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Assset Securitisation Notes

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This is an extract of our Assset Securitisation document, which we sell as part of our Banking Law Notes collection written by the top tier of King's College London students.

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How to reduce risk:
● Sharing amongst many through loan syndication and bond issue.
● Getting security
● Transferring to others through securitisation (to be covered now)
● Hedging
● Monitoring and influencing the borrower's behaviour
● Getting a better ranking than other creditors through subordination.
● What is asset securitisation?
○ Asset-backed securities
○ Collateralised debt obligations
● Policy considerations
What is securitisation?
● Definition:
Illiquid loan obligations (e.g. residential and commercial mortgages credit card receivables, commercial loans, et cetera) are pooled and repackaged as highly liquid and tradable debt securities that are supported by the underlying loan portfolio.
● Purposes:
○ Risky loans are removed from the originator's balance sheet;
○ Reduced regulatory capital requirements;
○ Debt securities are more highly rated;
○ Lower cost of capital due to bankruptcy remoteness;
○ Spreading of risk;
○ Structured finance: Tranches with optimum risk attributes; and
○ Capital can be raised more widely.
● Originate-and-distribute: ○ Originator has granted loans to B1 and B2 of 1000 each.
○ Assume that each loan carries a 10% risk of total default.
○ What is the expected value of each loan? How much would a risk-averse buyer be willing to pay?
■ Expected value = 900 each
■ Price that the risk-averse buyer will pay = Less than 900, because the risk-averse will "price in" the risk.
■ This give the originator an incentive to securitise rather than selling the loans directly on the markets.
○ B1 and B2 loans are sold (through an assignment of debt receivables) to an
■ This has to be a true sale.
■ This means that the SPV must be entirely separate from the originator
(and definitely cannot be a subsidiary of the originator); if there is such a link, the loans will not disappear from the originator's balance sheets because the balance sheets will still have to be consolidated in the end.
○ The loans are combined into a single pool.
■ The equity in the SPV is held by a charitable or purpose trust.
○ The SPV issues two tranches of debt securities.
■ Tranche 1: Receives the first 1000 coming in.
■ Tranche 2: Receives whatever else comes in.
○ The SPV pays the sale price of the loans to the originator through the proceeds of the issue of debt securities.
● Financial Alchemy (1):
○ B1 and B2: 10% of default each

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