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Securitization CA Final AFM (Advanced Financial Management)

Securitization CA Final AFM

Securitisation a chapter in Advanced Financial Management (AFM). This is an important chapter from the CA Exam point of view as well. The concept has been explained with a comprehensive example, to make sure the concepts are very clear. It mainly talks about Debt Securitisation, Mortgage-Backed Securities, Securitisation Process, Credit Rating Agency, Special Purpose Entity, Mortgage Pool, Raising Funds, Financing through Securitisation. The video is in Hindi; and suitable for anyone who wants to understand the above concepts of Mergers and Acquisitions in this language.

Video on Securitization CA Final AFM (Advanced Financial Management) - English

Video on Securitization CA Final AFM (Advanced Financial Management) - Hindi

Some Important Concept

Broadly, the participants in the process of securitization can be divided into two categories; one is Primary Participant and the other is Secondary Participant.

Primary Participants:

Primary Participants are the main parties in this process. The primary participants in the process of securitization are as follows:

  1. Originator:

    2. Broadly, the participants in the process of securitization can be divided into two categories; one is Primary Participant and the other is Secondary Participant.

  2. Special Purpose Vehicle:

    3. Also, called SPV is created for the purpose of executing the deal. Since issuer originator transfers all rights in assets to SPV, it holds the legal title of these assets. It is created especially for the purpose of securitization only and normally could be in the form of a company, a firm, a society or a trust.

    The main objective of creating SPV is to remove the asset from the Balance Sheet of Originator. Since SPV makes an upfront payment to the originator, it holds the key position in the overall process of securitization. Further, it also issues the securities (called Asset Based Securities or Mortgage Based Securities) to the investors.

  3. The Investors:

    4. Investors are the buyers of securitized papers which may be an individual, an institutional investor such as mutual funds, provident funds, insurance companies, mutual funds, Financial Institutions etc. Since they acquire a participating in the total pool of assets/receivable, they receive their money back in the form of interest and principal as per the terms agree.

Secondary Participants:

Besides the primary participant’s other parties involved in the securitization process are as follows::

  1. Obligors:

    2. Actually they are the main source of the whole securitization process. They are the parties who owe money to the firm and are assets in the Balance Sheet of Originator. The amount due from the obligor is transferred to SPV and hence they form the basis of the securitization process and their credit standing is of paramount importance in the whole process.

  2. Rating Agency:

    3. Since the securitization is based on the pools of assets rather than the originators, the assets have to be assessed in terms of its credit quality and credit support available. Rating agency assesses the following:

    1. Strength of the Cash Flow.
    2. The mechanism to ensure timely payment of interest and principal repayment.
    3. The credit quality of securities.
    4. Liquidity support.
    5. Strength of legal framework. Although rating agency is secondary to the process of securitization it plays a vital role.
  3. Receiving and Paying agent (RPA):

    4. Also, called Servicer or Administrator, it collects the payment due from obligor(s) and passes it to SPV. It also follows up with defaulting borrower and if required initiate appropriate legal action against them. Generally, an originator or its affiliates acts as servicer.

  4. Agent or Trustee:

    5. Trustees are appointed to oversee that all parties to the deal perform in the true spirit of terms of the agreement. Normally, it takes care of the interest of investors who acquire the securities.

  5. Credit Enhancer:

    6. Since investors in securitized instruments are directly exposed to the performance of the underlying and sometime may have limited or no recourse to the originator, they seek additional comfort in the form of credit enhancement. In other words, they require a credit rating of issued securities which also empowers marketability of the securities.

    Originator itself or a third party say a bank may provide this additional context called Credit Enhancer. While originator provides his comfort in the form of over-collateralization or cash collateral, the third party provides it in the form of a letter of credit or surety bonds.

  6. Structurer:

    7. It brings together the originator, investors, credit enhancers and other parties to the deal of securitization. Normally, these are investment bankers also called arranger of the deal. It ensures that deal meets all legal, regulatory, accounting and tax laws requirements.

Securitization Process

The process of securitization involves the following steps:

  1. The originator identifies the pool of assets to be securitized.
  2. The originator transfers the assets to the SPV.
  3. The SPV issues securities to the investors.
  4. The investors pay the purchase price to the SPV.
  5. The SPV uses the purchase price to pay the originator for the assets.
  6. The originator uses the purchase price to acquire more assets.
  7. The originator services the assets and passes the cash flows to the SPV.
  8. The SPV passes the cash flows to the investors.

Benefits of Securitization

Securitization offers several benefits to the originator, the investors, and the economy as a whole. Some of the key benefits of securitization are as follows:

  1. Diversification of risk: Securitization allows the originator to transfer the risk of the assets to the investors, thereby diversifying the risk of the originator.
  2. Access to capital: Securitization provides the originator with access to capital that may not be available through traditional financing channels.
  3. Lower cost of funding: Securitization can lower the cost of funding for the originator by reducing the amount of capital required to support the assets.
  4. Improved liquidity: Securitization can improve the liquidity of the originator by converting illiquid assets into liquid securities.
  5. Enhanced credit rating: Securitization can enhance the credit rating of the originator by transferring the risk of the assets to the investors.

Conclusion

Securitization is a powerful financial tool that can provide significant benefits to the originator, the investors, and the economy as a whole. By transferring the risk of the assets to the investors, securitization allows the originator to diversify its risk, access capital, lower its cost of funding, improve its liquidity, and enhance its credit rating. As a result, securitization can be an effective way for companies to raise capital and manage risk in today's competitive financial markets.

If you want to learn more about securitization and other financial topics, check out our other videos on the CA Final AFM (Advanced Financial Management) course. We have a wide range of videos on topics such as mergers and acquisitions, financial modeling, and more. So be sure to subscribe to our channel and hit the bell icon to get notified whenever we upload a new video. Thanks for watching!

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