Securitization: Explaining Meaning, Contribution, and Socio-Economic Implications

This article provides an in-depth explanation of securitization, including its meaning, contribution to the global financial system, and socio-economic implications. It also explores why banks lend to sub-prime borrowers and includes a case study. A comprehensive resource for understanding the complexities of securitization.

SECURITIZATION

Table of Contents
INTRODUCTION...........................................................................................................................1
1. Explaining the meaning of securitization ...............................................................................1
2. Representing contribution of securitization in sustaining and creating a global system of
financial .......................................................................................................................................3
3. Explaining the socio-economic implications associated to securitization ..............................4
4. Why do banks lend to the Sub-prime Borrowers ?..................................................................5
5 .Case Study ..............................................................................................................................6
CONCLUSION................................................................................................................................7
REFERENCES................................................................................................................................1

INTRODUCTION
Securitization can be defined as that financial practice in which pooling is being done
which is related to different type of contractual debt. The debt can include such as residential
mortgages, commercial mortgages, auto loans or credit card debt obligations. The selling in
securitization can be done to third party which is basically investors. Like for example a money
market account is an account at a bank used to store cash. Securities can also be defined as
financial security. It is one of the most important thing in financial market. It can be re packaged
into interest bearing securities.
1. Explaining the meaning of securitization
Securitization refers to the financial practice in pooling several kinds of the contractual
debt like residential mortgages, auto loans, credit card obligation, commercial mortgages and
selling the cash flows to the third party by way of securities that might be described as the bonds,
collateral obligation, pass through securities etc. Under this investors are been repaid from a
principal and an interest cash flows that are been gathered from an underlying debt that is
redistributed through capital structure of new financing (Broer, 2018). Securities that are been
backed by the mortgage receivables are known as mortgage backed securities whereas those
which are backed by other kinds of the receivables are stated as asset-backed securities. The
granularity of the securitized assets could help in mitigating credit risk of an individual borrower.
Unlike the general corporate debt, quality of the securitized debt is seen as non-stationary
because of the changes in the volatility which are dependent on the time and the structure.
Moreover, the SUBPRIME mortgage crisis that started in the year 2007 facilitates a
securitization concept as a bad name. It is the process within which certain assets are been
pooled together so that they could be re-packaged into the securities that are interest bearing. The
principal and the interest payments from an asset are been passed through purchase of securities.
Most of the financial institution applies securitization in transferring credit risk of an
asset as it originate from their respective balance sheet with that of other institutions like bank,
hedge funds and insurance companies (Helgesson and Mörth, 2019). It is reflected as very
cheaper funding sources. Until and unless subprime crisis unfolded, an impact of the
securitization has been largely appeared as positive and the benign. However, it is also indicated
as compromising an incentives for the originators in respect of ensuring minimum standards of
the prudent lending, management of risk and investment at the lower time when the lower returns

on the conventional products, default rates resulted below historical experiences (Mordel and
TeNyenhuis, 2018). Wide availability of the hedging tools were been encouraging an investors in
taking the more and more risk in achieving higher yield.
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The process of securitization includes two main steps that is in the first step, corporation
with the loans and the other income producing an asset. Thereafter, originators determines an
assets that it wants for removing from balance sheet and in pooling them within the reference
portfolio. Then it sells such asset pool to the issuer like SPV. An entity that is set up by the
financial institution, particularly for purchasing an asset and realizing its off-balance sheet
treatment for the legal and an accounting purposes (Messina, 2019). In the next step or second
step, issuer finances an acquisition of pooled assets with issuing a secutrities that bears interest
and could be traded which are been sold to the investors in the capital market. An investors
receives the floating and the fixed rate payments from the trustee account that is been funded by
cash flows which are been gained by reference portfolio.
Significantly, securitization presents the diversifies and an alternative source of the
finance on the basis of transferring credit risk from an issuer to the investors. Initially,
securitization eas used for financing simple and self liquidated asset that involves mortgages
(Bilan, Degryse, O’Flynn and Ongena, 2019). On the other hand, any kind of the asset with the
stable value of cash flow could in structured in principle into the reference portfolio which
supports securitized debt.
The securitization landscape over the decades has reflected dramatically changed. It is no
longer wed to the traditional assets along with the specific terms like bank loans, consumer
loans, mortgages etc. Improved level of risk quantification and modelling has encouraged an
issuer in considering wider range of the assets such as business loans, lease receivables etc.
Moreover, in the mature market, it has been registered for a significant growth in the emerging
markets where the large and the companies that are highly rated have opt for using securitization
for the purpose of turning their future cash flows from export or remittances into the present cash
flows.
In future, products that are securitized likely to become more and more simpler. After
the years of posting virtually for not any capital reserves against the debts that are high rated
(Zhang, 2019). Issuers or investors will soon facing with the regulatory changes which will
needed in charging higher capital and the comprehensive valuation. Reviving transaction relating
to securitization and restoring confidence of an investor may require issuers in retaining an
interest in performance of the securitized assets at every level.
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2. Representing contribution of securitization in sustaining and creating a global system of
financial
Securitization act as the major financial innovation that contains cost and the benefits
attached to it. There are various conditions within which securitization could be a net benefit fro
global financial system. As such, securitization acts as the concept that is neither considered as
good not counted as bad as the point underscored by variation of market in performance of the
various classes of the securitized assets at time and after a global financial crisis (Chiaramonte,
2018). This departure point stands in comparison to some more polarizing views attached with
the securitization that were been advanced in aftermath of GFC.
There exist various channels through which healthy market for the securitization may
support both broader economy and the financial system. It includes lower cost for funding and
the in economizing the capital for the financial institution. Securitization benefits might passes to
the businesses and the consumers as it helps an investors and the issuer in diversifying and
transferring risk around the different class of asset, industries, geographies, credit risk and an
instruments. By way of transforming pool of an illiquid assets into the securities that are been
traded. It also contributes in creating a potentially the most valuable tool in assisting with
resumption of the credit flows to the worthy borrowers.
However, such potential benefits required to be weighted against a potential risk towards
a financial system that could arise from a sub-optimally working of the securitization markets.
This happens because securitization has capacity in increasing credit flow in or outside the
formal system of banking (Alqaisi, 2018). Effect of Financial accelerator results in an excessive
increase in the asset prices and the credit growth.
Global securitization has expanded the markets without causing any type of market or
economic disruptions over three decades by leading it to late 1990s during the years preceding
to the GFC issuing patterns that changed dramatically. By securitization many of the industry
participants had became enforced or involved in the powerful reinforcing cycle that is driven by
the misaligned incentives. It is the system which is been consist of the for components that is
loan originators, intermediaries, investors and CRAs. Thus, from this it has been interpreted that
securitization was not been counted as the principal cause of crisis but resulted as creating and
sustaining the global financial system in a better way (Elson, 2019). Overall securitization
industry has became stigmatized and many of the securitization markets had performed well over
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crisis. This helps in restoring the credit flow to the worthy borrowers at present time which have
been rendered as uneconomical.
New developments in the securitization over 2000-2007 period that amplified financial
crisis specifically where then US subprime mortgages were been involved. Dealers or the brokers
found as the dominant actors on supply side as most of new trends have been emerged within the
securitization practices within this period. Against a backdrop of the accommodative monetary
policy, irresponsible origination of loan practices and the complex financial products and the
feedback loop is ensued where the growing demand for the highly rated products results in an
increased demand for the low quality loans for serving as the collateral. Hence, concentration of
the risk in financial system seen as magnified.
3. Explaining the socio-economic implications associated to securitization
In accordance to the forum, there are various economic and the social benefits had been
realised in the markets where the securitization is employed on the broader scale. For instance-
Efficient and the liquid secondary securitization markets could reduce a regional and the
geographical disparities in availability and cost relating to credit throughout the specific
jurisdiction linking to local level of credit extension activity to the national and an increasingly
global system of capital market.
Securitisation contains more pronounced effect on the proxies of supply side of an
economy than on the economic growth. This tends to be consistent with the shift from an
investment to the consumption by constraining supply side of an economy, however, boosting
the demand potentially (Securitization, 2018). As the financial crisis attained in last 20 months
depicts that the need in understanding better links between the financial intermediaries, real
economy and the financial markets. Considering a fact that most of the economy models had
underestimated in emerging problems with respect to the part of the financial links to real
economy.
Securitization provides for number of the reasons that involves reducing informational
asymmetries, reducing a regulatory capital and in reducing the bank, lower cost of the financing
sources. It increases risk relating to profile of an institution only in case of most creditworthy
assets are been removed from a balance sheet through the securitization. It has also been founded
that the securitization reduces bank lending to an external source of the fund availability. On the
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other side, securitization has potential in making the banks more and more vulnerable to the
economic shocks at the time when market for the loans is been disrupted.
4. Why do banks lend to the Sub-prime Borrowers ?
Sub-prime lending refers to provision for loans of people who have difficulty in
maintaining repayment schedule. Loans were characterized to higher interest rates, quality
collaterals and the less favourable terms for compensate for higher credit risks. Large number of
sub-prime loans have been packaged into the mortgage-backed securities that ultimately
defaulted by contributing to financial crisis of 2008.
Sub-prime borrower means a person having high credit risks for lender. These borrowers
are having low credit scores & have number of negative factors presented in their credibility
reports like delinquencies & account rejection. They have shorter credit history, and have no or
little activities in credit reports for basing the decision by bank. The credit scores are usually
below 670 with negative points. As they find difficulty in getting loans banks are able to charge
higher interest rates over the loans.
Banks are providing for the loans to sub-prime owners for many reasons. Banks takes
benefits from the sub-prime loans as they are given t lenders at higher rates that are greater than
prime rates candidates having poor credit scores (Arentsen and et.al., 2015). Along with higher
rates of interest they also come with much higher fees. Subprime loan have great variations. Risk
based pricing method are used for calculating the mortgage terms and rates. The more worse is
the credit of candidate the more it is beneficial for the banks. These loans are generally used for
financing mortgages. Banks also prefer these rates as they also include the prepayment penalties
which does not allows borrowers in paying off the loans earlier. This makes it expensive and
difficult for refinancing or retiring the loans prior to its ending term. Many of the loans come
with the balloon maturities that requires larger final payment. This has increased the benefits
and opportunities for homes. This helped banks in attracting large number of client who were in
meed of loans. Banks for earning higher interest rates provided large number of loans to people.
Defaulters and low credit risks individuals were also provided loans for home purchases. Due to
easy availability large number of people availed loans from banks for housing.
Banks were generating high revenues as loans were granted at higher interest rates. After
the global recession faced borrowers of loan started defaulting. The defaults were made mainly
by the sub-prime lenders who were given loans at higher rates. As number of houses were
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purchased on loans the resale of houses were not giving the costs of purchase (Foote and Willen,
2016). This dropped the prices of property and all the loans started lapsing. This caused huge
losses to banks and many of them became bankrupt (Adelino, Frame and Gerardi, 2017).
Default by homeowners also spilled downturn to other streams of economy.
Main reasons behind the financial crisis was the sub-prime mortgages for earning higher
interest rates on loans. The problems were initiated due to the lenders for advancing the loans at
poor credits and higher risks of default. When market were flooded by central bank with the
capital liquidity it lowered rates of interest and depressed broadly the risk premiums because
investors also looked for the riskier opportunities for bolstering their returns on investments.
Banks were having ample capital for lending. Banks were having willingness of undertaking the
additional risks for increasing the investment returns.
Banks started lending at an increased speed as demand raised for mortgages. Prices of
housing were rising due to substantial drop in interest rates. This made the lenders to see the sub-
prime mortgages less riskier than the actual situations. Banks made huge lending as economy of
nation was healthy, interest rates were lower and also the people were paying their instalments
on time.
After that situations were made even bad by the investment bankers. Increased use of the
secondary mortgage markets by the banks added more lenders for sub-prime loans. Banks in
place of holding the mortgages sold them in secondary market for collecting originating fees.
This helped in freeing more capitals for lending, that increased the liquidity more (Haughwout,
Okah and Tracy, 2016). Higher liquidity attracted more investors.
5 .Case Study
Owing to global reputations for the receivables financing & assets based lending in form
of the trade receivable securitizations, Demica was to be appointed for working with one of the
largest manufacturer of Europe in packaging and paper industry. Incumbent management teams
together with new equity owners focus immediately their efforts to minimise the interest cost and
paying senior debts for reducing the pressure of debt amortisation. Demica with clients worked
for paving way for trade receivable securitisations of 260 million in form of 7 year Medium
Terms Note receivables. With sale of receivables client was saving four million of annual
interest cost by sale of the receivables. Financing receivables allowed the clients in repaying
major senior debts. This transformed the risks profile of group post balance sheet statement.
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Consultants of Demica worked with management team of client and its lawyers for analysing
global receivable book of 800 million for assessing the operational, financial, tax and legal issues
defining structures of transactions. On the basis of stringent invoices eligibility criterias for AAA
rated transactions for ultimately including invoices representing 32.5% of global trade
receivables book.
Special technical skills are required for centralising the invoice tracking across the
multiple jurisdiction. Following review of the software system available in market. Proprietary
Citadel technology was selected as optimal solutions for running securitisation transactions and
existing discounting programme of invoices. Continuous management of internal invoice of
discounting programme system was key requirement of client. The critical important point was
also integration of IT system across the companies operating at multiple platforms. Asset based
lending of Citadel and the trade receivable securitisation solutions fulfilled most of the
requirement of client. For finalising financial structure Demica worked with client, investment
bank and its lawyers of trade receivables.
CONCLUSION
From the above study it has been analysed that securitization has been used by many
companies so that mortgages can be converted into liquid assets. It has been analysed that pool
of mortgages are been included securitization. Various assets which can be securitized are home
equity loans, auto loans, student loans. These loans are given on basis of security. The asset
needs to be mortgage in this. Also it has been analysed that if cash has not been given to loan
then security can not be relieved by individual. Securitization is merging various financial assets
into tranches.
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REFERENCES
Books and journals
Adelino, M., Frame, W.S. and Gerardi, K., 2017. The effect of large investors on asset quality:
Evidence from subprime mortgage securities. Journal of Monetary Economics.8
Foote, C.L. and Willen, P.S., 2016. subprime mortgage crisis, the. In Banking Crises (pp. 324-
336). Palgrave Macmillan, London.
Haughwout, A., Okah, E. and Tracy, J., 2016. Second chances: Subprime mortgage modification
and redefault. Journal of money, credit and Banking. 48(4).pp.771-793.
Alqaisi, F., 2018. The Impact of the 2008 Global Financial Crisis on the Jordanian Banking
Sector. International Journal of Economics and Financial Issues. 8(3). p.127.
Arentsen, E. and et.al., 2015. Subprime mortgage defaults and credit default swaps. The Journal
of Finance. 70(2). pp.689-731.
Bilan, A., Degryse, H., O’Flynn, K. and Ongena, S., 2019. Application in Banking:
Securitization and Global Banking. In Panel Data Econometrics (pp. 743-770). Academic
Press.
Broer, T., 2018. Securitization bubbles: Structured finance with disagreement about default
risk. Journal of Financial Economics. 127(3). pp.505-518.
Chiaramonte, L., 2018. The Concept of Bank Liquidity and Its Risk. In Bank Liquidity and the
Global Financial Crisis (pp. 5-34). Palgrave Macmillan, Cham.
Elson, A., 2019. The Special Role of the United States in the Global Financial System. In The
United States in the World Economy (pp. 75-109). Palgrave Macmillan, Cham.
Helgesson, K.S. and Mörth, U., 2019. Instruments of securitization and resisting subjects: For-
profit professionals in the finance–security nexus. Security Dialogue. 50(3). pp.257-274.
Lauretta, E., 2018. The hidden soul of financial innovation: An agent-based modelling of home
mortgage securitization and the finance-growth nexus. Economic Modelling. 68. pp.51-73.
Messina, P., 2019. Finance for SMEs: European Regulation and Capital Markets Union: Focus
on Securitization and Alternative Finance Tools. Kluwer Law International BV.
Mordel, A. and TeNyenhuis, M., 2018. The Characteristics of Uninsured Mortgages and their
Securitization Potential. Bank of Canada.
Zhang, F., 2019, January. The Systematic Endogenous Mechanism of Financial Crisis Based on
Big Data Analysis and its Quantitative Analysis. In 2018 6th International Education,
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Economics, Social Science, Arts, Sports and Management Engineering Conference
(IEESASM 2018). Atlantis Press.
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Securitization Case Study. 2019. [Online]. Available through :
<https://www.scribd.com/document/129264400/Securitization-Case-Study>.
Securitization. 2018. [Online]. Available through:
<https://helda.helsinki.fi/bof/bitstream/handle/123456789/14439/BoF_DP_1631.pdf?
sequence=1&isAllowed=y>
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