About Securitisation

A formal definition

Securitisation is the process of transforming illiquid asset pools into tradeable securities. It is all about the packaging of cash flows.

To be more specific, securitisation is the process of converting cash flows from underlying assets or receivables due to the originator into a smoothed repayment stream that in turn is transformed into self-liquidating asset-backed securities that are limited in recourse to the credit of the receivables rather than that of the originator.

Securitisation isolates the assets and enhancements so that their credit quality can be analysed absent of external factors and investors can focus primarily on the performance of the assets and servicing of the debt, rather than on the credit quality of the lender.

Another feature of securitisation is that the cash flows are often structured to redistribute risk by creating tranches with different risk profiles that can enhance both liquidity and overall cost of funds when effectively structured to match investor risk preferences.

A practical definition

An originator of financial assets (e.g. housing loans, automotive leases) sells a portfolio of assets to an insolvency remote special purpose vehicle (SPV).

The SPV funds the purchase of those assets by issuing debt securities to investors (i.e. residential mortgage-backed securities (RMBS) in the case of housing loans).

The interest and principal payments made on the underlying assets are used to make the interest and principal payments on the debt securities.

Various liquidity and credit enhancements are put in place to help ensure the SPV can repay investors what is promised on the debt securities.

Therefore, the key characteristics of securitisation are:

• The existence of a predictable cash flow;
• The establishment of an SPV to hold the assets for the benefit of investors; and
• Credit, liquidity and cash flow enhancements to support the payment of interest and principal to investors.

Generic securitisation structure