We have described the basic process of securitization, and the major participants involved in the securitization of financial assets.
But what kind of assets can be securitized? Assets that generate future income streams would generally be qualified. The more popular ones would be home mortgages, auto loans, credit-card loans and student loans. Less popular are equipment leases, small-business loans and corporate receivables.
The Securitization Act of 2004 defines assets eligible for securitization as “loans or receivables or other similar financial assets with an expected cash payment stream. The term ‘Asset’ shall include, but shall not be limited to, receivable, mortgage loans and other debt instruments: Provided, That receivables that are to arise in the future and other receivables of similar nature shall be subject to approval by the Securities and Exchange Commission [SEC] or the Bangko Sentral ng Pilipinas [BSP], as the case may be: Provided, further, That the term ‘Assets’ shall exclude receivables from future expectation of revenues by government, national or local, arising from royalties, fees or imposts.”
The implementing rules and regulations of the Act further qualifies the asset pool to be formed as “the group of identified homogeneous assets underlying the ABS”, i.e., asset-backed securities. Homogeneous means similar in character or having the same composition and properties. In other words, don’t mix home-mortgage loans and auto loans in the asset pool, for example.
The financial assets to be qualified for securitization would, of course, be active accounts, i.e., not delinquent and fully earned by the originator/seller. It is not surprising that securitized products are, by volume, generated largely from home-mortgage loans because that was how it all started. The introduction of securitization as we know it today is traced back to 1970, when the US Government National Mortgage Association, nicknamed GNMA or Ginnie Mae, issued securities backed by a portfolio of mortgage loans. These residential mortgaged-backed securities served as the collateral for securities sold in the secondary market.
Also, in 1970, the US Congress passed the Emergency Home Finance Act creating the Federal Home Loan Mortgage Corp., nicknamed Freddie Mac, authorizing it—and the Federal National Mortgage Association or Fannie Mae, as well—to buy and sell mortgages insured or guaranteed by the federal government. Freddie Mac, for example, engaged in purchasing mortgages from thrift institutions which had originated the mortgages, thereby injecting liquidity in the home-mortgage market.
These developments primed the availability of funds that supported the expansion of the demand for housing—a government policy encouraging affordable housing. This worked successfully. From 1971, when Freddie Mac first issued the first conventional loan securitization, the financial markets got enamored with securitization in the US
and elsewhere.
What are the benefits to securitization?
The benefits to the originator/seller in securitization is the transformation of its nonliquid assets (the receivables) to liquid assets (immediate cash received for selling the receivables to the SPV to form part of the asset pool). It’s a new different way of raising funds. Instead of waiting to collect the receivables over a period, the originator/seller has now converted its financial assets to cash, which, in turn, it can now use for its operations, and expand its base for generating profits.
Another way of looking at it, from the perspective of the originator/seller, is that the credit risk on the receivables has been transferred to the SPV. Important to note, for the accounting-minded, is that the financial assets are moved out of the originator/seller’s balance sheet.
There is here an advantage to balance-sheet management by the originator/seller.
So let us refocus our conversation. Securitization must be appreciated in a larger sense. By transforming illiquid financial assets to tradable securities, more funds are made available for productive enterprises from the capital market, diversifying from the limitations of bank financing. And investors are given the opportunity, likewise, for greater investment options.
Important to note, also, is that the creditors of the originator/seller, in case of the latter’s bankruptcy, do not have anymore access to the financial assets sold to the SPV and which have been securitized. The requirement in securitization, precisely, is to have a true sale to the SPV, and therefore shielded from the reach of such creditors, i.e., must be bankruptcy-remote.
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The opinions expressed here are the views of the writer and do not necessarily reflect the views and opinions of Finex. Finex Free Enterprise is a rotating column of members of the Financial Executives Institute of the Philippines appearing every Wednesday & Friday in BusinessMirror, Banking and Finance Section.