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DEBT SECURITIZATION

DEBT SECURITIZATION

What is Securitization?

Securitization is the process by which financial assets such as loan receivable, mortgage backed receivable, credit card balances, and hire-purchase debtors, lease receivable, trade debtors, etc. are transformed into securities.

Securitization is different from “Factoring” since factoring involves transfer of debt without transformation t hereof into securities.

Securitization is a process of pooling and repackaging homogeneous illiquid financial assets into marketable securities that can be sold to investors. Securitization is the process by which financial assets are transformed into securities.

Since through Securitization, the illiquid financial assets or debtors are converted into Securities, it can also be called as “Debt or Asset Securitization

ESSENTIAL FEATURE:

The following are the essential feature of a securitization transaction:

ü  Financial assets such as loan assets, mortgage, credit card balances, HP transaction, trade debtors,, etc. or defined rights therein, are transferred fully or partly, by the owner (the Originator) to a Special Purpose Entity (SPE) in return for an immediate cash payment and / or other consideration. The assets so transferred are the “Securitized Assets” and the assets or the rights, if any, retained by the Originator are the “Retained Assets”.

ü  The SPE finance the assets transferred to it by the issue of securities such as Pass Through Certificates (PTCs) and / or debt securities to investors.

ü   A usual features of securitization is ‘Credit Enhancements’. It is an arrangement which is designed to protect the holder of the securities issued by an SPE from losses and / or cash flow mismatches arising from shortfall, or delay in collection from securitized assets.

ü  The arrangement often involve one or more of the following:

Ø  Provision of Cash collateral, i.e. a deposit of cash which in specified circumstances can be used by the SPE for discharging its financial obligation in respect of securities held by the investors.

Ø  Over collaterisation, i.e., making available to SPE, assets in excess of the securitized assets, the realization of which can be used in specified circumstances to fund the shortfall and / or mismatches in fulfillment of its financial obligations by the SPE.

Ø  Recourse obligation accepted by the Originator

Ø  Third party guarantee, i.e., a guarantee given by a third party by accepting the obligation to fund any shortfall on the part of the SPE in meeting its financial obligation in respect of the securitization transactions.

Ø  Structuring of the instruments issued by an SPE into senior and subordinated securities such that the senior securities (issued to investor) are cushioned against the risk of shortfall in the realization of securitized assets by the subordinated securities (issued normally to the Originator). Payments to subordinated securities are due only after the amounts due on the senior securities are discharged.

ü  The Originator may continue to service the securitized assets (i.e. to collect amount due from borrowers, etc) with or without servicing fees for the same.

ü  The Originator may agree to securities future receivable, (i.e. receivable that are not existing at the time of agreements but which would be arising in future.) in case of such securitization, the future receivables are estimated at the time of entering into transaction and the purchase consideration for the same received by the Originator in advance.

ü  Securitization can also be in the form of “ Revolving Period Securitization” where future receivable are transferred as and when they arise or at the specified intervals, the transfer being on pre-arranged terms.

Securitization Process:

Steps involved in a Securitization Process:

The basic debt securitization process can be classified in the following three functions.

(i)           The Origination Function: A borrower seeks a loan from a finance company, bank, housing company or a lease from a leasing company. The creditworthiness of the borrower is evaluated and a contract is entered into with repayment schedule structured over the life of the loan.

(ii)         The Pooling Function:Similar loans or receivables are clubbed together to create an underlying pool of assets. This pool is transferred in favour of a SPV – (Special Purpose Vehicle), which acts as a trustee for the investor. Once the assets are transferred, they are held in the originators’ portfolios.

(iii)       The Securitization Function:It is the SPV’s job now to structure and issue the securities on the basis of the asset pool.

DEBT SECURITIZATION

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