Securitization of Receivables:
One of the applications of the securitization technique has been in the creation of marketable securities out of, or based on, receivables. The intention of this is to afford marketability to financial claims in the form of receivables. Obviously this is applicable to those entities where receivables form a large part of the total assets of the entity. Besides to be packaged as a security, receivables are the one which is repayable over or after a certain period of time, and there is a contractual certainty of its payment. Hence, the application has traditionally been directed towards housing/mortgage finance companies, car rental companies, leasing and hire purchase companies, credit cards companies, hotels etc. However, electricity companies, telephone companies, real estate hiring companies, aviation companies, etc have also joined as users of securitization Insurance companies are the latest of the lot to make an innovative use of securitization of risk and receivables, though the pace at which securitization markets are growing the word “latest” is not without the risk of soon becoming stale.
Securitization is a process whereby financial claims are transformed into marketable securities. It is a process by which cash flows or claims against third parties of an entity, either existing or future, are identified consolidated, separated from the originating entity, and then fragmented into “securities” to be offered to investors.
Securitization of receivables is unique application of the concept of securitization. For most other securitizations, a claim on the issuers themselves is being securitized. For example, in case of issuance of debenture, the claim is on the issuing company only. In case of receivable, what is being securitized is a claim on the third party/parties on whom the issuer has a claim. Hence, what the investor gets in receivable securitized product is a claim on the debtors of the originator. This may at times be further including by way of recourse, a claim on the originators themselves.
The involvement of the debtors in the receivables securitization process adds unique dimensions to the concept. Of which at least two deserve immediate mention. One the very legal possibility of transforming a claim on a third party as a marketable document. It is easy to understand that this dimension is unique to securitization of receivables, since there is no legal difficulty where an entity creates a claim on itself. However, the scene is totally different when rights on other parties are being turned into a trade able commodity. Two, it affords to the issuer the rare ability to originate an instrument which hinges on the quality of the underlying asset. To state it simply, as the issuer is essentially marketing claims on others, the quality of the issuer’s own commitment becomes irrelevant if the claim on the debtors of the issuer is either market acceptable or is duly secured. Hence, it allows the issuer to make their own credit rating insignificant or less significant and the intrinsic quality of the asset more critical.
The benefits that accrue from the securitization process are as follows:
Benefits to Originator>
Off Balance sheet Financing: Securitization offers the advantage of off balance sheet funding by allowing for the conversion of an otherwise non-liquid asset into ready liquidity. This allows for better balance sheet management. This also enables faster recovery of funds leading to higher business turnover and profitability.
Credit enhancement: Credit enhancement helps make the transaction attractive by means of an investment credit rating for the instrument. Since a variety of factors are taken into consideration for rating. It would give boost to investors’ confidence in the newly created market of instruments which have qualitative differences but have been built upon underlying debts.
Low Costs: Securitization helps reduce the funding cost substantially s compared to conventional fund rising instruments like bonds, debentures and commercial papers
Access to market: Asset securitization enables the originators to access the securities market at debt ratings higher than their own overall corporate ratings through the novel technique of credit enhancement and diversification of risk. For instance, the National Stock Exchange has announced that it will allow listing of securitized assets. This will definitely help develop an active secondary market and improve liquidity.