Securitization
Securitization is the creation of asset-backed securities. These are debt securities that are backed by a stream of cash flow. Typical debt securities may include; Residential & Commercial Mortgages and Real Estate Leases Consumer Assets such as Personal Loans, Vehicle Hire Purchase and Credit Card Receivables Commercial Loans Trade Receivables
The act of Securitization is the taking of the cash flow or income streams throughout the obligation and rolling it into a current lump-sum value. It is effectively bringing future income into today’s value for today’s use. Due to this act of relying on future income, most Securitizations are underwritten or insured. Assets to be securitized are first sold (or transferred) to a special purpose vehicle company (SPV) to isolate them from any claim or repayment obligation of the end borrower. The SPV will then issue Bonds or other debt instruments or obligations. The SPV then uses the funds raised by issuing the debt securities to pay the ultimate borrower for the assets.
The borrower has raised money without risking assets other than those held by the SPV and it has got a lump sum in return. It has lost some assets or cash flows in return for cash. The debt is also kept off-balance sheet. This is quite reasonable given the limited recourse. Securitization can therefore be seen as a way of selling off a stream of cash flows.
Securitization also has benefits for investors. It widens their choice of available investments. The asset-backed securities created by Securitization may also be easier to analyze as investors need only evaluate the cash flows from a small pool of assets, instead of a whole complex business. The assets most often securitized are loans of one kind or another which are usually (when pooled, not individually) a low-risk investment.
Securitization is a valuable financial tool for any organization.
It allows the principal to use future income streams as today’s assets.
It allows for cheap, non-recourse borrowings off-balance sheet and becomes economically viable for contracts over a minimum of $4m. Securitization can also be effectively employed in debt restructuring strategies.
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