The Concept of Securitization
Securitization is well established and practiced in the global debt capital market. Some sources describe it as the practice where issuers merge different financial assets into one unit, thereby creating a single financial instrument.
Securitization is a process by which a company assembles its different financial assets/debts to form a consolidated financial instrument which is issued to investors.
Similarly, it is the process of selling assets and generating cash flows from a company to another company specifically set up for that purpose. Subsequently, the receiving company issues out notes to the company from which the assets or cash flow generated was received. The cash flows from the sale of the assets back up these notes.
Securitization has also been employed as part of asset and liability management, in handling balance sheet risks. Sundaresan defines it as:
“A framework in which some illiquid assets of a corporation or a financial institution are transformed into a package of securities backed by these assets, through careful packaging, credit enhancements, liquidity enhancements and structuring.”
The practice of securitization allows institutions like Corporates and Financial Institutions to modify the assets that cannot be readily marketable to rated securities tradeable in the secondary markets. Residential mortgages and car loans are a typical example of these types of assets. This allows investors to gain access to these types of original assets which would not have otherwise been accessible. This merger and packaging process creates asset-backed bonds, which are debt instruments created from a smorgasbord of loan assets from which interest is payable on a floating basis.