Securitisation is the creation of asset backed securities. These are debt securities that are backed by a stream of cash flows.

The borrower issues debt securities that are repaid using only these cash flows. Buyers of these securities have no further recourse against the borrower if the cash flows prove insufficient.

Assets to be securitised are first sold to a special purpose vehicle (SPV), thus isolating the ultimate borrower from any claims for repayment. The SPV then issues bonds or other debt instruments. The SPV then uses the money raised by issuing the debt securities to pay the ultimate borrower for the assets.

The borrower has raised money without risking assets other than those held by the SPV and it has got a lump sum in return. It has lost some assets or cash flows in return for cash. The debt is also kept off the ultimate borrower's balance sheet. This is quite reasonable given the limited recourse. Securitisation can therefore be seen as a way of selling off a stream of cash flows.

Securitisation also has benefits for investors. It widens their choice of available investments. The asset backed securities created by securitisation may also be easier to analyse as investors need only evaluate the cash flows from a small pool of assets, instead of a whole complex business. The assets most often securitised are loans of one kind or another which are usually (when pooled, not individually) a low risk investment.

The last of these usually also means that, for the issuer, it is often a cheap way of borrowing.

Copyright Graeme Pietersz © 2005-2020