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What is Asset Securitization?

Best Asset Securitization lawyers in Canada as ranked by Lexpert

The Asset Securitization practice area includes acting for and advising asset originators, dealers, trustees, agents, liquidity lenders, credit enhancers, rating agencies and other participants in all matters relating to the structuring and implementation of asset securitization transactions, and includes structuring and establishing special purpose vehicles to purchase or otherwise acquire and administer assets from one or more originators and issue asset-backed securities to finance such acquisitions; structuring and documenting the acquisition of such assets and the issuance of such securities and ensuring compliance with all registration and other requirements with respect thereto; documenting any liquidity facilities required to finance such special purpose vehicles and any external credit enhancement facilities required to support their acquisitions; advising rating agencies on the efficacy of the structures employed; and providing opinions to various interested parties in connection with various aspects of the foregoing.

 

Please note that the Lexpert Directory has separate sections for:

  • The best Banking & Financial Institutions lawyers
  • The best Derivative Instruments lawyers
  • The best Investment Funds and Asset Management lawyers
  • The best Asset Equipment Finance and Leasing lawyers

 

You may have heard about Asset Securitization from the financial crisis of 2007 to 2009. There’s more to it when used properly to realize more of its advantages, which the best Asset Securitization lawyers listed below are able to deal with effectively.

 

What is asset securitization?

Before we start looking at the best Asset Securitization lawyers below, we need to understand what a security is. The simplest example of a security are stocks – it is based on the value of the company it represents and with what others (or would-be holders) are willing to pay for it. That is the essence of a security – a tradable financial product that takes its value from the market and from the properties (tangible or not) that it represents.

 

But how about in a case of an illiquid or non-tradable assets or liabilities? This is when Asset Securitization lawyers come in. Asset securitization is the process of transforming these illiquid or non-tradable assets or liabilities into securities – hence becoming liquid or tradable – to be bought by interested investors or traders and be sold for its value. Simply stated, asset securitization is a way of turning non-financial assets or liabilities into liquid securities that investors can buy and sell. An example of a case where an asset securitization lawyer would get involved would be the purchase of assets of a fleet leasing business.

 

This turning of illiquid asset/s into liquid ones can also be done by pooling large numbers of underlying assets. For example, a bank may pool numerous individual mortgages to become a single portfolio to be packaged as mortgage-backed securities (or MBS). Other assets like credit card debt, auto loans, commercial mortgages, and residential mortgages can also be subjects of asset securitization lawyers.

 

What is an example of asset securitization?

Generally, ABS is the process, or the general term used for asset securitization. However, asset securitization lawyers look at two common caregories – ABS or MBS – when referring to the type of illiquid asset the securitization is the subject of.

 

“Asset-backed security” or “ABS”

Asset-backed security (or ABS) are securities backed by income-generating assets, which is typically named after the underlying assets, such as the pooling of non-mortgage assets. Assets that can be subject of ABS are credit card receivables, and loans, such as home equity loans, student loans, and auto loans, among others. An example of an ABS is when a security is backed by auto loans which now turns into an auto-backed security. The most common types of ABS are:

  • Home Equity Asset-Backed Securities
  • Auto Loan Asset-Backed Securities
  • Credit Card Receivable Asset-Backed Securities
  • Asset-backed Commercial Papers (ABCP)
  • Collateralized Debt Obligations (CDO), which has its own subtypes:
    • Collateralized Loan Obligations (CLO)
    • Collateralized Bond Obligations (CBO)
    • Collateralized Mortgage Obligations (CMO)

 

“Mortgage-backed security” or “MBS”

Mortgage-backed security (or MBS) is a type of ABS that is secured by a collection or pooling of mortgages. While ABS are mostly based on loans and debts, any asset that has value can be turned into a security through securitization, as in the case of mortgages. There are multiple kinds of MBS, such as “pass-throughs” which is simply multiple mortgage payments bulked as one and sold to interested buyers or investors; or, collateralized mortgage obligation or “CMOs” which breaks the mortgage pool into several distinct parts called tranches to stretch out the risk of default. MBS may be classified into two:

  • Residential Mortgage-Backed Securities (RMBS)
  • Commercial Mortgage-Backed Securities (CMBS)

 

How do you securitize an asset and which parties are involved in asset securitization?

Generally, among the different types of asset securitizations, the process is all identical. It would only matter on the types of illiquid assets are being bundled or pooled together.

  • Firstly, an “originator” – which are mostly corporations, banks, lenders, mortgagees, or even public entities – would identify income-generating assets, such as loans or mortgages, that it would want to sell. Once pooled, the originator sells them as a single portfolio or bundled assets to a legal entity which is now called “special purpose vehicle” (SPV). After the sale, the originator now removes the pooled assets from its balance sheet.
  • An SPV may also be called an issuer when the SPV acts to fund the purchase price by issuing asset-back securities into the capital market. However, the SPV only exists to purchase the originator's pooled assets.
  • After buying the pooled assets into a single portfolio, the SPV – now an issuer – would now issue tradable shares in it. Those shares will pay a rate of return based on what has been generated by the pooled portfolio’s collected assets itself – loans, mortgages, debts. In addition, the issuer typically collects a commission or other form of fees for managing the whole fund.
  • An issuer may not be the same entity with the SPV. In this case, the SPV sells them to the issuer or third-party investors, who can now trade them at their pleasure.

 

Hence, illiquid assets, or even liabilities, are now turned into profitable investments through the work of the entities and the asset securitization lawyers involved.

 

The Securitization Food Chain

Asset securitization through MBS may be summarized through this “food chain”. This was also mentioned in the documentary film Inside Job, whose plot revolves around the financial crisis of 2007-2009.

  • The “first chain” would start from a borrower who would apply for a mortgage from an originator such as a bank. A loan is given to the borrower-mortgagor, which is secured by a claim against the property purchased by the borrower-mortgagor. A mortgage note is now owned by the bank as an illiquid asset, but this note comes with it the payment risk posed when the said borrower-mortgagor fails to pay the loan. In the normal course or if without securitization, the mortgage will be foreclosed, or the originator-bank would sell the mortgage note. This first chain is multiplied many times such as that the said originator-bank would have multiple mortgages at their disposal.
  • The “second chain” is where the actual asset securitization happens. In this stage, there would be the bundling or pooling of these multiple mortgages into a mortgage pool. The MBS comes as in as it would hold this mortgage pool in trust as its collateral. Mentioned earlier, the asset-backed security – or the MBS here – is issued either by a third-party, the SPV-issuer, or the originator-bank itself.

 

Hence, an asset-backed security in the nature of MBS is created, which is backed up by the claims against the assets of the mortgagors.

 

What are the benefits of having asset securitization lawyers?

 

Benefits for Originators

Securitization is commonly used by originators as it can raise substantial amounts of investment, help ensure greater liquidity, and to provide additional capital for the originator, while at the same time, lowering its own risk against outside factors.

 

An Alternative with Less Risk

The act of asset securitization is an alternative source of income based on the transfer of credit risk, interest rate, and currency risk, from the issuers to investors. After these pooled or bundled assets are sold, the originators cannot anymore collect profits out of these assets, but more importantly, they no longer assume that asset’s future risk, such as when the borrowers or mortgagors would be in default, reducing credit risk, liquidity risk, and interest rate risk. In addition, the interest rates on these bonds sold by an SPV are also lower compared to other bonds, attracting more investors for these bonds.

 

For the originators, since the portfolio or bundled assets or SPV is now sold, it is now entirely separate from the originating business. In the process, it has even secured these bundled assets in the SPV, even if the originator encounters some financial problems.

 

Securitized products, in addition, is itself a diverse kind of a fixed-income product and presents itself as an alternative type of bond, different from those of the conventional ones, such as corporate or government bonds.

 

Additional Returns

Also, asset securitisation allows these institutions or originators to make benefits out of their assets in an efficient way as it creates a more attractive financing profile for them, resulting to better funding terms in the future. Since loans is usually the subject of securitization, lenders such as banks may continue to service these loans through collection of payments and by adjusting floating interest rates.

 

As to Credit Card Receivable Asset-Backed Securities, this provides additional returns for the bank since they retain origination and servicing fees, and at the same time to receive sales treatment for accounting and regulatory purposes.

 

Tranches

Another benefit of asset securitization is that these are usually issued in tranches. Since, each tranche is its own kind or is characterized from others, this provides for a diverse set of products for investors to choose from – depending on its wants, desired return, safety or risk allowance, and other factors it considers.

 

Market Opportunities

Originators are afforded with a wider capital market – domestically or internationally. It allows the originator to diversify its funding sources away from traditional sources of capital, and reach out to markets directly, without having to issue securities along with the process.

 

Benefits for Investors

On the other hand, investors are also benefited from asset securitization or asset-backed securities.

 

Diversification

By asset securitization, investors can now invest in assets, which is previously inaccessible. Investors are given more choices on which assets to invest to and accrue income out of it.

 

Less volatile

Compared to corporate or other bonds, asset-backed securities have been said to be less volatile. Hence, the range to which the price of the bundled or pooled assets may fluctuate – increasingly or decreasingly – is not that wide. It may be said that it’s income or return would not too high, but it also means that there is lesser risk in these kinds of asset investments.

 

Lesser risk

Through asset securitization, just as with originators, the risk of losing in these types of investments are typically low, since it has lower event risk, or it is not susceptible to risk of a rating downgrade of a single borrower.

 

Benefits for Borrowers

Borrowers – such as mortgagors or owners of credit cards – may also benefit indirectly from securitization.

 

Preferred Credit

Asset securitization has provided originators – in their capacity as lenders – additional available credit which they can now provide to borrowers. This may provide lenders an opportunity to offer fixed rate debt, which is preferable over variable rate debt. All this is done while the interest rate risk is being eliminated, still as an effect of securitization. This goes the same with credit card banking corporations, who can now provide for as many credit card holders, as their loan portfolio or loan pools are also expanded with now lower rates.

 

Above all, asset securitization increases liquidity from a previously illiquid asset. Liabilities are turned into income-generating assets, providing for an additional array of product for the company or the originator.

 

What are 4 asset types that are common to asset securitizations?

Generally, any type of illiquid asset or entitlements which represents or is capable of future income can be securitized. However, there are 4 types of assets that are common subjects of asset securitizations. These illiquid assets – or debts for this matter – have a fixed schedule of payment and a set interest rate, which makes it easier for investors to securitize these assets. The 4 common assets that can be securitized are:

  • Mortgage loans (residential and commercial)
  • Credit card debts
  • Automobile loans
  • Student loans

 

However, this is not an exclusive list of products asset securitization lawyers work on, which means that any other asset may also be securitized, such as:

  • Tax revenues
  • Utilities payments
  • Commercial debts
  • Bank loans

 

There are also uncommon illiquid assets that are now securitized, and this includes patents and copyrights, leasing activities, royalties, advertising revenue, or public-sector assets.

 

Which assets are suitable for securitization?

As mentioned earlier, any illiquid asset can be used for asset securitization which makes it is suitable for any kind or type of business—asset securitization lawyers can be found working in a wide variety of industries. However, these illiquid assets should have a regular and consistent cashflow or return, and they should be able to be bundled or pooled together, such as when they are of the same class or type.

 

Interested to know more about asset securitization? Scroll down to see the best asset securitisation lawyers in your region.

Linda G. Brown
Linda G. Brown
Year called to bar: 1990
Vancouver, British Columbia
McCarthy Tétrault LLP
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