Securitization of Auto Loans
Essay Preview: Securitization of Auto Loans
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This article is made to give answer to some specific questions asked by an officer of a financial institution which is specialized on auto loans. Recently it has been found that a competitor has followed the process of securitization for auto loans amounting to $150 million. Now officer wants to get answer about some specific questions relating to this decision. Those are-
Why competitor did follow process of securitization?
Securitization is a financial process where an entity having large amount of receivable from a valid source sale a pool of such receivable to a special purpose entity who issue securities against such pool of assets. At the maturity of the security cash flow from receivable directly flow to the investor of the security.
Now as we know the process of securitization, we need to analyze the probable benefits from this process.
Liquidity benefit- The entity creates receivable known as originator (in this case the financial institution issuing auto loans) does not need to wait until it receive payments from receivables (auto loans) for flow of funds to the business. Because funds flow from sale of pool of receivables (pool of auto loans). These funds can be used by the company for generating more receivables. Hence this process provides liquidity.
Better Representations of financial status- The process of securitizations managed to offset receivables by cash in the balance sheet. So it provides a better look of the financial situation to attract more investors.
Benefits of the interest spread – Auto loans are amortizing assets. Therefore a payment of auto loans normally includes interest and principle. Now the security issued in securitization process normally carry a lower interest rate than that of the auto loans. Hence, originator gets the benefits of this interest rate spread.
Asset-Liability Management- Some financial institutions are not in position to raise long term international borrowings due to various limitations including the size of the institution. Securitization helps in improving the rating for particular deal much above the institutions. This rating enables institution to raise funds for a longer period. Hence this facilitate in matching the tenure of the liabilities and assets.
Analyzing the above benefits we can say that the competitor company has followed securitization in order to achieve liquidity which is one of the most important concerns for a financial institution. Additionally this spread the ownership of risk associated with recovery of auto loan.
What are the potential benefits of securitizations to Issuer, Investors and Borrowers?
Issuer: – Issuer is a special purpose entity (SPE) usually created pursuant to a trust agreement between originator and the entity. Securitization provides several benefits to an issuer such as-
Most securitization process is to structure the transactions that will result in “off-balance-sheet” treatment for the existing assets. If securitization is a sale, cash from sale will be added to the assets and the sold assets will be taken out of balance sheet. This will provide a better leveraged position as compared to issue of any other security.
As security issued in securitization is secured against a pool of assets, it is more secure as compared to other security. Hence this provides an oppournity of improved rating.
As security issued in securitization is more secured as compared to other securities, it normally attract more investors, hence coupon rate of this security is relatively less than other. So, it is a low in cost also.
Investors buying ABS: – The main participants in the ABS are institutional