Securitization is a financing term that the average finance person is not commonly used, let alone the average layperson who has no detailed knowledge of business financing and alternative financing.
The term 'securitization' became increasingly well known during the financial and liquidity crisis that the world experienced in 2008/2009. We discovered that one of the main causes of the worldwide financial collapse was, in effect, the securitization and marketing and sale of mortgages.
WHAT IS SECURITIZATION - HOW DOES IT WORK?
Securitization is an alternate form of funding underlying assets for corporations. When it works well, it is an excellent source of funding for many organizations. Securitization is a form of structured finance, primarily for asset backed securities on the balance sheet. It frees up cash on the balance sheets and allows companies to grow receivable and loan portfolios. Funding of tranches can be structured in a variety of ways
How does it work? A company or organization takes certain assets that various investors desire. These assets are most typically receivables, contracts, car loans, credit cards, mortgages on the balance sheet. The quality of these assets is key in the entire securitization process. We watched the financial world fall apart when people discovered those securitized mortgages bundled in the United States had a shallow credit quality when it came to credit risk!
One of the reasons investors like securitized assets is that the risk is spread among hundreds, probably thousands of different borrowers. This diversifies risk. We continually hear how one needs to diversify to control risk, whether in business or our personal financial affairs. The cash flows that come out of that pool of assets back up the investment's quality by the buyer of the securitized asset.
For a transaction to be properly securitized, there has to be a strong predictability in the repayment of the loans, leases, mortgages, etc.
HOW IS A SECURITIZATION STRUCTURED?
How are Securitized loans structured? The assets become known as a 'pool' of assets. Financial analysts or the credit rating agencies (Standard & Poors, etc.) assign a credit rating to this newly created SPV (Special Purpose Vehicle). Investors buy this pool of assets because they theoretically understand the asset quality and the risk. There are many subsets to the risk we won't cover in our article - for example, concentrations of assets or customers.
The pool of assets is usually 'serviced' by the seller. He collects and maintains the portfolio - of course; he also created the portfolio of assets. The ongoing collection of the portfolio flows back to the investors who purchased it.
Securitization has become more and more popular because it has provided great liquidity to the financial markets.
HOW TO UNDERSTAND THE SECURITIZATION FLOW CHART
In summary, the securitization flow chart is as follows:
A seller creates the assets
An SPV is formed around those assets
Investors purchase the SPV
A trustee monitors the flow of cash, collections, etc.
Of course, as one can imagine, all sorts of lawyers, accountants and financial analysts have a healthy hand in various aspects of the above process flow!
WHAT ARE THE BENEFITS OF SECURITIZATION
* It provides cash flow to many companies who would otherwise have to wait years for customer payments, etc.
* Profits from the sale of the pool of assets allow a company to grow and create more assets.
* When properly structured, there are certain balance sheet enhancements - i.e. the company selling the pool gets cash but does not take on debt.
If you are looking for securitization financing speak to 7 Park Avenue Financial, a trusted, credible and experienced Canadian business financing advisor who can assist you on cash flow solutions for companies that have current funding and liquidity needs.