Fixed-Income Securitization
Refresher reading access
Overview
Asset-backed securities (ABS) are securities backed by and repaid from a pooled group of loans or receivables. Creating securities that are repaid from particular types of loans or receivables transfers risk, provides flexibility to issuers and investors, and efficiently allocates capital. In a securitization, cash flows from a designated pool of assets are redistributed by a special purpose issuer to pay interest and principal to investors in a predetermined manner. Thus, ABS transactions create an entire new subordination structure on the designated pool of assets. Securitization takes place around the world — in the Americas, Asia, and Europe. This first of three Fixed-Income Learning Modules describes the benefits of securitization, the securitization process, and typical securitization structures.
- Securitization benefits investors by redistributing payment risks, enhancing the predictability of payments, diminishing the impact of unexpected changes in payment patterns (such as defaults, prepayments, or payment extensions), helping investors match risk, return and maturity needs, and reducing risk through various credit enhancements.
- Securitization enables issuers to operate more efficiently on a risk-adjusted basis by removing assets and lending risks from their balance sheets (thereby reducing their leverage), expanding their capacity to originate loans and to secure lower funding costs.
- Securitization enhances financial market efficiency, improving overall liquidity in the financial system and reducing liquidity risk.
- Several parties participate in a securitization, including the original corporate issuers of the assets (for example, loans, receivables, leases, or debt) to be securitized; a special purpose entity (SPE) created to buy/own these corporate assets, create new assets from them, and sell the new assets to investors; the servicer of the underlying loans or debt; and other (third-party) entities (for example, accountants, attorneys, and underwriters).
- When an original issuer elects to securitize assets, it first establishes an SPE to which it sells the assets. The SPE then issues and sells to investors securities backed by these assets. Interest and principal payments on the assets are used to pay the investors in the new securities.
- The separate legal entity structure of the SPE is designed to protect the underlying assets from any claims by creditors of the issuer should the issuer go into financial distress. However, ABS investors should evaluate the legal considerations of the actual jurisdiction where they purchase an ABS, since legal frameworks vary by country.
Learning outcomes
The candidate should be able to:
- explain benefits of securitization for issuers, investors, economies, and financial markets;
- describe securitization, including the parties and the roles they play.
0.75 PL Credit
If you are a CFA Institute member don’t forget to record Professional Learning (PL) credit from reading this article.