Moorad Choudhry - The Mechanics of Securitization: A Practical Guide to Structuring and Closing Asset-Backed Security Transactions

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Copyright 2013 by Suleman Baig and Moorad Choudhry. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Baig, Suleman.

The mechanics of securitization: a practical guide to structuring and closing asset-backed security transactions/Suleman Baig, Moorad Choudhry.

p. cm. (Wiley finance series)

Includes bibliographical references and index.

ISBN 978-0-470-60972-9 (cloth); ISBN 978-1-118-22073-3 (ebk);

ISBN 978-1-118-25895-8 (ebk); ISBN 978-1-118-23454-9 (ebk)

1. Asset-backed financing. I. Baig, Suleman. II. Title.

HG4028.A84C46 2013

332.178dc23

2012038292

To my parents

Suleman Baig

To a Solid Bond in Your Heart

Moorad Choudhry

Foreword

It is regrettable that many of securitization's contributions to modern finance have been overshadowed by infamy since the financial crisis. While it has made for popular journalism to debate securitization in the abstract, there has been surprisingly little attempted commentary to actually explain what securitization is or does. Possibly, this is due to the fact that most pundits seem to underappreciate the regularity with which securitization techniques can be found in the financial system. The volume of securitized debt alone warrants more study and transparency in terms of the technology's inner workings. Thus, rather than discounting its utility, current thought leaders of finance (and certainly future students) would be best served by having better access to information around securitization's basic value proposition. Surely a more enlightened understanding would allow the debate to move beyond the rhetorical and reorient efforts toward identifying and deploying more practical uses of the technology. With that in mind, a book focused on explaining the basic mechanics of securitization is long overdue.

In its most basic form, a securitization vehicle acts as a small, single-purpose bank. As such, it plays the role of a financial intermediary between end borrowers and end investors. Where it does depart from a traditional bank, though, is in its balance sheet construct. Although it still finances itself by issuing debt and equity like a bank, its assets consist of a single, focused asset strategy. The single-purpose nature of its balance sheet is a distinct value creator for the financial system. It affords an investor the practical ability of taking exposure to a virtual bank that has a clearly defined risk mandate (financing only consumer loans, corporate loans, or real estate loans, for instance). In this regard, securitization is a uniquely powerful financial technology; it redefines the investible universe for investors and increases the options they have to diversify their portfolio risk. In the context of an overall portfolio investment strategy, the ability to take pure asset class exposure provides for better risk calibration and more flexibility for investors to shape their targeted risk-return profiles.

The aforementioned diversification benefit made available to an individual investor can be expanded into a global context. Prior to the availability of securitization, the realistic ability of a lender to diversify globally was limited by practical access to foreign markets. Though a regionally concentrated lender may want to diversify its loan book, a lack of origination infrastructure in the new market would deem it prohibitive. Given such practical constraints, the lender would be limited to only indirect methods, which would mean either purchasing a stake in a foreign lender or sourcing a loan participation. The former approach lacks asset-class risk clarity and brings risks perhaps far beyond what the lender had initially desired (as it captures the foreign banks' entire business). The latter is restrictive in that it typically only works for exposures to large corporate loans (i.e., ones that can be parsed and syndicated). The fact that it practically allows for regionally sourced risk to be diversified with clearly defined alternative asset exposure makes securitization a key lever in reducing overall global systemic risk.