Asset securitization is the process of pooling illiquid assets of a financial institution to create special-purpose vehicles (SPVs), which is a separate entity for legal and regulatory purposes. These SPVs then becomes tradable securities and are sold to investors to generate income for the financial institution.
What are the different asset types that are common to securitizations?
There are different types of asset securitization based on the asset that is used or is pooled to create the ABS. Generally, any type of asset can be securitized and be sold or traded, but the ones which are mostly used are loans and other assets which generate receivables. The following are the types of assets common to securitizations, especially in Canada’s financial markets.
There are multiple laws and government bodies which regulates asset securitization in Canada; thus, asset securitization lawyers may be consulted by a financial institution for these laws and regulations. If you're looking to get started, or having some sort of legal issues around asset securitization, we encourage you to contact the best asset securitization lawyers in Canada.
Mortgage-Backed Securities (MBS)
The most common among the types of asset securitization in Canada are home mortgages. This is due to the fact that securities backed by home mortgages is referred to separately and distinctively from all other type of asset used in securitization.
For home mortgages-backed securities, they are called “mortgage-backed securities” (or MBS); while securities which are backed by non-mortgage assets are called “asset-backed securities” (or ABS).
Home Mortgages (MBS)
A mortgage is a contract between a mortgagee (the creditor or the lender) and the mortgagor (the borrower or the homeowner), where the mortgagor transfers their title to a property (house, land, or both) in exchange for the amount loaned from the mortgagee for the purchase of the said property itself.
This contract is based on the condition that once the mortgagor has completely paid the amount loaned, including its interest, the title will revert to the mortgagor.
In a mortgage-backed security (MBS) in Canada, the general process is:
- A financial institution, engaged in the business of mortgage-lending, pools mortgage portfolios into an MBS;
- These MBS are then insured under the National Housing Act Mortgage-Backed Securities (NHA MBS) Program of the Canada Mortgage and Housing Corporation (CMHC);
- CMCH-insured MBS are then sold to the Canadian government, which sells these MBS to various investors.
This is a more attractive type of investment since the MBS is insured by the Canadian government itself, through the CMHC. Thus, should any financial problem occur with the financial institution handling the mortgages, the investors are secured and are guaranteed a return of their investments.
An investor may purchase a minimum MBS of $5,000 from a list of financial institutions regulated by the Canadian government. These institutions may be a bank, an insurance company, a trust company, or a credit union, etc. From there, a monthly income or a proportional share out of these investments may be collected by the investor.
As to the term, it may vary depending on the discretion of the investor but may range from 1 year to 10 years. In addition, the investment may be sold at any time before maturity, although the financial yields are more advantageous when it’s held until its maturity.
Asset-Backed Securities (ABS)
Asset-backed securities (ABS) are securities backed by assets which are non-mortgages. The most common assets used in ABS are credit cards; auto loans or car loans; and student loans. Recent trend adds intellectual property assets or IP assets that are used in ABS.
Credit Card ABS
Credit card asset-backed securities (or credit card ABS) is one of the types of asset securitization where cash flows or receivables generated by these credit card debts are pooled together to form the ABS and is sold to investors.
Generally, credit card receivables, which are the debts that credit card holders incur when they use their credit cards in different transactions, are liabilities in the perspective of credit card issuers – who are typically banks. However, using credit card ABS, these credit card receivables are converted into tradable securities to generate additional income for these credit card issuers. These receivables may also include principal payments, interest payments, and annual fees incurred by the credit card holders.
In credit card ABS, after the pooling of credit card receivables or cash flows, they are then traded to another entity – private or public entities – who then trades these to investors. Unlike in MBS and in other types of ABS, credit card ABS usually has a “lock-up period” which is the period where the investor would not yet receive payments or income of their investments, but only after the said lock-up period.
Auto Loan ABS
When customers use auto loans or car loans, the receivables or cash flow generated from their loan payments may be pooled together to be traded as securitized assets. These payments may include:
- Principal payments
- Monthly interest payments
- Penalties
- Pre-payments
- Other fees on these auto or car loans
They are turned into auto loan or car loan asset-backed securities (or auto loan ABS, in short) which are based on the cash flow of these car loan debtors. This may also apply to leases on other vehicles.
One distinction of auto loan ABS is that the subject matter of the loan – which is the automobile or the car – depreciates over time, unlike in MBS and in some types of ABS. Another is the pre-payment of these auto loans which is one of the sources of the auto loan ABS, since it may only happen when the debtor in the auto loan is willing and is capable of pre-payment, or when insurance providers cover pre-payment due to unforeseen circumstances. These factors affect the payment of investments under the auto loan ABS.
Student Loan ABS (SLABS)
Although uncommon in some provinces but is prevalent in others, student loan ABS (or SLABS) is a type of asset securitization which is basically asset securities based on outstanding student loans. Financial institutions or entities which offer student loans pool these loans and they are sold to investors through bonds, much like in any other ABS.
SLABS has become an interesting type of ABS for investors because of the rising market of student loans – because more and more students are using student loans, this in turn stabilizes payments of investments under SLABS.
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