Understanding Securitization in Finance

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Securitization is a technique used in finance, it is directed towards investors of financial assets such as receivables by transforming respective claims, through financial securities issued on the capital market.

Securitization is set up by combining a portfolio with claims of a similar nature such as mortgages and consumer loans. The procedure involves selling an ad hoc structure in the form of an entity or trust funds, which in turn funds the purchase price by placing shares with investors.

The securities can be in the form of bonds or treasury notes constitute a fraction of the portfolio of securitized assets. They afford investors the right to obtain payments of claims in the event that bills or mortgages have been paid among other related payments, either as interest or repayment of the principal.

The technique can also be used as means of avoiding the transfer of financial risk to the investors in relation to assets involved, in which case the assets are not sold, instead the risk or part of the risk is transferred through a synthetic securitization.

Securitization can be utilized on loan portfolios or real estate, similar to any asset distribution of future payments. In its most basic form, it involves the holding of illiquid assets by a company, which are then sold to an intermediary entity created for the purpose, that funds the purchase by taking up credit on the market via the issuing negotiable debt securities backed up by the assets

In the main, the securities are bought by investors who take part in the transaction exclusively on the basis of the guarantee on assets whose future cash flows are used to pay off interest on the securities. Every investor acquires in a way, a portion of the portfolio of securitized assets – securities taken over by investors are supported by the portfolio of assets.

In financial markets, special references or terms are used to identify different aspects of securities, for instance asset-backed securities are generically  referred to as asset-backed security (ABS). On the other hand, the intermediary firm initiated for the purpose of borrowing on the market is known as a Special Purpose Vehicle (SPV), Special Purpose Company (SPC), Structured Investment Vehicle (SIV) or a pipe.

The securitization market is a market that depends mostly on the capacity of rating agencies to rate the financial transaction, and the reliability of the conclusions of the agencies.

For investors, the appeal of securitization lies in the fact that they are remunerated by the assigned portfolio and proceed by taking risks. The risks are at times partially covered or structured, and assessed by rating agencies that publish a determinations relating to qualitative risk on the securities.

 

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