VPS | What is Securitization Business?

Thanks to the products created through securitization business, the value and volume of securities issued and traded on global capital markets have experienced significant growth over the past 30 years.

History

The securitization business has a history dating back to 1977 when the Bank of America conducted the first securitization transaction by issuing AAA-rated debt securities secured by mortgage loans. However, this transaction was not successful because at that time only 15 states in the US recognized this investment product as legal. New York's retirement agency, for instance, regulated that investments could only be made in mortgage certificates if each mortgage loan used for securitization had a value of over 1 million USD.

It was not until the early 1980s, when the Government National Mortgage Association (GNMA) and the Federal Home Loan Mortgage Corporation (Freddie Mac), two government-sponsored entities in the US, securitized their mortgage portfolios, that securitization became successful. These entities utilized their credibility and legal status to overcome legal barriers that ordinary businesses could not. The securitization products through these entities were called "Mortgage Pass Through - MPT".

An issue at that time was that the law only allowed the issuance of debt securities with a term of 30 years. In reality, the liquidity of these securities was very low as investors were not keen on such long-term securities. Moreover, pricing long-term securities was challenging, and the risk emerged from mortgage borrowers repaying their loans early, which were used as assets for securitization. Therefore, these two entities introduced a pricing model based on a 12-year assumption (assuming all mortgage loans would be prepaid by borrowers within 13 years), although the securities had a 30-year term. This solution became a fundamental market metric adopted by investment banks.

Securitization began to evolve and become increasingly sophisticated and complex. Assets for securitization expanded beyond mortgage loans to include all credit-risk financial assets.

Today, securitization has spread to other developed markets, becoming a common securities issuance method in the US and Europe. In Asia, securitization has become popular in Hong Kong, South Korea, Japan, Thailand, and some other countries. China started implementing securitization business in 2005 when the China Construction Bank (CCB) created a mortgage loan portfolio worth 3 billion yuan.

In Vietnam, the financial market is still in its infancy, so there is no securitization business yet. However, the mortgage and consumer credit markets have developed strongly since 2007, providing potential asset portfolios for future securitization business. Securitization is a business under the fixed-income product line of investment banks as it involves issuing debt securities.

What is Securitization?

The essence of securitization is the process of raising capital by using existing assets on the balance sheet as collateral for issuing various types of debt securities. Instead of the traditional approach of using these assets as collateral to borrow money from banks, businesses use them as collateral to issue debt securities to investors. Thus, instead of borrowing from banks at high interest rates and often short terms, securitizing assets creates a channel for raising long-term capital with much more attractive interest rates by directly transferring risks to investors.

In other words, securitization is the process of issuing debt securities based on future cash flows from a pool of existing financial assets. Therefore, investors purchasing debt securities accept risks (credit, early repayment) associated with the underlying asset portfolio used for securitization.

A wide variety of financial assets can be securitized, including mortgage loans, commercial loans, commercial receivables, credit card receivables portfolios, non-performing loans (NPLs), high-yield bonds, or commercial real estate loans. Corresponding to each type of collateral used for securitization, the issued debt securities will have different names.