Introduction to Securitization

REASONS SECURITIZATION IS USED FOR FUNDING

Securitization appeals to both nonfinancial and financial corporations as well as state and local governments. The six primary reasons for corporations using securitization are:

1. The potential for reducing funding costs.

2. The ability to diversify funding sources.

3. The ability to manage corporate risk.

4. For financial entities that must satisfy risk-based capital requirements, potential relief from capital requirements.

5. The opportunity to achieve off-balance financing.

6. Generating fee income.

 

We discuss these reasons in the rest of this section.

Potential for Reducing Funding Costs

To understand the potential for reducing funding costs by issuing asset-backed securities rather than a corporate bond, suppose that our illustration, Ace Corporation, has a single-B credit rating. This rating is referred to as a speculative-grade rating and if Ace Corporation issued corporate bonds, those bonds would be referred to as high-yield bonds or junk bonds. If the CFO of Ace Corporation wants to raise $320 million by issuing a corporate bond, its funding cost would be whatever the benchmark Treasury yield is plus a spread for single-B issuers in the industry sector in which Ace Corporation operates. (The same is true if Ace Corporation wants to raise funds via commercial paper.) Suppose, instead, that the CFO of Ace Corporation uses $320 million of its installment sales contracts as collateral for a bond issue. Despite this form ...