Securitization Series: Part I. What is Securitization?

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“Economics is haunted by more fallacies than any other study known to man. This is no accident. The inherent difficulties of the subject would be great enough in any case, but they are multiplied a thousandfold by a factor that is insignificant in, say, physics, mathematics or medicine – the special pleading of selfish interests.” 
― Henry Hazlitt

Securitization gained its roots in the American economy as early as in the 1970s by pooling of home mortgages carried out by the Government-backed agencies. Eventually, this process spread beyond mortgages to other asset avenues. It gained popularity across the world and has established firm roots in India no different.

Securitization is the process of pooling of illiquid assets and repackaging the pooled assets into securities issued to investors in the capital markets. The holders of these interest-bearing securities get passed through, the principal payments and interest from the assets.

Securitization begins when an originator entity with loans and other income-generating assets pools those assets that it wishes to cross off from its balance sheets into a ‘reference portfolio’. It is then sold to an Asset pool of an issuer, e.g. SPV. The issuer sponsors acquisition of the pooled assets by issuing tradable, interest-bearing securities which are then issued to investors in the capital market. These investors collect disbursements from the trustee account funded by the cash flows generated by the ‘reference portfolio’.

Typically illiquid or less liquid assets are pooled together to create marketable securitized assets, these are then tailored into tranches depending on the risk tolerance of different types of investors. The newly created mortgage-backed security is then sold in the secondary market in parts and parcels, with hedge funds purchasing the higher risk part.

The flow-chart explains the process of securitization in an easy-to-understand way!IMG_20180921_230004.jpg

– Manal Shah

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