Process of Securitisation
Here are the steps included in the process of securitisation:
Step 1: Originator
It is the first step of the securitisation process. In this step, the financial institution or the bank is entitled as the originator. The originator’s task is to separate the receivables/loans/lease into groups that are comparatively similar in regard to the type of maturity, credit, or interest rate risk.
Step 2: Special Purpose Vehicle (SPV)
The group of assets is moved to an SPV (Special Purpose Vehicle), generally comprehended as a trust. It can be launched jointly by banks, financial institutions, originators, etc., who are concerned with securitisation. It can also be floated as a subsidiary of a limited company.
Step 3: Dividing Securities
The SPV divides different assets and generates asset-backed securities like pay-through certificates or pass-through certificated. These securities are issued as certificates of beneficiary ownership, debt, etc., with recourse or without one as per the maturity dates plus interest rate.
Step 4: Disbursement of funds for securities
The servicer accumulates the principal and interest payments on leases, loans, and receivables in the group of assets. The payments are then sent to the investors. The servicer can also be the originator.
Step 5: Credit Rating
It is the last step of the securitisation process. In this process, certified agencies provide pass-through certificates with a credit rating. It improves the creditworthiness of the certificates (like timely interest payments and principal by SPV), making them appealing to the public.
Note: Because of rapid globalisation, the securitisation market witnessed a rise in demand in the fourth quarter of 2022. The volume crossed Rs. 50000 crores in the fourth quarter of 2022.
A Brief about Securitisation
In the US, in the 1970s, banks started securitising house mortgages. At first, the mortgage-backed securities seemed safe. It enabled the banks to issue additional mortgage-backed securities loans to potential homeowners. However, it led to a housing boom in the US, increasing the price of houses significantly.
Later, in 1980, securitisation radically increased the number of securities positioned in the market but did not increase any actual economic variable. The number of securities present in the market increased the prospective transactions the banks could do.
Following this growth pattern, in the last 12 months, nearly 130 financing entities have securitised their assets.
Here is a detailed and step-by-step brief about securitisation:
Identification Process:
The originator needs to select a group of similar assets, considering the maturity, marketability, payment frequency, and interest rates involved. The process of choosing a group of loans and a receivable asset pool for securitisation is called the identification process.
Transfer Process:
Once the identification process is complete, the selected group of assets then goes via another institution. This institution helps the originator transform the group of assets into liquid assets. Such an institution is called SPV (Special Purpose vehicle).
The process of passing via the selected group of assets by the originator to a particular SPV is entitled the transfer process.
Issue Process:
Once this process is over, the SPV transforms these assets into different types of maturities. Based on this, the SPV issues securities such as Pass-Through Certificates, Pay Through Certificates, etc., to the investors.
Redemption Process:
The redemption process is connected with recovering issued securities and interest payments by the SPV through collections from liquid assets.
Credit Rating Process:
In this process, the rating agencies provide pass-through certificates with credit ratings to make them more appealing to investors.
Participants Involved in Securitisation Transaction
- Originator: In the books of the originator, the asset to be securitised exists. The Originator allocates the asset’s beneficial and legal interest to the given SPV.
- SPV: This entity issues the security or asset. It purchases the assets to be scrutinised from an Originator, keeps them in its books, and pays upfront to the Originator.
- Investors: Either an individual or financial institution, insurance companies, mutual funds, pension funds, etc., can be the investors.
- Obligor(s): The original debtor of the loan is the borrower. The amount the Obligator needs to pay is an asset and should be transferred to the SPV.
- Rating Agency: Rating agency helps to identify the process of choosing loans of the right quality, the extent of liquidity, and the credit support offered that can boost the legal framework.
- Administrator or Servicer: It accumulates the outstanding payment to the obligator and shares it with the SPV. It also enforces legal procedures against defaulting borrowers.
- Trustee and Agent: It manages all the parties engaged in the securitisation transaction performed in regard to the agreement and securitisation.
- External Credit Enrichments: There are many external credit enhancements like third-party guarantees, bonds, letters of credit, etc.
- Structurer: Usually, it is the investment banker. The banker is accountable for bringing the originator, the investors, other partners, etc., together to a securitisation deal.
Final Words
This is because the process of securitisation includes lowering the individual risk management related to the individual default assets. Banks and other financial institutions use the securitisation tool to cut down their risk level and decrease the total balance sheet size.
It turns the illiquid assets into liquid assets and frees up the capital from an originator.