DO YOU KNOW HOW SECURITIZATION WORKS IN CONVERTING YOUR RECEIVABLES INTO BONDS?
Aug 17, 2016 Vipul Mittal, CPA
Securitization is a type of finance. In its simplest form, securitization results in converting receivables into bonds. These bonds are asset backed securities because these bonds are backed by assets such as trade receivables, student loans, or mortgage loans. Let�s understand this using an example.
Suppose American Express has issued mortgage loans worth $1,000 million. These loans are its assets; and the bank wants money against these assets. But the problem is that these mortgage loans are not easily bought and sold in the open market. So it creates a separate entity (also referred as a special purpose vehicle - SPV) and sells all its mortgage loans to this entity. In this process, American Express is the originator. The creation of an SPV ensures that the mortgages are taken off the books of the bank. This basically separates the mortgages from the other assets of the bank.
Now all the interest payments and loan repayments flow to the SPV. The SPV issues securities that have right to receive the interest and principal payments on those mortgages. These securities are called mortgage backed securities. Now there are large number of buyers of securities (or investors) and all get a piece of this mortgage backed security. These investors get the right to receive the mortgage payments, that includes principal and interest payments. Payments made by the borrowers in respect of the mortgage goes directly to the SPV and are distributed among the investors.
This is how securitization works.
Securitization is a wonderful way to move receivables of your balance sheet and meet short-term cash needs.
Hope you find this helpful for you CPA Exam. Thanks and happy reading.