Methods, Advantages and Disadvantages of Securitization - Coursework Example

?Securitization Securitization is a form of structured finance where an issuer creates a financial instrument by combining financial assets based on the cash flows and risks associated with a given asset or a pool of assets and then marketing different tiers of the repackaged instruments to investors. Securitization accommodates all financial assets and promotes liquidity hence allowing the owners to sell the assets more easily1. Securitization largely supports the financial strength and stability of electric distribution utilities by availing the capital to purchase and make develop investments in utility infrastructure. Indeed, the Shikshak Sahakari Bank Ltd & another Vs Indian Oil Corporation Ltd & Another case law that explains property mortgaged to the Bank leased out to a third party. Possession is subject to the leasehold rights of the Lessee2. This case law explains the different parties to securitization. In an asset securitization process, a collection of assets transform into asset-backed securities. Securitization has greatly evolved with time. In the modern times, securitization finances transition and stranded costs that relate to an open market, storm cost recovery, and environmental control equipment costs. Indeed, the difference between securitization and other forms of traditional financing is that in securitization, the cash flow generated by the asset pool to support securities with higher credit quality than the company has secured debt. Ideally, the ultimate goal of securitization is to enable a corporation obtain proceeds from the sale of assets and not necessarily borrowing funds. Methods of Securitization There are different securitization methods that have different goals. However, they share common elements that include the pledge from the state not to take or permit any action that would impair the value of the transition property and the recognition that alternative financing is beneficial to ratepayers. In addition, the variant securitization methods adopt the same mechanism for periodic true-ups, requirements of a financing order issued by the public service commission, and authorization of a non-by passable rider in the repayment of the securitized debt. In addressing, real property securitization, the two methods are the "Asset Liquidation Scheme" and "Asset Investment Scheme.” In an Asset Liquidation Scheme, there is a transfer of identified real property and other assets are to a vehicle that issues negotiable instruments supported by income from the real property and other assets. Then, managers sell the proceeds to investors to raise funds. In an Asset Investment Scheme, the issuance of negotiable instruments to raise funds from investors establishes an investment fund. Then, the investment fund invests those funds in a chosen real property3. Special types of securitization include master trust, issuance trust, grantor trust, and owner trust. A master trust handles revolving credit card balances, and is flexible to handle different securities at different times. In an Owners trust, there is more flexibility in allocating principal and interest received to different classes of issued securities. Issuance trust on the other hand, provides more flexibility in issuing senior/subordinate securities, can increase demand and significantly reduce the cost of issuing securities. A grantor trust relevantly applies in Real Estate Mortgage Investment Conduits and automobile-backed securities. Additionally, securitizers use the cash reserve account and the cash-out method to estimate the effect of reserve account on the timing of cash flows4. Liabilities of Each Party Parties to securitization are the originator, the servicer, and the investors in the asset-backed securities. An originator makes the loans in line with the underwriting standards and consequently sells the collection of the made loans in a true sale under law to a Standalone Special Purpose Vehicle (SPV). An originator can only use collateral on existing assets like corporate loans and commercial mortgage loans or assets to arise in the future like tax revenue receivables and airline ticket receivables. The servicer collects payments and monitors the assets that are the crux of the structured financial deal. It also controls the collection policy that influences the proceeds collected, recoveries on the loans and the charge-offs. Actually, the transfer or collection of payments faces a delay or reduction if the servicer becomes insolvent. The servicer has a mandate to protect the assets and the investors. The SPV subsequently purchases the originated loans from the proceeds he gets from the sale of asset-backed securities. Investors usually rely on the deal manager to price the securitizations’ underlying assets. They have a mandate to purchase the asset- based securities, repay, prepay, and invest in the securities. However, they are subject to currency interest rate fluctuations, changes in the ownership and value of the securities5. Advantages of Securitization The advantages of securitization apply to nonfinancial, financial corporations, and federal governments. In comparing securitization with nonrecourse and modified recourse, lower risks and funding costs apply in securitization. This compares to the Gujarat Industrial Co-op Bank Ltd Vs District Magistrate case law that relates to taking possession of a secured asset. The District Magistrate and any originator are not entitled to re-open a concluded issue subsequently6. Hence, a low lower risk in securitization. In addition, receivables that factors will not purchase are actually acceptable for securitization. Moreover, all the proceeds from the sale involving securitization accrue immediately and securitization has the ability to diversify funding resources, and manage corporate risks. In corporate organizations, securitization aids financial entities offering potential relief from capital requirements. At the same time, it offers a chance to achieve off-balance financing and generate fee income7. On the other hand, consumers enjoys various benefits from securitization that include lower cost of funds, consistency in the availability of funds, increased buffet of credit forms, and available competitive rates both locally and nationally. Advantages to originators include profits on sales, increased servicing income, efficiency in the use of capital, and ability to sell assets quickly. Investment banks enjoy benefits from securitization that include high trading volumes and profits, potential innovation and market expansion, new products, and the continuous flow of originations and fees. On the other hand, investors enjoy liquidity, potential trading profits, high yields on rate security and enhanced diversification from securitization8. Securitization also supports the financial strength and stability of electric distribution utilities by providing the capital to purchase and make incremental investments in utility infrastructure. Disadvantages of Securitization In Homeowner’s mortgages, the risk inherent in securitized mortgages shifts to the buyers of the mortgage-backed securities. This adequately manifests in United Bank of India Vs Satyawathi Tondon and others case law where the Supreme Court held that issuing notices to guarantor under Section 13 (2) and (4) and filed an application under section 14 of the SARFAESI Act without first initiating action against the borrower for recovery of the outstanding dues is permissible. It equally confirmed that that the Bank can proceed against the guarantor before exhausting the remedy against the principal borrower9. Additionally, the pooling of mortgages into a mortgage-backed security can come with the potential for fraud. Moreover, it might be difficult for the investors to work out what they own, and the security could become worthless if the mortgages used to build the security are not quality instruments. The possibility of the value of a mortgage-backed security to vary wildly along with the quality of the mortgages held is a great disadvantage to the mortgage holders. Mortgage-backed securities are demerits to lenders, since the lenders had to get rid of low-risk, profitable loans in order to balance out the high-risk loans they included in these pools. As a result, securitization leads to decreased credit ratings of these lenders and the subsequent availability of few quality loans left in their exposure. Indeed, where a mortgage loan changes holders several times over the course of its term there is a possibility of problems with title, escrow and account information. Moreover, since lenders did not hold onto the mortgages, they lost the control of the long-term stability of the loan. Bibliography F Fabozzi & V Kothari, Introduction to Securitization, John Wiley & Sons, London, 2008. J Kravitt, Securitization of Financial Assets, Volume 1, 2, Aspen Publishers Online, London, 1997. L Kendall & M Fishman, A Primer on Securitization, MIT Press, London, 2000. M Jain, Gujarat Industrial Co-op Bank Ltd Vs District Magistrate case law, 5, Wadhwa & Co., London, 2003. Ministry of Land, Infrastructure and Transport, Methods of Real Property Securitization and its Characteristics, Ministry of Land, Infrastructure and Transport, 2011, Retrieved 17 April 2012, < http://tochi.mlit.go.jp/h13hakusho/setsu_2-4_eng.html> Supreme Court of India, Shikshak Sahakari Bank Ltd. vs. Indian Oil Corporation Ltd. And ... on 26 May, 2006, Retrieved 19 April 2012, < http://indiankanoon.org/doc/330901/> Supreme Court of India, United Bank of India vs. Satyawati Tondon & Ors. On 26 July 2010, Retrieved 19 April 2012, < http://indiankanoon.org/doc/175816/> Read More