Securitization involves the creation of one or more securities backed by a pool of loans or receivables.
Securitization is an important vehicle for raising funds that are used by nonfinancial and financial firms.
Another reason for the use of securitization is to manage corporate risk.
The securitization process involves the creation of a special-purpose vehicle and the transference of assets to that entity.
All securitization transactions require one or more forms of credit enhancement to obtain a credit rating.
Securitization is the process of creating securities backed by a pool of loans or receivables. For a corporation, securitization is an alternative fund-raising process to the issuance of secured corporate bonds. The securities issued via the securitization process differ from traditional secured corporate bonds, where it is necessary for the corporate issuer to generate sufficient earnings to repay the bondholders. So, for example, if an equipment manufacturer issues a bond in which the bondholders have a first mortgage lien on one of its plants, the ability of the manufacturer to generate cash flow from all of its operations is required to pay off the bondholders. In contrast, in a securitization transaction, the burden of the source of repayment to those holding the created securities shifts from the cash flow of the corporate issuer to the cash flow of a pool of loans or receivables, and/or to a third party that guarantees the payments if the asset pool does not generate sufficient cash flow.
Although securitization was first used in the late 1960s by US government entities to create mortgage-backed securities, it was not used by nonfinancial corporations (i.e., corporations whose principal activity is the production of goods and nonfinancial services) to raise funds in the public market until March 1985 when Sperry Lease Finance Corporation (now Unisys) issued securities backed by a pool of lease receivables. Despite a major setback in the securitization market due to problems with one asset class—residential mortgage-backed securities backed by subprime borrowers—securitization continues to be an important funding alternative for nonfinancial corporations.
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