A tooi for the trade
securitization
rjeptune
With solvency management a
major concern, securitization has
emerged as a valuable tooi to
achieve more with less. Just how
does it work for the bank? What's
NewS talks to experts in Europe
and the US to shed some light on
this complex instrument.
Critical understanding
Back to basics
Risk transfer
Ample reward
Flip side
What'sNewS Issue 4 July/August 2001
Since the early 1990s, Rabobank has
been actively involved in securitization.
The business is run on a global basis, but
today's key initiatives are led out of Eu
rope and North America. In the European
market, the team - Graham Bruce, Sarah
Mason, Michael Eleftheriou and Barry
Jeddo - is based in London and headed up
by recent joiner Alan Cameron. North
America is covered by the New York-
based team of Wing Ng, James Han and
Alyssa Jaffe, led by Eraj Asadi.
We all speak highly of
securitization - it's a
term often used when
discussing solvency, as-
sets, risk, credit - the
list goes on. But what
does it actually do?
Comments London's
Alan Cameron, 'Secu
ritization is a complex
financing which uses a
vast array of poten-
tially confusing buzz-
words and acronyms.
In order for the ner-
work to understand
how and why it's such
a powerful tooi for the bank, it's impor
tant to breakdown some of this mystique
and explain the concepts in a way that
anyone can understand. Certain securiti
zation programs benefit clients, others
benefit RI itself. Because of these advan-
tages both internally and externally for RI.
it's essential everyone knows how securiti
zation programs work so that we all can
contribute to increasing this business.'
London's Graham Bruce (I), Sarah Mason,
Alan Cameron and Barry Jeddo (Missing
from photo is Michael Eleftheriou)
Let's start out with a gen-
eral outline. According to
Cameron, securitization is
'a process whereby pools of
cash generating assets are
sold to an independent third
party which is specifically set up
for this purpose. This entity then issues
debt securities to investors to fund the
purchase. Repayment of the securities is
limited to the cash flow generated from
the purchased assets.' Key words here are
'pools of cash-generating assets', 'sale' and
'repayment limited to the cash flow gener
ated'. 'The types of assets that can be se-
curitized are always expanding," Cameron
explains. 'But classically, we look at port-
folios of residential mortgages, credit
cards, car loans, leases, consumer loans,
corporate loans or bonds, commercial
property and trade receivables. Diversified
"portfolios" are key - they spread risk
across a number of individual obligations
which optimizes the benefits that securiti
zation can deliver.' The fact assets are sold
is also an important component. 'Repay
ment limited to
cash flow' means
there are no conse-
quences to the
party selling the
assets if the cash
flow from the un-
derlying assets is-
n't enough to re-
pay the securities.
In order to man
age risk, an impor
tant feature in
most securities is-
sued is a rating
provided by at
least one of the in
ternational rating
agencies, such as
Standard and Poors, Moody's and Fitch.
When a company or bank sells a portfolio
of assets (as a genuine sale without any re-
course), you could conceivably say the risk
of that portfolio has been transferred to
the purchaser. Graham Bruce elaborates:
'Because banks are required by central
banking regulators to maintain a pre-
scribed level of solvency or regula-
tory capital against assets they
own or have originated on to
their balance sheet, reducing
these assets is strategically a wise
step. In general, solvency is a lim
ited resource - often banks are
measured based on the return on
solvency (RoS), also known as return
on equity (RoE). When we sell a portfolio
of assets through a securitization vehicle,
the amount of assets held on the bank's
balance sheet is reduced. The reward is
that the amount of solvency required to
support the balance sheet is then signifi-
cantly reduced. And what's more, depend-
ing on the sale price of the pool of assets,
the selling institution may be able to retain
an economie interest in the portfolio sold -
selling the portfolio without giving up all
the income on the assets.'
Once a sale is completed, the following
advantages occur:
- Solvency has been reduced;
- If an economie interest in or income
from the sold pool has been retained by
the bank, its RoS will generally increase
compared to the pre-securitization posi-
tion. In simple terms: the solvency require-
ment for a pool of assets is sold off, while
a certain amount of the income arising
from these assets has been retained. Effec-
tively this gives a theoretically infinite RoS
for the income retained, improving the
solvency ratio for the rest of the bank's re
tained or non-securitized business;
- The bank has accessed new/alternative
non-bank funding or liquidity sources
known as Asset Backed Securities (ABS),
viewed by capital market investors as dis-
tinct from traditional bank funding.
While securitization achieves particular
advantages for banks, it functions in an-
other way for corporates. Sarah Mason
explains, 'Corporates tend to have slightly
different objectives when using securitiza
tion - mostlv due to the fact that their
