Asset securitisation involves the aggregation of assets into a pool then issuing new securities backed by these assets and their cash flows.
The securities are then sold to investors who share the risk and reward from these assets.
Securitisation is similar to ‘spinning off’ part of a business, whereby the holding company ‘sells’ its right to future profits in that part of the business for immediate cash.
The new investors receive a premium (usually in the form of interest) for investing in the success or failure of the segment.
The main reason for securitising a cash flow is
that it allows companies with a credit rating of (for example) BB but with AAA-rated cash flows to possibly borrow at AAA rates.
This will lead to greatly reduced interest payments as the difference between BB rates and AAA rates can be hundreds of basis points.
Most securitisation pools consist of ‘tranches’.
Higher tranches carry less risk of default (and therefore lower returns) whereas junior tranches offer higher returns but greater risk.
Securitisation is expensive due to: