Credit Encyclopedia Series: Structured Finance
In this edition of Fitch’s Credit Encyclopedia series, we look at securitization. Created for newcomers to the asset class, or those looking to review the basics, our guide covers the fundamentals of the sector, key risk factors, regulatory considerations and more.
01Table of Contents
- What Structured Finance Is and How it Works
- The Benefits for the Issuer
- Fundamentals of Securitization
- Key Counterparties in a Securitization
- Regulatory Summary
- The Role of Rating Agencies
- Key Risk Factors
- Securitization Asset Classes
02Overview
Structured finance or securitization is the process of converting assets into securities. The assets are typically loans that are pooled together and sold to a bankruptcy-remote special-purpose vehicle (SPV). The SPV then issues securities that often use credit enhancement through the slicing of the securities into tranches with different cash flow prioritizations. The types of assets most commonly securitized include: residential mortgages, commercial real estate assets, secured and unsecured consumer credit (e.g. auto loans), and non-investment grade corporate debt.
Origins of Securitization
While securitization dates back to 17th Century Great Britain, the recent history starts in the 1970s, when residential mortgages were pooled by U.S. government-backed agencies. This expanded to the securitization of mortgage bonds with varying maturities and risk profiles, and later, in the 1980s, to non-mortgage assets such as auto loans and credit card receivables.
In the 1990s, mortgage products grew in sophistication and banks increasingly extended loans with higher risk knowing that the risk would be transferred through securitization. High-risk mortgages, categorized as sub-prime, were a main contributor to the build-up of a housing bubble in the U.S., which peaked in the mid-2000s and contributed to the 2008 global financial crisis.
After the financial crisis, laws were adopted globally that significantly increased regulation of securitization and required a much stronger alignment of interest between the issuer and investors. Today, a wide variety of assets are available for securitization.