Credit securitisation – brief summary and benefits
Credit securitisation is the process whereby loans are packaged, underwritten and sold in the form of securities. The objective is to reduce the risk and uncertainties that arise from portfolio concentration, lender’s discretion and exposure to non-credit losses. The transparency of the expected credit risk is increased which leads to a lower cost of borrowing by removing part of the excess equity cushions and funding yield premiums that traditional lending channels demand.
The loans are pooled into homogeneous portfolios and sold to trusts or other Special Purpose Vehicles (SPVs), thus making the offering more transparent to capital market investors. Since the pool is pre-specified, investors know the risk they are absorbing – they are funding only a clearly delineated pool of loans. They are not funding future discretionary lending or other risk taking the original lender may engage in. Nor are they absorbing interest rate or other risks. This produces two benefits.
Firstly, grouping of loans into large homogeneous pools facilitates the actuarial analysis of their risks. Secondly, it makes it easier for rating agencies and credit enhancers to review and reinforce the credit underwriting decisions taken by the originating lender. This is all part of the process to reduce the cost of borrowing.
Credit securitisation using asset backing is a process whereby cashflows from a portfolio of financial assets (e.g. receivables from trade debtors) are packaged together and refinanced by newly raised debt in transferable form on a non or limited recourse basis. Normally, an SPV (Special Purpose Vehicle) is set up to allow securitised assets to be excluded from the Originator’s capital adequacy and risk asset ratio calculations; the SPV being an “orphan” vehicle which is not required to be consolidated as a subsidiary of the Originator. This makes the structure bankruptcy-remote.
Applications of securitisation
Securitisation has been widely employed in the following areas:
Re-packaging mortgages or other home loans
Credit card receivables
Any asset which has the potential of producing a future income stream may be securitised.
Air India undertook a project to securities receivables from forward ticket sales. Essar Steel securitised trade receivables. Our firm played a leading role in a substantial project to securitise receivables from energy assets for a major Indian corporation. We are currently engaged in a deal to securitise receivables from real-estate sales for another Indian group. The liberalisation of the insurance sector in India has resulted in new opportunities for insurance-backed securitisation using credit enhancement techniques.
The opportunities for companies to lower their cost of finance by using asset-backed securitisation are increasing. By using credit enhancement techniques it is possible to raise ratings to AA status thus dramatically increasing funding opportunities and lowering funding costs as it will be now possible to approach international investors, subject to Exchange Control Regulations where applicable.