Loans securitization

These provisions were referred to as file Small Business Loan Securitization and Secondary Market Enhancement Act of 1993, S. 384,103d Cong., 1st Sess. (1993). 

See J. Paul Forrester, et al.. Securitization of Project Finance Loans and Other Private Sector Infrastructure Loans, The Financier ACMT, 1994, at 7. 

Other opportunities for securitization may be politically influenced. While the House of Representatives adopted Representative Paul Kanjorski s bill promoting the securitization of commercial loans in 1994/ the Senate incorporated provisions into its version of the Community Development Banking bill that attempt to create a favorable legal framework for banks wishing to securitize their... 

As noted, a bond may contain an embedded option which permits the issuer to call or retire all or part of the issue before the maturity date. The bondholder, in effect, is the writer of the call option. From the bondholder s perspective, there are three disadvantages of the embedded call option. First, relative to bond that is option-free, the call option introduces uncertainty into the cash flow pattern. Second, since the issuer is more likely to call the bond when interest rates have fallen, if the bond is called, then the bondholder must reinvest the proceeds received at the lower interest rates. Third, a callable bond s upside potential is reduced because the bond price will not rise above the price at which the issuer can call the bond. Collectively, these three disadvantages are referred to as call risk. MBS and ABS that are securitized by loans where the borrower has the option to prepay are exposed to similar risks. This is called prepayment risk, which is discussed in Chapter 11. 

The flexibility of securitization is a key advantage for both issuers and investors. Financial-engineering techniques employed by investment banks today enable bonds to be created from any type of cash flow. The most typical such flows are those generated by high-volume loans such as residential mortgages and car and credit card loans, which are recorded as assets on bank or financial-house balance sheets. In a securitization, the loan assets are packaged together, and their interest payments are used to service the new bond issue. 

In addition to the more traditional cash flows from mortgages and loan assets, investment banks underwrite bonds secured with flows received by leisure and recreational facilities, such as health clubs, and other entities, such as nursing homes. Bonds securitizing mortgages are usually treated as a separate class, termed mortgage-backed securities, or MBSs. Those with other underlying assets are known as asset-backed securities, or ABSs. The type of asset class backing a securitized bond issue determines the method used to analyze and value it. 

Conduits are commercial lending entities set up solely to generate collateral to be used in securitization. They are required by more-frequent issuers. The major investment banks have all established conduit arms. Conduits are responsible for originating collateral that meets the investor s requirements on loan type (whether amortizing or balloon, and so on), loan term, geographic spread of the properties, and the time that the loans were struck. Generally, pool diversification in terms of size and location is desirable, since this reduces the default risk for the investor. After it has generated the collateral, the conduit structures the deal with terms similar to those of CMOs but with the additional features described in this section. 

ACE Securities series 2004 is a sub-prime RMBS transaction that closed in the U.S. market in January 2004. It is a securitization of a pool of sub-prime mortgages originally on the balance sheet of Fremont Investment and Loan. Fremont is a commercial banking institution that had been engaged in sub-prime mortgage lending for more than ten years prior to the transaction, and also originated previous home equity securitization deals. 

The driving force behind securitization has been the need for banks to realize value from the assets on their balance sheet. Typically, these assets are residential mortgages, corporate loans, and retail loans such as credit card debt. Let us consider the factors that might lead a financial institution to securitize a part of its balance sheet. These might be for the following reasons ... 

To the extent that securitization provides regulatory capital relief, it can be thought of as an alternative to capital raising, compared with the traditional sources ofTier 1 (equity), preferred shares, and perpetual loan notes with step-up coupon features. By reducing the amount of capital that has to be used to support the asset pool, a bank can also improve its return on equity (ROE) value. This will be received favorably by shareholders. 

Auto loan pools were some of the earliest to be securitized in the ABS market and still remain a major segment of the U.S. market. Investors have been attracted to the high asset quality involved and fact that that the vehicle offers an easily sellable, tangible asset in the case of obligor default. In addition, since a car is seen as an essential purchase and a short loan exposure (three to flve years) provides a disincentive to finance, no real prepayment culture exists. Prepayment speed is extremely stable and losses are relatively low, particularly in the prime sector. 

The technique itself brings forth a dilemma. In a classic banking regime there is no detachment between the borrower and the lender. The bank does its own credit analysis, offers the loan to its client, and monitors the client over the life of the loan. In securitization, however, the link between the borrower and the bank is disconnected. The loan is packaged into different pieces and moved on to an unknown client base. As a consequence, there is less incentive for the arranger to be risk conscious. 

The mark-to-market accounting rules accelerated the problem by creating a downward spiral of asset values as the secondary market dried up. Banks had to mark ABS assets at the market price, unconnected with the default performance of the underlying portfolios however, in a flight-to-quality environment, all structured credit products became impossible to trade in the secondary market, so values were marked down almost daily, in some cases down to virtually zero. The price of many securitized mortgage pools is well below their value now. The accounting rules force banks to take artificial hits to their capital without taking into account the actual performance of the pool of loans. 

Government-chartered corporation that buys qualified mortgage loans from the financial institutions that originate them, securitizes the loans, and distributes the securities through the dealer community. The securities are not backed by the U.S. government. The market value of these securities prior to maturity is not guaranteed and will fluctuate. 

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