securitization

Financial market interdependence & securitization

Presented to:Dr. Tejinderpal Singh

Presented by:Leena SethiRoll No.- 9

Contents

Introduction Factors responsible for advancement of globalization Market interdependence Globalization of financial marketsLiberalization of international capital account Implications Securitization Asset characteristics Parties to a securitization transaction Securitization Process Instruments of securitization Types of securitiesBenefits of Securitization Examples of Securitization in IndiaConclusion

Introduction

• Interdependent • Open & competitive world

Liberalization

Factors responsible for advancement of globalization

Expansion of

world trade

Technological

advancements

Entry in the

foreign markets

Competitive

development of financial instrume

nts

Contingent asset

Acceptability of USD

Market interdependence

Meaning:Market interdependence is when the movement of one market is affected by the movement of another market.

It means that different countries are voluntarily dependent on one another in their own individual economic interest ofproducing goods and services at which they have the mostcompetitive advantage and import those that are producedcheaper elsewhere, voluntarily invest across the borders on thebasis of same treatment as if they are investing in their owncountries.

Example: a drop in the value of the dollar vs. other currencies can cause a rise in the price of oil in dollars as oil is a dollar denominated asset.So, the oil market is dependent on the foreign exchange market.

Globalization of financial markets

It has resulted in the demise of financing along the predominantly national lines.

Now- a – days not just one bank approaches companies regularly, instead many banks from different countries compete atCorporate level.

This competition between financial intermediaries has resulted From liberalization and globalization of financial markets

Liberalization of International Capital Account

This has given rise to the rapid development of an Integrated International Capital Account. This development has enhanced Capital Mobility and Substitutability between domestic and foreign bonds.EUROS & DOMESTIC INTEREST RATES have converged for most major currencies.There also appears to be a tendency for REAL INTEREST RATE DIFFERENTIALS BETWEEN COUNTRIES.

Efficiency of macro-

economic policy

•If domestic real interest rates are affected more by the development of the world real interest rates than in the past, efficacy of monetary policy in influencing domestic private investment might be reduced

Impact of fiscal policy

on real output

•The more closely linked are financial markets, stronger are the exchange rate crowding out effects & the weaker are the interest rate crowding out effects.

International allocation of

capital

•How does the tendency towards convergence, financially open countries?

Implications

SECURITIZATION

Securitization is the transformation of an illiquid asset into a liquid and tradable security.It is a financial transaction in which assets are pooled and securities representing interests in the pool are issued. The process of pooling and repackaging of homogeneous illiquid financial assets into marketable securities that can be sold to the investors.

• Asset to be analysed as a series of cash flows• Principal part of the asset should be the right

to receive from the debtorsCash flow

• If the security available to collalateralize the cash flows is available the security can be realised by SPV

Security

• Assets should have either a distributed risk feature or backing by a credit supportDistributed risk

• No wide variations in documentation, product type etc..Homogeneity

• Must work even if the originator goes bankrupt

No executory clauses

• Independent of the existence of the originator

Independence from the originator

Asset characteristics

1. Originator: An entity making loans to borrowers or having receivables

from customers2. Special Purpose Vehicle: The entity which buys assets from Originator and packages

them into security for further salea. Bankruptcy remoteb. Separates the risk of assets from the credit risk of the

seller3. Credit Enhancer: To reduce the overall credit risk of a security issue by

providing senior subordinate structure, over-collateralization or a cash collateral.

4. Investors : The party to whom securities are sold. May be in the form of

individuals/institutional investors like FI’s, MF’s,PF’s, pension funds , insurance companies etc…

Parties to a securitisation transaction

5. Credit Rating Agency: To provide value addition to security6. Administrator or servicer: Collects payment due from the obligor & passes it

to the SPV.7. Obligors: Whose debts and collateral constitute the

underlying assets of securitization.8. Structurer: They bring together all the parties to a

securitization deal.

1. Selection of assets by the Originator2. Packaging of designated pool of loans and advances (assets)3. Underwriting by underwriters4. Assigning or selling to of assets to SPV in return for cash 5. Conversion of the assets into divisible securities6. SPV sells them to investors through private placement or

stock market in return for cash7. Investors receive income and return of capital from the assets

over the life time of the securities8. The risk on the securities owned by investors is minimized as

the securities are collateralized by assets9. The difference between the rate of the borrowers and the

return promised to investors is the servicing fee for originator and SPV

Process of Securitization

ORIGINATOR

OBLIGOR ANCILLARY SERVICE PROVIDER

SPECIAL PURPOSE

VEHICLE (SPV)INVESTORS

RATING AGENCY

STRUCTURER

Interest & principal

Sale of assets

Consideration for assetspurchased

Issue of securities

Subscription of securities

Credit rating of securities

1. Pass Through Certificates:• Sale of asset to SPV• Investors purchase interest in the assets of SPV• Cash flow (interest and principal) passed through as and

when occurred without any reconfiguration• Payments made are most often on monthly basis• Reinvestment risk carried by investor

2. Pay Through Certificates:• Sale of assets to SPV• SPV issues a debt security collateralized by asset cash

flows• Cash flows (interest and principal) reconfigured to suit the

requirements of the investors i.e. based on the maturity period of the security

• Reinvestment risk carried by SPV• Each trench is redeemed one at a time• Payments would be at different time intervals than the

flows from the underlying assets

Instruments of securitization

•Those securities whose income is derived from pool of underlying assets. •Example: payments from car loan, credit card

Assets backed

securities

•Mortgage loans are purchased from banks and assembled into pools which become securities•Example: mortgage of real estate property..

Mortgage backed securities

Types of securities

Benefits of Securitization1. Separates the credit risk of the assets from the

credit risk of the Originator

2. Lower the cost of borrowing for Originator as the security is independent of the rating of the corporate securitizing these assets

3. Illiquid assets converted into marketable securities and thus provide alternate funding source

EXAMPLES OF SECURITIZATION IN INDIA

First securitization deal in India between Citibank and GIC Mutual Fund in 1991 for Rs 160 million.

L&T raised Rs 4,090 mn through the securitization of future lease rentals to raise capital for its power plant in 1999.

Securitization of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001 through offshore SPV.

India’s largest securitization deal by ICICI bank of Rs 19,299 mn in 2007. The underlying asset pool was auto loan receivables

Conclusion

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