Introduction to Securitization

STRUCTURING GOALS

We have stated that securitization allows the creation from an asset pool securities that are more appealing to a wide range of investor types. Yet it is difficult to appreciate that statement if the process of structuring a transaction at the microlevel is not understood. In the next two chapters, we describe how different types of bond classes (i.e., asset-backed securities) are created.

In the structuring illustrations in the next two chapters, we use residential mortgage loans as a representative asset. It is helpful to classify securitizations in terms of the borrower’s credit. The market can be broadly divided into prime borrowers and subprime borrowers. Prime borrowers are viewed as having high credit quality because they have strong employment and credit histories, income sufficient to pay the loans without compromising their creditworthiness, and substantial equity in the underlying property. The loans made to such individuals are broadly classified as prime loans, and have historically experienced low incidences of delinquency and default. In contrast, loans to borrowers of lower credit quality that are more likely to experience significantly higher levels of default are classified as subprime loans and the borrowers are referred to as subprime borrowers. Subprime loan underwriting typically relies on nontraditional measures to assess the borrower’s credit risk, as these borrowers often have lower income levels, fewer assets, and blemished credit ...