For Funding & Risk Sharing - CFA Institute - Societies Files/Securitisation.pdfWhat is securitization ? Securitization is the pooling of cash flows and the issuance of securities backed

For Funding & Risk Sharing

Securitization;

Dinesh Warusavitharana, CFA

What is securitization ?What is securitization ?

Securitization is the pooling of Securitization is the pooling of cash flows and the issuance of cash flows and the issuance of securities backed by underlying securities backed by underlying assets.assets.The repayment of securities is The repayment of securities is solely dependent on the solely dependent on the performance of the assetsperformance of the assetsSecuritization deSecuritization de--links the credit links the credit risk of the issuer from the risk of the issuer from the securitization transactionsecuritization transaction

Basic Model of SecuritizationBasic Model of Securitization

Borrowers(Obligors)

Originator(Bank/FI)

SPV

Investors

LiquiditySupport

CreditEnhancement

Loan

Receivables

Sell Receivables

Securities

Cash

Cash

Types of securitization Types of securitization

Residential mortgage backed Residential mortgage backed securities (MBS) securities (MBS) Asset backed securities (ABS)Asset backed securities (ABS)Collateralized debt obligations Collateralized debt obligations (CDO)(CDO)Commercial mortgage backed Commercial mortgage backed securities (CMBS)securities (CMBS)Future flow securitizationFuture flow securitization

Requirements for Requirements for securitization securitization

Legal environmentLegal environmentAccounting environmentAccounting environmentRegulatory environmentRegulatory environmentTax environmentTax environmentBack office systems/Information Back office systems/Information SystemSystemStrong investor demandStrong investor demand

Why securitize assets ?Why securitize assets ?

Efficient funding Efficient funding Lower CostLower CostAlternative investor baseAlternative investor baseIssuer’s credit rating becomes Issuer’s credit rating becomes irrelevantirrelevant

Improving balance sheet structureImproving balance sheet structureImproves capital utilizationImproves capital utilizationReleases capital Releases capital

Why Securitize assets ?Why Securitize assets ?

Arbitrage Arbitrage –– yield and termyield and term

Enables better utilization of Enables better utilization of resourcesresources

Risk managementRisk management

“Dress up” accounting profits if “Dress up” accounting profits if “true sale” criteria is satisfied“true sale” criteria is satisfied

Benefits to investors?Benefits to investors?

Better security Better security Greater moral responsibilityGreater moral responsibilityCreate instruments to match Create instruments to match investment objectivesinvestment objectivesBetter and more resilient credit Better and more resilient credit ratings ratings

Risks in securitization Risks in securitization

Credit Risk

Recovery Risk

Liquidity Risk

Pre Payment & Yield Risk

Tranching, Cash reserves,Over Collateralization

Portfolio Seasoning

Liquidity Support

Loan to Value (LTV) Asset Depreciation Rates

Risk MitigantRisk

Static Pool Loss Curve Static Pool Loss Curve

Static Pool Delinquency Static Pool Delinquency Experience Experience

Static Pool PreStatic Pool Pre--payment payment Curve Curve

Securitization in Sri Lanka ?Securitization in Sri Lanka ?

Predominantly used for Auto Predominantly used for Auto LeasesLeasesNot securitization, but Asset Not securitization, but Asset Backed LendingBacked LendingNo “True Sale” No “True Sale” --> “On Balance > “On Balance Sheet financing” Sheet financing” The credit rating of the The credit rating of the transaction is linked to the transaction is linked to the issuers credit rating issuers credit rating Commingling risk of cash flows?Commingling risk of cash flows?

Current Model in Sri LankaCurrent Model in Sri Lanka

Borrowers(Obligors)

Originator(Bank/FI)

Trust

Investors

CreditEnhancement

Loan

Receivables

Pledge

Receipts

Securities

Cash

Cash

Recourse

Risks management through Risks management through securitization securitization

Service & Collection

Funding

Originate 1%

1%

6%

Loan 8%

Retain the client without the risk !!Retain the client without the risk !!

Basic CDO structureBasic CDO structure

Bank

Senior notes

Mezzanine notes

Equity

SPV

Loans

Cash Funds

Coupons & principal

Impact to originatorImpact to originator

Not exposed to Credit & Interest Not exposed to Credit & Interest Rate RiskRate RiskNet income would be close Net income would be close –– due to due to originating & servicing fees as well originating & servicing fees as well as the excess spreadas the excess spreadCash flows improveCash flows improveBetter utilization of capital & Better utilization of capital & infrastructureinfrastructureImproves ROA / ROEImproves ROA / ROE

Impediments for Securitization in Impediments for Securitization in Sri LankaSri Lanka

Finance Leasing ActFinance Leasing ActConcerns on the Loss of Concerns on the Loss of ParateParatePowers ?Powers ?Transaction CostTransaction CostRegistration ProcedureRegistration ProcedurePoor information systemsPoor information systemsLack of educationLack of education

Practical Issues in undertaking Practical Issues in undertaking Securitization Securitization

Greater disclosure of information Greater disclosure of information Internal systems may take time to Internal systems may take time to generate the information requiredgenerate the information requiredInitial cost and time involved in Initial cost and time involved in the first transaction will be higher the first transaction will be higher than other forms of financingthan other forms of financingLess flexible covenantsLess flexible covenants

Way forward….Way forward….

Finance Leasing Act needs to be Finance Leasing Act needs to be amended to facilitate securitizationamended to facilitate securitization

New Securitization Act ?New Securitization Act ?

Transaction cost Transaction cost

Registration Procedures Registration Procedures

Way forward….Way forward….

Clear accounting treatment for Clear accounting treatment for securitizationsecuritization

Clear tax treatment for Clear tax treatment for securitizationsecuritization

Internal information systems need Internal information systems need to be modified to be modified

Way forward….Way forward….

Investors need to get used to Investors need to get used to taking on the risk of the taking on the risk of the securitized assetssecuritized assetsInvestors need to be prepared to Investors need to be prepared to accept unscheduled cash flowsaccept unscheduled cash flowsRMBS could be undertaken RMBS could be undertaken under the existing legal under the existing legal framework framework

Panel DiscussionPanel Discussion

Mr. Mr. VajiraVajira KulatilakaKulatilakaCEO, NDB Investment BankCEO, NDB Investment Bank

Mr. Naomal GoonewardenaMr. Naomal GoonewardenaPartner, Partner, NithyaNithya PartnersPartners

Mr. Ajith FernandoMr. Ajith FernandoCEO, Capital AllianceCEO, Capital Alliance