Securitization involves selling assets into special purpose, bankruptcy-remote entities (SPEs) that fund themselves with the issuance of ABS. Figure 1 illustrates the process. In any given securitization, a bank can play one or more roles, including originator, credit enhancer, service provider, arranger, and/or investor. The originator initiates the assets to be securitized by making or purchasing loans. If the originator accumulates a sufficiently large portfolio of similar loans most ABS issues exceed $100 million and if the quality of that portfolio is statistically verifiable and stable, the portfolio is a candidate for securitization.
In order to remove the assets from the originator's balance sheet, the sale must be a "true sale" such that, in the event of bankruptcy of the originator, the creditors of the originator would have no recourse to assets sold to the SPE4. After asset sale, usually the assets continue to be serviced by the originator, and indeed most borrowers are unaware that their loans have been securitized. The SPE finances its purchase with the issuance of ABS to investors, most of whom are institutional investors who hold the securities to maturity. Most of the ABS in any given securitization carry high credit ratings.
The bank arranging the securitization usually works closely with bond rating agencies to achieve desired credit ratings in the senior tranches by designing credit enhancements that serve as equity cushions (see Fabozzi (2003) and Raynes and Rutledge (2003)). These credit enhancements are often provided by the originator, but may be provided by third parties, many of whom are financial institutions. Credit enhancements can take the form of partial guarantees, over collateralization, tranche subordination, lines of credit, letters of credit, asset repurchase obligations, cash collateral accounts, spread accounts, etc. In Figure 1, we show the credit enhancement as a subordinate tranche provided by a third party investor.
As Greenbuam and Thakor (1987, 1995) observe, securitization permits banks to unbundled the traditional lending function, allowing them to specialize in the more basic activities in which they enjoy comparative advantages.
