4 Securitisation of Financial Assets

SECURITISATION OF
FINANCIAL ASSETS
SECURITIZATION OF FINANCIAL ASSETS
Elements of Securitization:
1. Conversion of existing illiquid assets like loans, advances
and receivables into tradable security.
2. Reconverting them into fresh marketable assets through
capital market operations.
SECURITISATION OF FINANCIAL ASSETS
Why Securitisation:
 A convenient mechanism to suit changing needs of
borrowers and lenders.
 Matches supply of funds with demand for funds through
floating negotiable securities.
 Shifts the source of repayment from earning to a pool of
assets.
Genesis and Growth:

 Severe financial crisis faced by certain states in US during
1969-70.
 Federal government restriction on inter-state lending and
borrowing.
 Raised funds from surplus states by issuing instruments
backed by mortgaged properties.
Benefits of Securitisation:
 Separates the credit risk of the assets from the credit risk
of the Originator
 Lower the cost of borrowing for Originator as the security
is independent of the rating of the corporate securitising
these assets
 Illiquid assets converted into marketable securities and
thus provide alternate funding source
Benefits of Securitization:
 Remove assets from balance sheet and thus improve
capital adequacy.
 Operations in a particular portfolio of assets can be
increased without increasing total exposure.
 Creates a highly diversified portfolio in terms of assets and
geography.
 Dependability of cash flows from the assets as signified by
the ageing of the portfolio.
 The Players and their Role:

 Originator: An entity making loans to borrowers or having
receivables from customers.
 Special Purpose Vehicle: The entity which buys assets from
Originator and packages them into security for further sale.
 Bankruptcy remote
 Separates the risk of assets from the credit risk of the seller
 Credit Enhancer: To reduce the overall credit risk of a
security issue by providing senior subordinate structure,
over-collateralization or a cash collateral.
The Players and their Role:

 Credit Rating Agency: To provide value addition to
security.
 Insurance Company / Underwriters: To provide cover
against redemption risk to investor and / or under-
subscription.
 Obligors: Whose debts and collateral constitute the
underlying assets of securitization.
 Investor: The party to whom securities are sold.
Requirements for Eligible Collaterals:

 Assets to be securitised to be homogeneous in terms of:
 Underlying assets
 Maturity period
 Cash flow profile
Eligible Collaterals:
 Housing finance
 Term loan finance
 Car loan
 Credit card receivables
 Export credit
 Insurance companies
 Bank loans
 Structure of Securitisation:
 Pass Through Certificates:
 Sale of asset to SPV
 Investors purchase interest in the assets of SPV
 Cash flow (interest and principal) passed through as and
when occurred without any reconfiguration
 Payments made are most often on monthly basis
 Reinvestment risk carried by investor
 Pay Through Certificates:

 Sale of assets to SPV
 SPV issues a debt security collateralized by asset cash
flows
 Cash flows (interest and principal) reconfigured to suit
the requirements of the investors i.e. based on the
maturity period of the security
 Reinvestment risk carried by SPV
 Each trench is redeemed one at a time
 Payments would be at different time intervals than the
flows from the underlying assets
Instruments:
Depending on the structure of securitisation, the
instrument would be pass-through certificate (PTC), a
promissory note, a bond or debenture.
 The PTC passes the cash flows from borrowers in the same
form to investors. However, negotiability is restricted as
the investor has to return the PTC to SPV.
 Promissory note / bonds / debentures make available
different tenor maturities and yield to different investors.
Securitisation Process:
 Selection of assets by the Originator
 Packaging of designated pool of loans and advances
(assets)
 Underwriting by underwriters
 Assigning or selling to of assets to SPV in return for cash
 Conversion of the assets into divisible securities
 SPV sells them to investors through private placement or

stock market in return for cash.
 Investors receive income and return of capital from the
assets over the life time of the securities.
 The risk on the securities owned by investors is minimized
as the securities are collateralisied by assets.
 The difference between the rate of the borrowers and the
return promised to investors is the servicing fee for
originator and SPV.
 Legislations / Enactments and their impact on securitisation

transactions:
 The Companies Act 1956 affect the SPV in the following
manner:
 Framing of Memorandum and Article of Association of the
SPV and formation of SPV as a Limited Company
 Management of affairs viz. Board of Directors, Borrowing
Powers / delegation of powers for recovery of receivables etc.
 Share Capital Structure
 Issuance of Bonds / Debentures etc. to investors (whether by
public issue or private placement) and servicing the investors

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SECURITISATION OF

Genesis and Growth:

 The Players and their Role:

The Players and their Role:

Requirements for Eligible Collaterals:

 Pay Through Certificates:

 SPV sells them to investors through private placement or

 Legislations / Enactments and their impact on securitisation

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