Securitization

Securitization

          Securitization is the process of pooling and repacking of homogeneous   long term illiquid financial assets and non-performing assets into marketable securities, which can be sold to investors. Thus it is taking a primary role in imparting liquidity & profitability to marketers by converting long term illiquid and non-performing assets into short term liquid and performing assets. The process leads to creation of financial instruments that represents ownership interest in/ is secured by segregated income producing assets /pool of assets, where the pool of assets collaterises the securities. These assets are generally secured by personal/real property such as automobiles, real estates or equipment loans (but in some cases unsecured). Securitization in India is regulated by the SARFAESI Act 2002- (Securitization & Reconstruction of Financial Assets & Enforcement of Security Interest).

Process of Securitization involves the following:

1.       Assets are originated through receivables, leases, housing loans/ any other form of debt by a company and funded on its balance sheet.(The company is normally referred to as the originator)

2.      Once a suitable large portfolio of assets has been originated, the assets are analyzed as portfolio and then sold to a third party, which is normally a Special Purpose Vehicle Company (SPV) formed for the purpose of funding the assets. SPV issues debt and purchases receivables from the originator. The SPV will be owned by a trust or the originator.

3.      The administration of the asset is then sub-contracted back to the originator by the SPV. It is responsible for collecting the principal amount and interest on the loans in the underlying pool of assets.

4.       The SPV issues tradable securities to fund the purchase of assets. The performances of these securities are directly linked to the performance of the assets.

5.       The investors purchase the securities (because they are satisfied that the securities would be paid in full and on time from the cash flow available from the asset pool).

6.      As cash flow of arise on the assets they are used by SPV to repay funds to the investors in the securities.

Advantages of Securitization

1.        It provides liquidity to the originators (Non-Banking Finance Companies / Banks)

2.        Better Credit Rating is possible.

3.    Securitized debt is cheaper as the original investors can beat the ratings given by the rating agencies and thereby diversify their credit risk.

4.       Originators can plan their capital adequacy requirements by using securitization to reduce the risk of weighted assets and thereby improve their capital adequacy.

            Main demerit of Securitization is that, it is an off balance sheet funding, where the true picture of the originators’ financial position is not clear merely from the balance sheet. The best assets of the company may be transferred to the SPV and the company may be left with the substandard assets on its books. Similarly if the receivables which have been securitized to the SPV become bad, the SPV will have the right to recover the dues from the originator.

                                                                     

Underwriting of Securities

      Underwriting is a guarantee given by the underwriters to take up whole or part of the issue of securities not subscribed by the public. It is a marketing technique whereby corporate enterprises are able to sell their securities to the public and thereby achieve success in the public issue. The agreement between the issuing company and the financial intermediary            , called the underwriter, whereby the sale of certain quantum of securities is guaranteed for the issuing company, is known as the underwriting agreement. The underwriter works for a commission called ‘underwriting commission’.

Types of Underwriting

1.      Firm Underwriting

It is an underwriting agreement whereby, the underwriter agrees to take up a specified number of securities, irrespective of the securities being offered to the public. It is an agreement for outright purchase of securities, the underwriter being given a preference in allotment over the general public in respect of the commitment given by the company issuing the securities. Such an agreement is designed to create confidence in the minds of investing public.

2.      Sub-underwriting

         When a large issue of securities is made and the underwriting of securities is contracted out by the main underwriter to other underwriting intermediaries for a commission, it is known as ‘sub-underwriting’. This type of underwriting helps the main underwriter minimize the risk of loss of investment in the event of the issue being unpopular.

3.      Joint Underwriting

         When an issue of securities by a company is underwritten by two or more underwriting intermediaries jointly, it is called ‘joint underwriting’. The objective is to minimize the risk and share the benefit arising from the capital issue.

4.      Syndicate Underwriting

         When a syndicate of underwriters, by means of an agreement, underwrites the issue of securities collectively, it is known as ‘syndicate underwriting’. Such an agreement is worked out in the case of issues that are considered potentially risky. There will be two types of agreements which will form part of the syndicate underwriting. They are: agreement between the issuing company and underwriter, and agreement among the underwriters themselves stating the terms and conditions.

Benefits/Functions of Underwriting

1.      Adequate Funds

            Underwriting being a kind of a guarantee for subscription of a public issue of securities enables a company to raise the necessary capital funds.

2.      Expert Advice

            Underwriters of repute often help the company by providing advice on matters pertaining to the soundness of the proposed plan etc. thus enabling the company to avoid certain pitfalls.

3.      Enhanced Goodwill

            The fact that the issues of securities of a firm are underwritten would help the firm achieve a successful subscription of securities by the public.

4.      Assurance to Investors

            The investors are assured of having low risk when they buy shares or debentures which have been underwritten by them. Their firm commitment towards fulfilling their underwriting obligations helps create confidence in the minds of in the investing public about the company.

5.      Better Marketing

            Underwriters ensure efficient and successful marketing of the securities of a firm through their network arrangements with other underwriters and brokers at national and global level.

6.      Benefits to Buyers

            Underwriters are very useful to the buyers of securities due to their ability to give expert advice regarding the safety of the investment and the soundness of the companies. The information and the expert opinion published by them in various newspapers and journals are also helpful.

7.      Price Stability

            Underwriters provide stability to the price of securities by purchasing and selling various securities. This ultimately benefits the stock market.