Securitisation means to convert (an asset, specially a loan) into marketable securities, typically for the purpose of raising cash, according to the Concise Oxford Dictionary. Securitisation is a process by which the forecast future income (the money that is due to come in) of an entity is transformed and sold as debt instruments, such as bonds, with a fixed rate of return.
Securitisation allows the company to get cash upfront which can be put to productive use in the business. Securitisation is done by suitably repackaging the cash flows or the free cash generated by the firm thats issuing these bonds. The assets securitized will go out of the books of the finance company once they are securitized and the risk from its books are removed. Securitisation has emerged globally as an important technique of debt financing. Over the last 20 years, securitisation has become one of the largest sources of debt financing in the US and is enjoying a very strong growth across Europe and Asia.
In India, securitisation transactions have been taking place for some time now. However, the participation of the banks and financial institutions in the securitisation activity, but for a few major players, is very minimal. This activity is however, picking up. A high-powered, Andhyarujina Committee was constituted to suggest changes in banking laws comprising of officials from RBI, ministry of finance, ministry of law and ICICI. The Committee which submitted its recommendations in February 2000, suggested the enactment of a new Securitisation Bill that would provide the legal framework for securitisation. What can be securitised? All assets that generate funds over time can be securitised.
These include repayments under car loans, money from owners of credit cards, airline ticket sales, total collections from roads or bridges, and sales of petroleum based products from oil refineries. Securitisation works well if the securitised asset (say, the pool of car loans) is homogenous (the same kind) with regard to credit risk (how sound the borrower is) and maturity. Ideally, there should be historical data on the portfolios performance and that of the issuing company with regard to credit quality and repayment speed.
How is it beneficial to the Issuer?
- The issuer can raise funds of longer maturities than he would have been able to through the conventional routes such as bonds or term loans.
- The process of securitisation allows the borrower to raise funds against future cash flows rather than existing assets.
- Moreover, if a company decides to raise a conventional loan, it has an impact on its debt: equity ratio. Securitising as a means of raising funds does not have any impact on the debt: equity ratio as the assets are taken out of the issuers books.
- What are the components of a securitisation transaction?
The entities involved in the securitisation transaction are the originator or the seller (the entity raising funds), the issuer (special purpose vehicle which issues the securities), the servicer (which manages the portfolio on behalf of the special purpose vehicle and ensures timely payments), the trustee and the credit rating agency. Other entities involved are credit enhancement providers and the investors. What is the role of each of these players? The originator is the party which has a pool of assets which it can offer for securitisation and is in need of immediate cash. The Special Purpose Vehicle (SPV) is the entity that will own the assets once they are securitised. - Usually, this is in the form of a trust. It is necessary that the assets should be held by the SPV as this would ensure that the investors interest is secure even if the originator goes bankrupt. The servicer is an entity that will manage the asset portfolio and ensure that payments are made in time. The credit enhancer can be any party which provides a reassurance to the investors that it will pay in the event of a default.
This could take the form of a bank guarantee also. Partial Securitisation: An originator may transfer only a part of the asset in a securitisation transaction instead of transferring the complete asset. Such transfer may occur in two ways. One way is where a proportionate share of the asset is transferred. For example, the originator may transfer a proportionate share of loan (including right to receive both interest and principal), in such a way that the originator and the SPV will share all future cash flows from the loan in the agreed ratio. - A second way of transferring a part of a financial asset arises where the asset comprises the rights to two or more benefit streams, and the originator transfers one or more of such benefit streams while retaining the others. For example, the originator may securitise the principal strip of the loan while retaining the interest strip and servicing asset. If the originator transfers a part of a financial asset while retaining the other part, the part of the original asset, which meets the true-sale criterion, should be derecognised in the books; whereas the remaining part should continue to be recognised in the books. In case the asset comprises the rights to two or more benefit streams and one or more of such benefit streams are transferred while retaining the others, the carrying amount of such financial asset should be apportioned between the part(s) transferred and the part(s) retained on the basis of their relative fair values as on the date of transfer.
Sources & Referrences:
[https://www.educba.com/asset-securitization/]
