Chapter 1
Introduction to Securitization and Asset-Backed Securities
Perhaps the best illustration of the flexibility, innovation, and user-friendliness of the debt capital markets is the rise in the use and importance of securitization. As defined in Sundaresan (1997, page 359), securitization is “a framework in which some illiquid assets of a corporation or a financial institution are transformed into a package of securities backed by these assets, through careful packaging, credit enhancements, liquidity enhancements, and structuring.”
The flexibility of securitization is a key advantage for both issuers and investors. Financial engineering techniques employed by investment banks today enable bonds to be created from any type of cash flow. The most typical such flows are those generated by high-volume loans such as residential mortgages and car and credit card loans, which are recorded as assets on bank or financial house balance sheets. In a securitization, the loan assets are packaged together, and their interest payments are used to service the new bond issue.
In addition to the more traditional cash flows from mortgages and loan assets, investment banks underwrite bonds secured with flows received by leisure and recreational facilities, such as health clubs, and other entities, such as nursing homes. Bonds securitizing mortgages are usually treated as a separate class, termed mortgage-backed securities, or MBSs. Those with other underlying assets are known as asset-backed ...
