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Securization. The definition of securitization is that a group of assets, for example, mortgages is placed in a pool, and certificates representing ownership of those assets are issued to pay for them. (Alexander et al., 2000). The holders of certificate

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Securization

The definition of securitization is that a group of assets, for example, mortgages is placed in a pool, and certificates representing ownership of those assets are issued to pay for them. (Alexander et al., 2000). The holders of certificates receive the interest and principal payments which are made by homeowners, minus a small service charge. Standard loans features, determined payment plan and predictable cash flows, at least one year maturity, low risk of default is the main features of the asset which can be securitized. Car loans, consumer loans, mortgage loans, credit card payments, leasing and factoring credits are assets which can be securitized. (Alexander et al., 2000) But there are two limitations about securitization. First one is moral hazard. When the financial institutions issue securitized assets they are not paying attention about payments of assets. The other one is the adverse selection problem. Issuers of asset can securitize the asset which is unqualified. Securitization brings some risks; we can list them, credit risk, early payment risk, interest rate risk. Credit risk is the collection risk of the credits by issuer to avoid the credit risk issuer can devote collateral which is more valued. Early payment risk, payments before maturity date can be change the interest and principal structure of payment pool. Interest rate risk, fluctuations in the interest rate can decrease the demand of the securitized assets therefore issuer make securitisations with variable rate.

Securitization is the financial process which is created beginning of 1970. Financial institutions need new financial instruments because there were changing cyclical reasons. (Davidson et al., 2003)

Fluctuations of inflation and interest rates are one of the reasons. To decrease the risk which is occurred with the fluctuations in the interest rates and inflation causes to create new instruments. In other words, after collapsing Bretton Woods, the exchange rate system is changed and free floating exchange rate system is valid.(Davidson et al., 2003) therefore new instruments are required. In those times investors are willing to invest different rate instruments instead of constant rate instruments. After that futures and options occurred to protect the investors from fluctuations in rates. These instruments bring the opportunity to investors to protect their investment from fluctuations. With the change in the technology, and regulations on markets develop many financial instruments. Securitization is the one of the financial instruments. There are types of securitization;

Pass-through securitization is the simplest way of securitization. An asset which has a regular cash flow is securitized by selling to direct participations in the pool of assets. In other words, pass-through certificates  represent the direct partnership in a portfolio which has  similarity of maturity, interest rate. The steps of process are that, firstly certificates which are created as investment fund are sold to the investors. The fund is managed by issuer, interest and principal payments are collected by issuer and distributed to investors after service commission is deducted. Assets which are in fund, are belong to investors therefore assets are not included in balance sheet of issuer, also they are not liabilities of issuer.(Austin and Anne, 2005) this kind of certificates are traded more in secondary markets which are efficient.  

Asset-backed securitization is converse of pass-through securitization, they are liabilities of issuer. (Austin and Anne, 2005) Therefore assets which are collateral of certificates are included in the balance sheet of issuer as asset. Also cash flows which come from collaterals are not devoted to interest and principal payments. The most important feature of asset-backed securities is that they need more collateral which is valued in determined time intervals.  

Pay-through asset securitization brings liabilities to the issuer. It incorporates pass-through and asset-backed securities. The asset pool is shown as collateral in pay-through mercerization and it is included in balance sheet of issuer as liabilities. The cash flow from assets is distributed to value of certificate and interest and principal payments are distributed to investors. Collection of payments is made by issuer. Pay-through asset securitization based on the credit card payments and consumer credits which are not related collateral.

Securitization can be defined as the process of converting assets of banks to marketable securities which are traded in secondary markets. With the securitization, institutions increase the liquidity of assets which are not liquid. (Davidson et al., 2003) With the securitization investors can earn high returns. Also, it decreases the financing cost because there is proper cash flow with securitization so the borrowing cost will decreases. With securitization firm’s capital structure will be improved because they will demand less capital. Credit risk and liquidity risk are distributed and decreased with securitization. (Austin and Anne, 2005)  

Benefits of securitization

Securitization process limits credit exposure to assets. Typically, following securitization the bank’s credit exposure will be limited to any credit enhancement it may provide. In the case of banks, this may allow them to obtain regulatory capital relief. At the same time, the bank usually retains the ability to extract future profits from the assets. (Austin and Anne, 2005)

Securitization improves balance sheet efficiency of bank which has securitized assets. A true sale of securitization may move the assets of the bank’s balance sheet, contributing to an improvement of the relevant balance sheet ratios. For instance, to the extent that proceeds of the securitization are used to repay existing liabilities, this may reduce the bank’s leverage.

Securitization allows the issuers to diversify its funding sources away from creditors and tap the capital markets directly, without having to issue its shares. Banks, who already have established direct access to the capital markets, sometimes enter into securitizations to demonstrate to the capital markets that securitization is available to them as a source of funding and to access different types of investors.

Securitization makes the issuer-rating irrelevant when a bank issue securitized assets buyers do not car about the rating of bank, the important indicator of rating which is belong to asset.(Davidson et al., 2003) This is good for banks securitized assets. When investor decide they consider the asset’s ratings. Securitization brings advantages to banks, including balance sheet management, lower cost of funds and access to additional fund. Also, flexibility of income tax characterization is another benefit of securitization. Securitizations also have some disadvantages for banks such as cost of transactions which increases with the additional cost of required professionals to complete maintain transactions. And there is an always risk about the securitizations especially for mortgages certificates there is always default risk for payments of homeowners. For example when bank issued mortgage named certificate the payments of credits which will made from homeowners has default risk. Therefore the risk of securitized assets always carries default risk. The global crisis is the result of the securitized mortgage loans. Banks securitized all loans payments to market then when payments were late the liquidity crisis began. We are still living the results of that. When we evaluate the securitization, we should consider the disadvantages of it. Because it is risky process which can be resulted disaster for global economy. It is global because the assets which are securitized are traded in global market. Therefore the assets carry global risk. Beside the disadvantages, securitization brings opportunity to issuer and investors. The most important advantage of securitization is effective source of funding when it controlled and managed, efficiently.

Application of securitization brings to commercial banks, the well asset-liability management, efficient capital structure, liquid balance sheet and low-cost financing source.  Also securitization improves to investors trustable and high return investment opportunity chooses. But securitization causes to prevent the perfect financial reporting, the increase the loans stock in the economy, moral hazard and inverse selection problems. Therefore, the securitization is a concept which needs to develop according to market conditions, regulations. Especially in banking, with global crisis, which occurred in 2007, this concept loses the value of it. Because the all reason of the crisis was mortgage based certificates.  Now reliability of securitized assets, mortgage based certificates,  is decreased with the global economic crisis. After the crisis, issuers of mortgage based securities, are devoting more collateral to avoid the credit risk of mortgages loans. In my opinion, secondary markets will be more reliable with this precaution.  But increased collaterals are not useful for commercial banks. Because devoting more collateral for securitized assets,  may decrease the rating of securitized assets. Because credit risk of securitized asset means that asset is unqualified and this decrease the rating of assets. Also price is decreased with based on assets ratings. This is not favourable situation for commercial banks.

References

SHENKER, Joseph C.  COLLETTA, Anthony J. (1991) Asset Securitization: Evolution, Current Issues and New Frontiers

DAVIDSON, A., SANDERS, A., WOLFF, L., CHING, A., (2003), Securitization: structuringand investment analysis: Wiley Finance

STONE, C. Austin, ZISSU, Anne, (2005) the securitization markets handbook: structures andDynamics of mortgage- and asset backed securities: Bloomberg

ALEXANDER, G. J., SHARPE, W. F., BAILEY J. V. (2000) Fundamentals of investments: Prentice Hall

LOUTSKINA, Elena, (2001) Does Securitization Affect Bank Lending? Evidence from BankResponses to Funding Shocks

ISMAIL, A. G., ZAKARIA, R. H. (2007) Securitization and the stability in Islamic Banking

International Finance Corporation: Securizitation,Key Legal and Regulatory Issues

www.ifc.org

HULL, John, (2007) Fundamentals of Futures and Options Market: Prentice Hall

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