Securitization is the process of turning, say, a mortgage into an asset that can be traded on credit markets. It is the process by which we transform ordinary loans and mortgages into tradeable securities. Securitization has played a significant role in the global economy, and in the recent financial crisis most observers agree that it was securitized mortgages (rather than losses among banks) that were at the core of why our economic system collapsed. It is now universally agreed that the financial system was fragile due to too much leverage, and securitization made this problem worse. The growth of securitization coincided with growing problems in government policymaking (taxation/regulation, monetary/monetary policy), which led to greater complexity in financial products; this was accompanied by an increase in central bank support for financial markets (by lowering interest rates); and international institutional changes (international capital flows).
Steps for Securitization
The first step in the securitization process is to get the asset into the hands of a third party. The trustee loans the asset to an institution which will make it available for purchase. The next step is to get the details on all aspects of the asset, like who owns it, if there are any liens against it, and who has access to the collateral. That information goes into a prospectus that’s made available for investors.
Once everything has been inputted into the prospectus, investors buy shares of trust certificates that represent shares in collateral held by that trust. The trust owns the asset, which is then transferred into the trust. The trust can then transfer that collateral to another investor or sell it to someone else. As long as the ownership of the asset stays with the trustee, no one will be able to get their hands on it without permission from the trustee.
Investors make their investment based on buying shares of trust certificates in order to get a piece of collateral held by that trust. That means they are contributing money to a pool of assets owned by a third party. With the prospectus, all aspects of what they are investing in are explained before any money is exchanged hands. Although there are some fundamental differences in the process, in terms of what is being purchased, the process for securitization is very similar to that of real estate.
Three Types of Securitization
A. Secondary markets: Mortgage-backed securities, credit card receivables and commercial paper were all securitized in secondary markets.
B. Primary markets: The more important type of securitization was the securitization of non-mortgage assets such as auto sales, student loans and credit card receivables.
C. Coffee can: In this third type of securitization, a bank or other financial institution takes a non-mortgage asset and adds another non-mortgage asset on top of it, combining it with a mortgage. It is akin to putting a lid on a coffee can and calling it a container.
Securitization grew very rapidly from 1970 to 2008, but after 2008 securitization contracted. There was a brief resurgence in 2010 which has since faded away again. There is considerable risk associated with securitization; its inherent complexity makes it difficult for regulators to monitor; and there is also considerable ambiguity as to what securitized assets actually are (they are complex derivatives). There is a direct connection between securitization and the financial crisis: It transferred risk from regulated financial institutions to the unregulated shadow banking sector. Firms have a number of options when it comes to raising funds for their business and securitization is just one. Whichever option a firm chooses to follow, it is best their choice is backed by appropriate expert advisory. To obtain such top level financial advisory service, firms can engage Financial Analysts from Fintalent, the hiring and collaboration platform for tier-1 strategy and M&A professionals, as well as Capital Raising as well as Debt and Equity Capital Raising consultants from the platform.
