by Mike Licht, NotionsCapital.com

Question by Itsybitsy: Can someone explain the securitization process?
and the precautions the originator takes for issuing the securitized instrument?

Best answer:

Answer by ronwizfr
Imagine a real estate company needs money to invest in a new project. The three classic ways to raise new capital are a loan, a bond issue, or a stock issue. However, stock offerings dilute the ownership and control of the company, while loan or bond financing is often expensive due to the credit rating of the company.

Securization is another possibility.

Imagine the company has a lot of mortgages or leases outstanding. Those will provide a steady income stream over the next couple of years.
The company can not demand early repayment on the leases and so it can not get its money back today. What it does instead is sell the rights to the cash flows to someone else, in exchange for a lump sum today.

Several precautions have to be taken.

In case of bankruptcy of the issuer, the mortgages would have to be distributed among it’s creditors. To prevent this the pool of assets is transferred to a separate entity, the special purpose vehicle.
Secondly, the income stream might not be very sure itself, so to increase the creditworthiness the assets pool might contain also other loans with a higher credit rating. The cash flow might also be insured by another company, specializing in such “surety bonds.”

All in all, it’s fun stuff: take one brick of the pyramid away and ….

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