MEANING AND PROCESS OF SECURITIZATION
Securitization is a process where various financial assets/debts 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 are sold to investors such as bonds and stocks. In simple terms, it is a method which free up the blocked capital of firm by transforming the illiquid assets into liquid assets. Securitization is an efficient tool which enhances the overall liquidity in 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 portfolio offering quality returns. Securitization generally takes place with loans and assets that generates receivables like commercial or consumer debt.
Process of securitization is a very complex and lengthy process that comprises of various stages and involving different parties.
These steps are discussed in detail as given below: –
- Identification Process: First stage in the process of securitization is termed as identification process. Financial institution which chooses to go for securitization of its assets is called originator. In this stage, 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 transformation process of converting the selected pool of assets into securities takes place. Once the pool of assets to be securitized is identified by originator, then it is passed on to another institution known as 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 originator as soon 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 them to public. SPV gets its fees for carrying out 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”. Structure of these securities is created in such a way that maturity of these securities and maturity of securitized receivables synchronies with one another.
- Redemption Process: 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 originator himself or a special service agent is appointed who charges 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 and without recourse certificate. If securities are issued with recourse, in that case SPV will held 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 securitization process which improve the credit worthiness of certificates to increase their acceptability to investors. This credit rating agency gives guarantee to investors for timely payment of interest and principal by SPV.