Securitization (Essay Sample)

Securitization Name Institutional affiliation Course Instruactor Date Securitization Briefly describe what securitization is. Slide 1 cover page Slide 2 stating questions. Slide 3 “Hello, everyone. I focused on describing the concept of securitization. Based on my research, I found that securitization refers to a financial mechanism used to convert illiquid assets such as loans and mortgages into marketable securities. It involves bundling significant assets into the pool, which backs the assurance of new securities structured as bonds or notes (Nyman,2023). The securities are sold to the investors, enabling the asset's originator to raise capital upfront. The investors get returned based on the performance of the underlying asset. The originator works very hard to ensure they reduce the exposure to risks and free up capital for lending. One of the primary benefits of securitization is that it provides liquidity and allows them access to capital. When these assets are transformed into tradable securities, the originator can free up the capital, making it possible to use it in new lending activities(Gauthier & Gauthier, 2020). Despite having many benefits, it is also prone to risks. The risks are associated with the quality of the underlying assets, the structure of the security, and the moral hazard. Therefore, organizations must ensure they adopt a functional security management strategy to increase the confidence and trust of the investors. 7.7: What are the building blocks of securitization? Slide 4 I also found that securitization is a comprehensive and dynamic concept that contains various components commonly referred to as the block. These blocks work dependently on each other, each having a significant role in the entire system (Gauthier & Gauthier, 2020). The following are the building blocks of securitization. The originator: The originator is the primary owner of the underlying assets to be securitized. According to Nyman(2023), the originator can be a financial institution, bank, or lender. They are the primary and original owner of the asset, hence the name originator. Assets refer to loans, mortgages, or receivables that are pooled together to form an asset pool. Slide 5 Particular Purpose Vehicle(SPV): This refers to the legal entity structured to hold pooled assets and issue securities. According to Cetorelli & Peristiani (2012), the SPV separates the pooled assets from the originator bank and also gives necessary protection to the investors if the originator cannot clear the debt. This enhances security in the system and also ensures financial discipline among the participants. Securities: These refer to the financial instruments that the SPV uses in the system. They are sold to investors. According to Nyman (2023), securities are divided into the level of subordination and rating before being sold to investors. Slide 6 Transferor: These entities' prime role is to transfer the assets to the SPV. These assets are paid back in cash or securities. Assets pool: It refers to the collection of both homogenous and heterogenous financial assets pooled together to back the securities given by the SPV(Gauthier & Gauthier, 2020). Assets pools are vital as they enhance the credibility of the securities. Servicer: It refers to the entity in charge of servicing the underlying assets. According to Cetorelli & Peristiani (2012), the primary roles of the services are to collect the payments from the borrowers and facilitate the transfer of cash to the investors. The investors refer to the individuals or groups who purchase the securities the SPV issues and seek returns based on the amount of cash flow generated by the underlying assets. 7.8: Why is Collateral important in structuring securitization? Slide 7 Doing more research on the Collateral and its significance in structuring securitization was also fascinating. Since the term Collateral was a new term to me, I had to first search for the actual meaning of Collateral in the financial world. I found that Collateral refers to the pool of funded assets (Gauthier & Gauthier, 2020). Collateral, therefore, plays an integral role in the structuring of securitization. These roles include; Risk mitigation Collateral helps to reduce the credit risk by providing an assert as a backup to the securities issues. According to Simon (2019), when loans are scrutinized, they serve as Collateral to the securities, minimizing the chances of default to the investors. When the borrower fails to pay back the loan, the Collateral is liquidated to cover up some of the debt, hence protecting the interest of the investors(Gauthier & Gauthier, 2020). This helps reduce cases of bankruptcy. According to Simon(2009), more than 20,000 companies file for bankruptcy every year. This makes it easier to balance between the right of the debtor and the creditor. Collateral also helps mitigate the market risk by providing a stable asset, making it easier to predict its cash flow. Enhanced credit quality Collateral allows the implementation of the credit enhancement mechanism. Using reserved loans and subordination provides additional protection to investors, enhancing the security's creditworthiness of the risks and improving credit quality(Kendall & Fishman, 2000). Pulling assets with different risks together enhances risk diversification, making it possible to minimize the effect of an individual borrower default on the overall performance. When people take large loans and fail to pay, the bank is more likely to go bankrupt. In mid-2000, the Airline United, Delta, and American business debtors filed a case seeking reorganization protection against falling bankruptcy(Simon, 2019). This filling enables the debtor to emerge from bankruptcy and continue to operate. Slide 8 Liquidity The collateralized securities are more marketable and liquid compared to individual loans. Therefore, this attracts many investors who buy most securities, enhancing the price discovery process. Securitization also provides a source of funding to the originators by converting the loans and receivables into securities (Gauthier & Gauthier, 2020). This allows the originators to access the liquidity upfront, enabling them to run other activities effectively. Furthermore, in securitization, Liquidity plays an integral role in ensuring market stability by ensuring that assets can be sold and bought, hence impacting the market prices. Investors confidence Collateralization enhances transparency and disclosure by providing investors with information about the asset and the backup securities. Investors can freely access information about quality and performance, improving their confidence (Gauthier & Gauthier, 2020). This makes it easier for them to make investment decisions because they are guaranteed safety. The use of asset backing also increases their confidence. The asset backup convinces the investors that their interests are protected. 7.9: How is securitization used for risk transfer? Slide 9 In the last section, I examined how securitization is utilized in the risk transfer. I consulted various sources to understand first the concept of risk management and its significance in the financial sector. In the research, I realized that the securitization process is integral in the economic industries and is used to mitigate challenges associated with loans, mortgages, and other types of financial debt. The process allows the financial institution to manage risk exposure, improve liquidity, and free up capital(Cetorelli & Peristiani, 2012). Securitization facilitates risk transfer in the following ways; It combines similar financial assets, such as loans, into the SPV. As a result, risk is diversified across a wide range of assets, reducing the impact of an individual defaulting...