defined as the difference between interest earned on the assets and the interest plus servicing costs of security.
ADVANTAGES OF SECURITISATION
Higher Credit Quality: The structure of the instrument can be tailored in such a manner that a desired credit rating, which is higher that the rating of company holding the assets, is achieved.
Asset Liability Management: Securitisation offers an efficient way of tenure matching of assets, is achieved Funding Sources: Securitisation allows the issuer to find alternate sources of funding and also raise funds at low costs with improved credit rating.
To Investor
Liquidity: instruments are freely tradable in the market. Safety: instruments are rated and backed by assets and collaterals. Bankruptcy of seller will not have any impact since SPV is in charge of assets and it will protect the interest of investors. Cash flows: flexible range of maturities to suit different cash flow requirements. Diversification: different types of instruments in different portfolios for risk mitigation.
To Seller (Originator)
Securitisation mitigation the risk arising on account of liquidity and interest rates. Exposure norms, i.e., Borrower wise (single/ group) & industry can be taken care. Diversification of funding services whenever seller wants to fund new projects. Capital adequacy requirement can be addressed, i.e., In short, it is a total risk management on the balance sheet itself.
To Market
It creates more depth in the market by adding more diversified instruments with different maturities. More fee based income for financial institutions, since they may act as administrators.
Securitisation in India
In India, few player such as Citibank, GE Capital Services India, Countrywide Consumer Financial Services and ICICI Credit Corporation have done securitisation transactions. The first deal in India was struck in February 1991 between ICICI and Citibank, with the letter securitising the formers bills in respect of lines of credit granted to manufacturers and suppliers of equipment.
Citibank securitised these bills through pass-through certificates (PTCs) by offering these bills to investors on behalf of ICICI for a specified interest on the principal amount. Ceat Financial Services (CFSL) did a Rs. 9 crore securitisation deal in July 1998.
Routing the transaction through a Special Purpose Vehicle is yet to gain popularity. There appears to be no secondary market for securitised debt. The market is unregulated and lacks transparency in terms of volume, price, parties to the transaction, etc. The settlement procedures are not clear. There are no standard accounting and valuation norms.
Fourth, some provisions of the Income Tax Act, 1961, are reported to have an impact on securitisation. For Ex., Section 60 of the Act contemplates transfer of income without transfer of assets, which are the source of the income. Fifth, the existing set of foreclosure laws are said to increase the risks of mortgage backed securities by making it difficult to transfer property in cases of default.
Conclusion
It is a right hand of the Balance Sheet approach of raising funds based on the cash flows and values of the specific pool of assets. Firms can improve their liquidity position and improve certain key ratios like ROE and ROA through Securitisation. It enables banks and institution to borrow at a lower cost. The Securitisation market in India, though in infancy stage, holds good promise especially in the Mortgaged based Securities (MBS) area.