Section 4: Securitisation
- International Monetary Fund
- Published Date:
- November 2009
4.1 Section 4 focuses on debt securities issued under securitisation schemes. It provides a general description of securitisation covering the principal features of securitisation and the main institutional units that can be involved in securitisation transactions, together with a streamlined classification for various financial instruments within the statistical framework for debt securities statistics.
4.2 The securitisation of assets or future income streams is a well established process that has operated for some decades. Recent financial innovation led to the establishment and extensive use of new financial corporations to facilitate the creation, marketing, and issuance of debt securities. Furthermore, securitisation schemes have become increasingly sophisticated.
4.3 Securitisation has been driven by various considerations. For corporations these include: cheaper funding costs than available through banking facilities; reduction in regulatory capital requirements; risk transfer, and diversification of funding sources. For governments, the main motivating factor has been to reduce the average cost of budget financing relative to when conventional government debt securities issues are used.
Definition of securitisation
4.4 Securitisation results in debt securities for which coupon or principal payments (or both) are backed by specified financial or non-financial assets or future income streams.14 A variety of assets or future income streams may be used securitised including, among others: residential and commercial mortgage loans; consumer loans; corporate loans; government loans; credit derivatives, and future revenue.
The securitisation process
4.5 Securitisation schemes vary within and across debt securities markets. They can be grouped into three broad types.15 First, those in which the original asset owner creates new debt securities, that is, there is no securitisation corporation and no transfer of assets (Type 1 in Diagram 4.1). Second, those involving a securitisation corporation and a transfer of assets from the original asset owner (Type 2 in Diagram 4.1). Third, those involving the transfer of credit risk only, but not the transfer of assets, either through a securitisation corporation or through the direct issuing of debt securities by the original asset owner (Type 3 in Diagram 4.1).
Diagram 4.1Securitisation process
4.6 The first type of securitisation scheme, usually known as on-balance sheet securitisation, involves debt securities issues backed by an income stream generated by the assets. The assets remain on the balance sheet of the debt securities issuer (the original asset owner), typically as a separate portfolio. The issue of debt securities provides the original asset owner with funds.
4.7 The second type of securitisation scheme, typically referred to as true-sale securitisation, involves debt securities issued by a securitisation corporation where the underlying assets have been transferred from the original asset owner’s balance sheet. The proceeds received from selling the debt securities to investors fund the purchase of the assets. The income stream from the pool of assets (typically, interest payments and principal repayments on the loans) is used to make the coupon payments and principal repayments on the debt securities.
4.8 The third type of securitisation scheme, often referred to as synthetic securitisation, involves transfer of the credit risk related to a pool of assets without transfer of the assets themselves. The original asset owner buys protection against possible default losses on the pool of assets using credit default swaps (CDS).16 The proceeds from the issue of debt securities are placed by a securitisation corporation on deposit, and the interest accrued on the deposit, together with the premium from the CDS, finances coupon payments on the debt securities. If there is a default, the protection buyer (the original asset owner) is compensated by the protection seller for the default losses related to the pool of assets, while the holders of the debt securities suffer losses for the same value.17
4.9 Synthetic securitisation without a securitisation corporation occurs when the original asset owner issues credit-linked notes (CLN). CLN are debt securities that are backed by reference assets, such as loans and bonds, with an embedded CDS allowing credit risk to be transferred from the issuer to investors. Investors sell credit protection for the pool of assets to the protection buyer (or issuer) by buying the CLN. Repayment of principal and interest on the notes is conditional on the performance of the pool of assets. If no default occurs during the life of the note, the full redemption value of the note is paid to investors at maturity. If a default occurs, then investors receive the redemption value of the note minus the value of the default losses.
4.10 In each type of securitisation scheme described above, a range of debt securities may be issued by the original asset owner (Type 1) or the securitisation corporation (Type 2 and Type 3), such as: asset-backed securities (ABS), including asset-backed commercial paper (ABCP), covered bonds,18 CLN, and debt securities with credit structuring, including collateralised debt obligations (CDO).
4.11 ABS, such as residential mortgage backed securities (RMBS), are debt securities created through securitisation that typically have an original term to maturity of more than one year, and are usually backed by long-term mortgages. ABCP are debt securities similar to ABS, but they have an original term to maturity of one year or less. ABCP may be backed by residential mortgages, but also by short-term trade receivables, leases, or margin loans, among other assets. ABS and ABCP are classified as debt securities because the security issuers are required to make payments, while the holders do not have a residual claim on the underlying assets; if they did, the instrument would be classified as either equity securities or investment fund shares (BPM6 5.47).
4.12 Covered bonds are debt securities created through securitisation and issued by the original asset holder that are backed by assets remaining on its balance sheet, but are identified as belonging to a cover pool.19 The cover pool consists mainly of mortgages with a high credit rating or loans to the public sector. In the MFS Guide, covered bonds are referred to as mortgage backed bonds (MFS Guide 4.24).
4.13 The criteria used to determine whether CLN are securitisation debt securities are based on whether or not they are backed by payments on specified assets or income streams, rather than whether or not they are issued by a securitisation corporation. For further details, see Annex 1.
4.14 CDO are debt securities created through securitisation that are backed by a relatively small pool of heterogeneous debt instruments, such as bonds and loans. Liabilities are ranked to protect investors against different levels of credit risk. Similar instruments include collateralised mortgage obligations (CMO), collateralised loan obligations (CLO), and collateralised bond obligations (CBO).
4.15 The treatment of securitisation schemes and their classification into sectors and sub-sectors varies according to the type of scheme. In Type 1 and some Type 3 securitisation schemes, where the original asset owner issues debt securities, the issuing institutional unit is either a non-financial corporation, financial corporation, or general government unit. In Type 2 and some Type 3 securitisation schemes, where the debt securities are issued by a securitisation corporation, the issuing institutional unit is a financial intermediary in the financial corporations sub-sector “other financial intermediaries except insurance corporations and pension funds”.
4.16 Some financial corporations are created to hold securitised assets or other assets that have been removed from the balance sheet of the original asset owner, or issue debt securities that are backed by these assets (or both). It is essential to establish whether these corporations actively manage their portfolio and bear risk, or simply act as trusts that passively manage assets or hold debt securities. When the corporation is the legal owner of a portfolio of assets, issues debt securities that represents an interest in the portfolio, has a full set of accounts and bears market and credit risks it is acting as a financial intermediary, and in particular a securitisation corporation. In this case, the securitisation corporation is classified in the financial corporations sub-sector “other financial intermediaries except insurance corporations and pension funds”.
4.17 Securitisation corporations are distinguished from units that are created solely to hold specific portfolios of financial assets and liabilities. When the unit does not bear market or credit risks it is combined with its parent corporation, if it is resident in the same country as the parent. When the unit is set up outside the economic territory in which the parent corporation is located, it is considered resident in the country in which it is incorporated, even if it has little or no physical presence. In these cases, it is treated as a separate institutional unit of the financial corporations sub-sector “captive financial institutions and money lenders” of the host economy.
4.18 General government units may also be involved in securitisation schemes. There are two cases that need to be considered for classification.
Where a general government unit is the original asset owner and it transfers assets, such as government loans extended to other sectors, to a separate securitisation corporation, the distinction between securitisation debt securities and conventional government debt securities is based on the involvement of the securitisation corporation that issues debt securities backed by the loans.
A general government unit may also issue debt securities backed by specific, earmarked future revenue rather than loans or other financial assets that it holds on its balance sheet. In this case, the distinction between securitisation debt securities and conventional government debt securities is not so straightforward.20