29-01-2013, 10:44 AM
Asset securitization
Asset securitization.doc (Size: 164 KB / Downloads: 22)
INTRODUCTION
Asset securitization is one of the ways in which assets can be hedged in a derivative market. It is designed to give traditional commercial banking, a new direction. Asset securitization is used by banks that actually look to transform their non-liquid assets into liquid assets, thereby allowing them to allocate their capital more efficiently. In addition to this, asset securitization also helps banks access diverse and cost-effective funding sources, and help in the better management of business risks.
Challenges and opportunities.
In the scenario, where the non-banking securities have given tough competition to the banks, these banks have now got chances to adopt some of their practices. Earlier, different underwriting and Captive Finance companies have been main threat to bank's market share and profitability in the prime credit and consumer loan businesses. And the growing competition within the banking industry from specialized firms that rely on securitization puts pressure on more traditional banks to use securitization to streamline as much of their credit and originations business as possible. Because securitization may have such a fundamental impact on banks and the financial services industry, bankers and examiners should have a clear understanding of its benefits and inherent risks.
Traditionally non-banking securities have been tough competition to banks. Through asset securitization, banks now have the opportunity to adopt some of the practices of non-banking securities.
There are limitations too. In the prime credit and consumer loan businesses different underwriting and Captive Finance companies have been a threat to a bank's market share and profitability. The increased use of asset securitization within the banking industry has put undue pressure on traditional banks to adopt similar methods. This in turn has had a fundamental impact on banks and the financial service industry. Bankers therefore need to be advised about the benefits and inherent risks of asset securitization.
Definition
Asset securitization is a financial instrument of structured finance in which loan interest and receivables are packed and sold in the form of ABS securities. Asset securitization maximizes capital & minimizes risk due to its diversification nature.
In other words, this is the process which helps create a financial instrument by combining other financial assets and then marketing them to investors. Again, in this process certain assets from the balance sheet of a company get separated and are used as collateral for the issuance of securities. The securitized assets like commercial papers, notes or bonds are typically sold through special purpose vehicle (SPV) in order to provide funding.
Asset securitization differs from collateralized debt or traditional asset backed lending. Loans are sold to a third party through a special purpose vehicle (SPV) or trust. This SPV issues one or more debt instruments - asset backed securities whose interest and principal payments are dependent on the cash flows coming from the underlying assets. It can be figured like:
Securitisation
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or Collateralized mortgage obligation (CMOs), to various investors. The principal and interest on the debt, underlying the security, is paid back to the various investors regularly. Securities backed by mortgage receivables are called mortgage-backed securities(MBS), while those backed by other types of receivables are asset-backed securities(ABS).
Critics have suggested that the complexity inherent in securitization can limit investors ability to monitor risk, and that competitive securitization markets with multiple securitizers may be particularly prone to sharp declines in underwriting standards. Private, competitive mortgage securitization is believed to have played an important role in the U.S. subprime mortgage crisis. [1]
History
In February 1970, the U.S. Department of Housing and Urban Development created the transaction using a mortgage-backed security. The Government National Mortgage Association (GNMA or Ginnie Mae) sold securities backed by a portfolio of mortgage loans.[6]
To facilitate the securitization of non-mortgage assets, businesses substituted private credit enhancements. First, they over-collateralised pools of assets; shortly thereafter, they improved third-party and structural enhancements. In 1985, securitization techniques that had been developed in the mortgage market were applied for the first time to a class of non-mortgage assets — automobile loans. A pool of assets second only to mortgages in volume, auto loans were a good match for structured finance; their maturities, considerably shorter than those of mortgages, made the timing of cash flows more predictable, and their long statistical histories of performance gave investors confidence.[7]
This early auto loan deal was a $60 million securitization originated by Marine Midland Bank and securitised in 1985 by the Certificate for Automobile Receivables Trust (CARS, 1985-1).[8]
Structure
Pooling and transfer
The originator initially owns the assets engaged in the deal. This is typically a company looking to either raise capital, restructure debt or otherwise adjust its finances. Under traditional corporate finance concepts, such a company would have three options to raise new capital: a loan, bond issue, or issuance of stock. However, stock offerings dilute the ownership and control of the company, while loan or bond financing is often prohibitively expensive due to the credit rating of the company and the associated rise in interest rates.
The consistently revenue-generating part of the company may have a much higher credit rating than the company as a whole. For instance, a leasing company may have provided $10m nominal value of leases, and it will receive a cash flow over the next five years from these. It cannot demand early repayment on the leases and so cannot get its money back early if required. If it could sell the rights to the cash flows from the leases to someone else, it could transform that income stream into a lump sum today (in effect, receiving today the present value of a future cash flow). Where the originator is a bank or other organization that must meet capital adequacy requirements, the structure is usually more complex because a separate company is set up to buy the assets