Investment Bank Dương Tấn Khoa

Asset Securitization
Turning Income Streams into New
Investment Vehicles

ThS. Dương Tấn Khoa

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❖What is Securitization?
❖Asset securitization, the selling of securities
backed by cash flows from a pool of financial
assets
❖Or Securitization is the process of taking an
illiquid asset or group of assets and, through
financial engineering, transforming it (or them)
into a securities.

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❖Example of Securitization

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Securitization
Structure

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❖Securitization Structure (Cont.)

❖Securitization involves several key elements:
 Originator and Collateral
 Servicing
 Special Purpose Vehicle
 Credit Enhancement
 Credit Rating

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❖Securitization Structure (Cont.)

Originator and Collateral
• The originator may be a bank, a finance company, a
credit card issuer, or a securities firm.
• In structuring a securitization program, it is essential
that the originator achieve a true sale in the transfer
of assets to the trust holding the collateral, called
special purpose vehicle (SPV).

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❖Securitization Structure (Cont.)

Servicing
• The servicer collects money from debtors and
distributes the funds, net of fees, to the SPV and
to investors.
• Many securitization programs retain the
originator as the servicer.
• To ensure that the originator’s retention of some
control over the assets will not prevent the
transfer from being a true sale, the originator’s
role must be clearly limited to that of a collection
agent for the trust, and the originator must be
paid a reasonable servicing fee.
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❖Securitization Structure (Cont.)

Special Purpose Vehicle
• A special purpose vehicle is a subsidiary
created by a parent company to isolate financial
risk.
• Its legal status as a separate company makes
its obligations secure even if the parent
company goes bankrupt. For this reason, a
special purpose vehicle is sometimes called a
bankruptcy-remote entity.
• Constraints in the documents setting up the
transaction restrict the business activities of the
SPV to those associated with the securitization.
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❖Securitization Structure (Cont.)

Credit Enhancement
• Credit enhancement may be used to reduce
the risks to investors of certain structured
financial products (Ex: securitization)
• This can be done through internal credit
enhancement and external credit
enhancement
 Internal credit enhancements include
overcollateralization, excess spread, or a reserve
account.
 External credit enhancements may be in the form of
a bank letter of credit or a financial guarantee from a
bond insurance company.
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❖Securitization Structure (Cont.)

Credit Rating
• Credit ratings provide investors with an
indication of the likelihood that they will be
repaid on time and in full.
• In analyzing a securitization program, rating
agencies examine the legal and structural
protections provided to investors.
• In future cash-flow transactions, the agencies
also review the generation and business
risks applicable to the origination.

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❖Benefits of securitization
❖Issuers, investors, and investment bankers all
benefit from asset securitization.
❖Benefit to originator:
• Securitization allows institutions to convert assets that
are not readily marketable into rated securities that
are tradable in the secondary market
• To the extent that the originator continues to service
the underlying assets, a steady stream of servicing
fees is generated.
• Because assets are removed from its balance sheet,
the originator’s exposure to interest rate risk is
reduced. In addition, the credit risk associated with
those assets is passed on to investors.

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❖Benefit to originator (cont.)

• The transfer of title to the assets to the SPV is of
particular value to banks as originators, because it frees
up capital for the bank to make new loans. As such, it
permits the bank to lend additional funds to its
customers.
• If the originator is at or near the debt/equity ratio
permitted under financial covenants in outstanding
indentures, securitization will allow the originator to raise
additional needed capital without incurring balance sheet
debt and triggering a breach of these financial
covenants.
• A securitization is also an effective way to divest excess
or nonessential assets.
• By packaging individual illiquid loans into marketable
securities, the issuer increases the liquidity of its assets.
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❖Disadvantages to originator:
• The up-front expenses and effort required for a
first-time securitization are likely to exceed the
expenses and effort associated with a bank
borrowing or other debt offerings
– However, those costs can be amortized over
the life of the transaction.
– In addition, the follow-up transactions can be
completed more easily and with lower
transaction costs.
• Another disadvantage is the required disclosure of
asset data, which the originator may be reluctant to
provide
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❖Cost to originator
– Investment-banking fees
– Filing fees, fees to rating agencies, fees
associated with the trustee of the asset pool,
and credit enhancement costs.

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❖Benefit to Investment Bank

• The securities created generate profits to

bankers; there are the underwriting spreads

and potential proprietary trading profits.
• The securitization process produces a
continuous flow of underwriting income.

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❖Benefit to investors
• Securitization helps investors to access assets that
would otherwise not be open to them, e.g., credit card
receivables.
– They are able to gain exposure to real consumer and
corporate assets without having to develop in-house
origination and servicing capabilities.
• Securitization offers investors unique investment
opportunities and attractive risk-return profiles compared
to other asset classes such as government and corporate
bonds.
• For most investors, the benefit comes from portfolio
diversification because correlation between asset classes
is not perfect..
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❖Types of security issued in securitization

process
❖Mortgage-backed securities (MBS): are
debt instruments backed by residential or
commercial mortgages.
❖The MBS market has been the largest market for
securitized instruments.
❖MBS is similar to a bond that is made up of a
bundle of home loans bought from the banks
that issued them.
❖Investors in MBS receive periodic payments
similar to bond coupon payments and principal
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❖Mortgage-backed securities (MBS) (Cont.)

❖Mortgage backed securities (MBS) turn a bank
into an intermediary between the homebuyer
and the investment industry.
❖The bank handles the loans and then sells them
to be packaged as MBSs to investors as a type
of collateralized bond.
❖For the investor, an MBS is as safe as the
mortgage loans that back it up.

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Process of issuing MBS

IB

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❖Types of security issued in securitization

process (Cont.)
• Asset-backed securities (ABS): securities backed by
non-mortgage assets such as installment loans, leases,
receivables, revolving credit, commercial loans, and high-
yield bonds/loans, or any types of assets that generate
cash flow
• Asset-backed securities (ABSs) are bond backed by
income-generating assets.
• ABSs are created when a company sells its loans or other
debts to an issuer, a financial institution that then
packages them into a portfolio to sell to investors.
• ABSs appeal to income-oriented investors, as they pay a
steady stream of interest, like bonds.
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