Securitization

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This article is about securitization in finance. For securitization in international relations, see securitization (international relations).

Securitization is a financing technique that allows the corporation to separate credit origination and funding activities. The technique comes under the umbrella of structured finance as it applies to assets that typically are illiquid contracts. It has evolved from tentative beginnings in the late 1970s to a vital funding source with an estimated total aggregate outstanding of $8.06 trillion (as of the end of 2005, by the Bond Market Association) and new issuance of $3.07 trillion in 2005 in the U.S. markets alone.

Black’s Law Dictionary (7th ed.): Securitization is the process of homogenizing and packaging financial instruments into a new fungible one. Acquisition, classification, collateralization, composition, pooling and distribution are functions within this process

Securitization (Mark Fisher & Zoe Shaw, eds., Euromoney Books, London 2003): Securitization is the packaging of designated pools of loans or receivables with an appropriate level of credit enhancement and the redistribution of these packages to investors. Investors buy the repackaged assets in the form of securities or loans which are collateralized (secured) on the underlying pool and its associated income stream. Securitization thereby converts illiquid assets into liquid assets.

Securitization has two prototypical transaction types: cash and synthetic. In cash securitization, the corporation pools assets together for purchase by a bankruptcy-remote special purpose vehicle (SPV) or special purpose entity (SPE); purchase is effected by issuing multiple tranches of securities based on the cash flow generating capacity of the asset pool. (For more on the capital structure of SPEs please consult the section on asset-backed securities.) In synthetic securitization, the corporation buys a credit default swap (or, less commonly, a total return swap) on certain asset exposures as a kind of default insurance for credits that remain on balance sheet; the swap can be an outright trade or it can be embedded in the balance sheet of an SPE against which liabilities are issued.

Financial institutions and businesses of all kinds use cash securitization to immediately realize the cash value of their illiquid contracts or remove assets from the balance sheet. However, balance sheet restructuring via securitization is much harder to effect under IFRS than under US GAAP.

Contents

[edit] Asset-backed security

Main article: Asset-backed security

Asset-backed securities (ABS) are bonds backed by a pool of financial assets that cannot easily be traded in their existing form. By pooling together a large portfolio of these illiquid assets they can be converted into instruments that may be offered and sold more freely in the capital markets.

In a basic securitization structure, the originator creates a pool of financial assets, such as mortgage loans, and then sells these assets to a specially created investment vehicle that issues bonds backed by those financial assets. These are asset-backed securities. When investors hold a conventional bond they get a regular interest payment during the life of the bond, plus repayment of the full face value of the bond (the principal) at the end of its life. So long as the issuing company is financially healthy it will continue to make these payments, which means that the risk of default is directly linked to the company's solvency.

In a securitization, these payments depend primarily on the cash flows generated by the assets in the underlying pool. This protects ABS investors from losing their money if the company that originated the financial assets goes bankrupt.

While residential mortgages were the first financial assets to be securitized, non-mortgage related securitizations have grown to include many other types of financial assets, such as credit card payments, trade receivables, leases, auto loans and student loans. The royalty payments on David Bowie's back catalogue have even been used as securitizable assets.

Adapted from the U.S. Securities and Exchange Commission's definition of ABS as incorporated in its proposed ABS rules, published in the Federal Register on May 13 2004 and as promulgated in final form as Regulation AB published in the Federal Register on January 7, 2005

[edit] Size

The ABS market is fairly young and has rapidly become an important part of the US capital markets. One source estimates that US public ABS issuance grew from $46.to $800 billion.

[edit] Whole Business Securitization

An application of securitization technology to the cashflows of entire companies was developed in UK capital markets in the late 90's. Given that securitization requires stable cashflows, companies in low-volatility business sectors were most suitable. Typical examples would include highly-regulated water companies, pub companies (which have substantial real estate backing) and infrastructure/transport project companies. The approach has enabled a number of private equity companies to realise substantial returns by investing in sectors that were poorly regarded by public equity markets as having low growth prospects.

[edit] Germany

Debt issue: In June 2004 the German government issued €5.436 billion worth of fixed- and floating-rate credit-linked notes through a newly formed Special Purpose Entity domiciled in the Federal Republic of Germany. The notes are linked to obligations of Russia that were issued through the so called "Paris Club" throughout the 1980s.

[edit] Hong Kong

Equity issue: In December 2004 the Hong Kong Housing Authority issued a Real Estate Investment Trust with government-owned shopping centers and parking lots valued at $2.8 - $4.5 billion. Southeast Asia's biggest property owner by assets, CapitaLand Ltd. has agreed to buy $180 million of the offering. That will transfer management of the properties on to them. The issue, called "The Link REIT", was oversubscribed 28 times with real estate assets of US$3.3 billion and orders of almost $80 billion.

Point of fact - the above HKHA REIT issue was aborted in the final stages after a legal challenge. The government's position was ratified in July by the decision in Hong Kong's Court of Final Appeal. As at Oct 2005 they are preparing to re-launch without Cornerstone Investors but amidst slightly higher bank deposit rates. They will however keep a strategic investor and maintain the ability to allocate more units to funds such as the Mandatory Provident Fund.

In true Hong Kong style it is expected to be the world's largest initial public REIT offering.

[edit] Thailand

According to the Financial Times of 31 July 2006, the Government Housing Bank (GHB) was planning to raise at least Bt40bn ($1.06bn) in a securitization to be backed by residential mortgages.

[edit] See also

[edit] External links

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