It is an innovative fund raising process which came into existence in the late 1970’s and has multiplied phenomenally over the years. The crux of the concept on which this process is based is the grouping or pooling of assets with predictable and pre-defined cash flows structure or rights on future expected cash streams and the re-engineering or re-packaging of such cash flows into financial instruments or securities that are then sold to investors. Such cash flows can accrue out of loans, trade receivables, mortgages, royalties etc.
The term “securitization”, itself is derived from the fact that securities are the final mode of financial instruments which are issued to investors to obtain funds.
As any asset with an associated stream of cash flows can be securitized the securities which result from a securitization transaction are termed as Asset Backed Securities and the transaction itself is termed an Asset Backed Securitization (ABS). With more such issuances being based on underlying mortgage based loans, Mortgage Based Securitization (MBS) became widely popular.
Securitization Practices – Crystallization of the crisis
Once mortgage backed securities started flooding the markets, the banks and financial institutions also resorted to securitization of the pool of assets to shift the risk to investors in these securities as well as to obtain funds well ahead of the scheduled tenor of these assets. This implied that originators/issuers could repeatedly re-lend a given sum, greatly increasing their fee income and providing a multiplier effect of the underlying notional. Securitization resulted in a secondary market for mortgages, and the lenders were no longer required to hold them to maturity. With increasing securitization deals being struck, and the resultant transfer of default risk, the issuers lowered their underwriting practices to increase their loan disbursements.
The flair for securitization i.e. mortgage backed securities accelerated in the 1990s and total amount of mortgage-backed securities issued tripled between 1996 and 2007, to $7.3 trillion. Alan Greenspan has commented that credit crisis cannot be blamed on sub-prime mortgages alone, but rather on the securitization of such mortgages which created a notional far exceeding the actual value of the underlying assets actually available. The credit risk in sub-prime mortgages got passed on to other investors through the securitization mechanism and with a wide arena of investors globally, the impact of the credit crisis is felt on a global level.