1.1 Definition of securitizationSecuritization is a financial practice that issues tradable securities backed by a specific portfolio of assets or a specific cash flow such as house mortgages. Through the issuance of securities in the capital markets to access to finance, it is able to maximise the liquidity of illiquid assets which has a predictable income.
1.2 Securitization characteristic1.2.1 Lowering the financial hurdleTraditionally, to apply for a loan, one has to prove its credibility as well as his/her ability to pay back the capital to be eligible for a loan from the bank. For example, banks will require houses or company stocks as a pledge.
However, for small-and-medium enterprise, it is not possible for them as they need these assets to help them to scale up their operation.The appearance of asset securitization provides a solution to this problem by taking stable future income as a guarantee to get the current financing. For instance, Singapore Polytechnic is able to transfer its future earning on tuition fees to current assets through the form of securitization.By using this “trick” the firm can use these funds to further leverage on the current investments, provided that future earnings continue to be realized.1.
2.2 LiquidityAs securitization is one of the financial products which is tradable on the financial market, it is much more liquid than the normally fixed assets. For instance, banks are able to convert a portfolio of mortgages which are mainly illiquid assets to cash through selling to the investors through securitization. There are many advantages of holding onto liquid securities, such as the financial flexibility as well as the added layer of security.
Liquid products provide a “safety net” that allows it to convert into cash in a timely manner as compared to illiquid assets, while the flexibility enabled by this product will increase in a form of purchasing power, where investors can either use such assets to purchase or quickly convert these assets into cash to conduct their business. Due to such advantageous features, Investors are more likely to prefer to hold onto the securitization as this will also mitigate their liquidity risk exposure in the market.1.3 Asset-Backed SecuritizationIn a narrow sense, securitization of credit assets can be divided into Mortgage-Backed Securitization (MBS) and Asset-Backed Securitization (ABS) Mortgage-backed SecuritizationMortgage-backed securitization is a type of financial instrument that its cash flows promised to investors come from the principal and interest generated by a pool of home-equity loans.
Mortgage-backed securitization means that financial institutions (mainly commercial banks) converge and reorganize their own mortgage-backed mortgages held by them in illiquid but future cash flow into mortgage lending groups. The financing process, which is purchased by securitization institutions in cash and sold to investors in the form of securities after being increased by guarantee or credit. This process transforms assets that are not readily liquid usable to investors but that generate predictable cash inflows into marketable securities.