Securitization

Securitization

Securitization allows an issuer to finance certain assets, mortgage loans and/or consumer debts and transform them into bonds or other forms of debt security that can then be traded or sold to a trader for a certain sum that can be used by the company to invest in itself or to expand the company. 

What Is securitization? 

Securitization is a process that allows a company to pool all of its assets and transform them into bonds or securities that can bear interest. Investors can now purchase these bonds for a certain amount, and in return they will receive the principal and the interest amounts. A mortgage-based security is one fine example of securitization. 

Understanding securitization 

Take mortgage-based security loans for example. The original lender will sell a bunch of home loans to a bank or any other financial institution that in turn will turn these loans into a single unique investment package. The bank will then allow the public to invest in the package, for which they will receive principal and interest amounts from the various loans inside the package. 

How much the public receives in the form of interest and principal will be in proportion to the amount they invest in it. Unlike other investments, it’s a win-win situation for every party involved. The investors get paid in the form of principal and interest amounts, while the original lender gets to clear out any liabilities that often arise in these situations. This is one of the reasons why the public isn’t as enthusiastic about it as they once were. 

The public believes that securitization often leads to unnecessary borrowing and debt, especially after the 2008 economic crisis.  

Working of securitization 

Securitization is a process that begins when the original lender sells a bunch of assets to a financial institution. Here’s a detailed breakdown of how the securitization process works. 

  1. The original lender who is in possession of certain assets that it no longer needs may decide to sell them. This not only allows them to get rid of unnecessary assets but also helps them avoid any liability from the assets. They will then pool the assets into a reference portfolio, ready to be sold. These assets can be anything from mortgage loans to personal loans. 
  1. The original lender will then sell the reference portfolio with all its assets to a financial entity such as a bank or private lender. The financial entity will then turn the assets into a security where the public can invest in. Once an investor invests in the assets, he will in return receive principal and interest payments proportional to the stake they bought. The higher the securities you buy, the higher your stakes will be in that reference portfolio. 
  1. Potential investors purchase these securities at a certain rate of return. The original lender receives all the payments, which will be then transferred to the bank apart from a small fee. The bank will then pay the investors from that. 

Advantages and disadvantages of securitization 

Here are the advantages of securitization: 

  • The original lender, also known as the originator, is in possession of a bunch of assets that he is unable to sell. Securitization allows him to sell these assets and free up the money blocked in those assets. This allows him to focus on other investment options. 
  • The financial entity can shift the risks by securitizing its receivables. 
  • The financial entities get to diversify its portfolio by bringing in securitized securities. These bonds are a lot different than any other form of security. 
  • The originator can also gain some financial leverage from the financial entities. This can certainly help when the originator is in need of some cash. 

Here are some disadvantages of securitization: 

  • There’s very little to no transparency between an investor and the bank. That means an investor has very little knowledge of the kind of assets that are involved in the said bond. 
  • The securitization process involves multiple parties and handling everything can be a difficult process. 
  • There are a lot of processes involved in securitization, including legal proceedings, administrative and underwriting, among others. This increases the cost of securitized bonds. 
  • The investors are the ones at the highest risk and the originator gains the most.

Example of securitization 

Here are a few examples of securitization: 

  • Government National Mortgage Association (GNMA) 
  • Federal National Mortgage Association (FNMA) 
  • Federal Home Loan Mortgage Corporation (FHLMC) 

Frequently Asked Questions

Securitization involves the financing of multiple types of assets into a singular unit. Here are the 5 asset types of securitization: 

  • Mortgages: In mortgages, securitization happens with home loans that are combined into one large portfolio before it is sold to financial institutes. 
  • Auto loans: Auto loans or car financing is a form of ABS securitization that is initially combined together but later split into multiple groups according to their risk profiles. They are then sold to potential investors. 
  • Credit card receivables: It’s also a form of ABS securitization and it involves buying a certain stake from the credit card balance. 
  • Student loans: Student loans are provided to students who require loans to finish graduation from college. It’s a great opportunity for investors as these are protected by the US Department of Education. 

Securitization and factoring are two different ends of the spectrum. Securitization is the process of financing and refinancing existing assets into one single unit, which the public can invest in. While factoring refers to the process of selling receivable accounts in a bid to increase the flow of cash. 

It refers to the process of pooling certain assets, such as debt securities, into bonds that can be later sold to financial entities/investors. These bonds are also called collateralized debt obligations or asset-backed securities. 

It is the process of financing the assets into a bond or a security debt that can be sold or traded for a certain sum. The investors who buy them gain the principal and the interest amount. 

MBS refers to mortgage-backed security, whereas ABS refers to asset-based security. Mortgage-based security pools in mortgage loans as assets, while asset-based security pools in student loans as assets. These assets are non-mortgagable assets in nature. 

Related Terms

    Read the Latest Market Journal

    Weekly Updates 26/2/24 – 1/3/24

    Published on Feb 28, 2024 47 

    This weekly update is designed to help you stay informed and relate economic and company...

    All-in-One Guide to Investing in China via ETFs

    Published on Feb 27, 2024 238 

    Start trading on POEMS! Open a free account here! Why China? In the vast landscape...

    Navigating the Post-Inflation Landscape in 2024: Top 10 US Markets Key Events to Look out for

    Published on Feb 23, 2024 283 

    Start trading on POEMS! Open a free account here! In 2023, the United States experienced...

    From Boom to Bust: Lessons from the Barings Bank Collapse

    Published on Feb 23, 2024 60 

    Barings Bank was one of the oldest merchant banks in England with a long history...

    Decoding FX CFD 2.0

    Published on Feb 20, 2024 66 

    This article is aimed at availing information and knowledge essential to intermediate forex traders. It...

    Weekly Updates 19/2/24 – 23/2/24

    Published on Feb 19, 2024 89 

    This weekly update is designed to help you stay informed and relate economic and company...

    Unlock Prosperity with 5 Sure-Fire Financial Instruments!

    Published on Feb 14, 2024 197 

    In Singapore, the concept of guaranteed returns may evoke the spirit of prosperity, reminiscent perhaps...

    Weekly Updates 12/2/24 –16/2/24

    Published on Feb 13, 2024 70 

    This weekly update is designed to help you stay informed and relate economic and company...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you

    IMPORTANT INFORMATION

    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <www.phillipfunds.com> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  

     

    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066 www.phillipfunds.com