The Capital Markets

CHAPTER 17Securitization

Daniel I. Castro, Jr.

SECURITIZATIONS IN GENERAL

The term securitization generally refers to two separate, though related, activities. First, a financial institution is said to have securitized a pool of financial assets when it creates securities backed by the cash flows from those assets and sells some or all of these securities to investors. The financial institution may or may not retain responsibility for servicing—providing on an ongoing basis some or all of the services necessary to collect payments from borrowers, monitor performance of the loans, and distribute the cash flows generated to investors. Second, securitization may also refer, more narrowly, to the process of creating multiple securities with different payment priorities from a pool of underlying loans. For example, a pool of loans may be transformed into a senior tranche that is first in line to receive cash flows and a junior tranche that is last in line to receive cash flows.

Securitization provides economic benefits that may lower the cost of credit to households and businesses. Financial assets are securitized for a number of reasons: Assets can be removed from the originator's balance sheet; issuers can obtain a lower cost of funds, which can be passed on to consumers and businesses; originators can get regulatory capital relief; issuers can enlarge and diversify their investor base; and sometimes securitization is the only viable financing option available. One of the key ...