Securitization

The transfer of loans (ASSETS) of a homogeneous nature, from a lending institution to
investors through an intermediary, by packaging them in the form of securities which are usually termed “PASS-THROUGH CERTIFICATES”. The cash flow by way of PRINCIPAL and
interest on the underlying loans is “passed through” to the security holders. The
assignment of loans is mostly without recourse to the original lender. Various assets that generate cash flows can be securitized - as e.g., housing loans and car loans.
The lending institutions benefit by this arrangement since it frees a large amount of funds for reinvestment, long before they become due. The assets are selected from a pool that is carefully selected - this is known as ‘Cherry Picking’. They are subsequently monitored over a period of time to confirm their financial soundness – this part is termed‘Seasoning’. Considering that there is such a careful appraisal coupled with the backing of the underlying assets, the financial instruments that are created present an attractive investment opportunity. Moreover, their investment quality can be determined from theCredit Rating, if available.
A trust or an intermediary termed ‘Special Purpose Vehicle’ (SPV) is involved in the
arrangement of securitization. The SPV holds the loans and issues paper against the
security of the loans, say MORTGAGES. The proceeds from the issue of securities are given to the housing finance company. The periodic interest and principal are collected by the SPV and passed on after retaining service costs and insurance fees.