MEANING AND PROCESS OF SECURITIZATION
Securitization is a process where various financial assets/debits of the firm are clubbed together into a consolidated financial instrument for trading in the financial market. It converts the assets into tradeable securities that carry interest which is sold to investors such as bonds and stocks. In simple terms, it is a method that frees up the blocked capital of a firm by transforming the illiquid assets into liquid assets. Securitization is an efficient tool that enhances the overall liquidity in the market by acting as a source of funds, especially for financial companies. In addition to this, it offers better investment opportunities to investors with diversified portfolios offering quality returns. Securitization generally takes place with loans and assets that generate receivables like commercial or consumer debt.
The process of securitization is a very complex and lengthy process that comprises various stages and involves different parties.
These steps are discussed in detail as given below: –
- Identification Process: The first stage in the process of securitization is termed an identification process. A financial institution that chooses to go for securitization of its assets is called the originator. In this stage, the originator selects a pool of assets of homogenous nature in terms of rate of interest, maturity period etc.
- Transfer Process: This is the second stage of securitization where the transformation process of converting the selected pool of assets into securities takes place. Once the pool of assets to be securitized is identified by the originator, then it is passed on to another institution known as a Special purpose vehicle (SPV) or trust. Outright sales basis is the manner in which pass-through transaction takes place in between the originator and SPV. The selected assets are removed from the balance sheet of the originator as soon as this transfer process takes place.
- Issue Process: In this process, SPV does the task of converting the pooled assets into tradeable securities for issuing them to investors. The package of assets is split into individual securities of smaller denominations by SPV for selling to the public. SPV gets its fees for carrying these functions out of the sale process of these securities. The securities are issued in various forms such as “Pay through certificates”, “Interest-only certificates”, “Principal only certificate” and “Pass-through certificates”. The structure of these securities is created in such a way that the maturity of these securities and the maturity of securitized receivables synchronize with one another.
- Redemption Process: The redemption process is concerned with interest payments and redemption of issued securities by SPV via collections from securitized assets. Collection of dues related to securitized assets is either done by the originator himself or a special service agent is appointed who charges a commission for this work. SPV plays a major role in processing all payments related to interest and principal to the investors. A pass-through certificate is issued either with recourse or without recourse certificate. If securities are issued with recourse, in that case, SPV will hold the originator liable in case of any default payments.
- Credit Rating Process: It is the process in which passed through certificates is granted a credit rating by rating agencies to make it more attractive. It is the last stage in the securitization process that improves the creditworthiness of certificates to increase their acceptability to investors. This credit rating agency gives guarantees to investors for timely payment of interest and principal by SPV.