Securitisation turns illiquid receivables, such as loans or rents, into financial securities that investors can buy. It is a neutral and very widespread tool: useful for financing the economy, but dangerous when it serves to dilute or conceal a risk.
1 What is securitisation?
Pooling receivables, then reselling them as securities.
Definition
Receivables turned into tradable securities
A bank or a company holds receivables: sums others owe it (mortgages, car loans, invoices, rents). Securitisation consists in pooling a large number of these receivables, then issuing securities backed by them. The investor who buys these securities receives the repayment flows in return. The issuer, in turn, immediately recovers cash and transfers part of the risk.
2 How it works
A dedicated vehicle steps in between the receivables and the investors.
①
Sale to a dedicated vehicle. The receivables are sold to a legally separate entity created for the purpose (a special purpose vehicle).
②
Issuance of securities. The vehicle funds this purchase by issuing securities, often sliced into tranches of differing risk and return.
③
Pass-through of flows. As the receivables are repaid, the vehicle passes the sums on to the security holders, following the priority order of the tranches.
3 Why it matters
A tool that finances the economy, but can scatter risk.
The lesson of 2008
The subprime crisis revealed the dark side of securitisation: fragile mortgages, securitised and then re-securitised, had scattered a risk that no one really measured any more. The tool was not guilty in itself; its use was.
Upside
Liquidity
The issuer recovers funds and can lend again: securitisation irrigates credit.
Downside
Opacity
Risk is redistributed and fragmented, sometimes to the point of becoming hard to locate.
4 Off-balance-sheet
Lodging an asset or a debt in a separate structure, so it no longer appears on the balance sheet.
Related notion
Moving a commitment off the books
When an operation passes through a separate, unconsolidated vehicle, the corresponding asset and debt no longer appear in the company's accounts: this is called off-balance-sheet. It is sometimes legitimate, to ring-fence an activity. But it is also the device that let Enron, in the early 2000s, hide debts and losses before its collapse. The line between the two comes down to one word: transparency.
5 Takeaways
To remember in a few sentences.
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To securitise is to turn receivables into securities sold to investors.
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A dedicated vehicle steps in and isolates the risk off the issuer's balance sheet.
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The tool is neutral: it finances the economy, but can also scatter or hide risk.
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Off-balance-sheet becomes problematic when it serves to conceal rather than to organise.
This notion illuminates an analysis