9.9 Securitisation of assets

Question 1

What is securitisation?

Answer 1

The process of taking an illiquid asset or group of assets and transforming it into a security that can be sold to raise more finance. i.e. debt obligations such as loans, bonds, mortgages, can be pooled together and sold as securities.

Question 2

What is a “special purpose vehicle”?

Answer 2

A legal entity created for a specific purpose. It provides a funding structure whereby pooled assets are transferred for legal and tax reasons. The SPV then issues interest-bearing securities which are used to raise more finance.

Question 3

Which accounting scandal involved SPVs?

Answer 3

Enron - SPVs were used to hide assets and debt from the public and investors.

Question 4

How was the US sub-prime housing market crisis linked to SPVs?

Answer 4

Banks converted risky mortgages to marketable securities and sold too many of them, leading to defaults which collapsed the housing market and caused the baking crisis.

Question 5

What are the advantages of securitisation?

Answer 5

• can raise large amounts of funding
• SPVs are separate from the main business, allowing off-balance sheet treatment of assets
• interest rates on securitised bonds are usually lower than those on corporate bonds
• private companies can access wider capital markets
• shareholders interests are not diluted
• intangible assets such as patents can be used for security to raise cash
• SPVs usually have excellent credit ratings and low borrowing costs

Question 6

What are the disadvantages of securitisation?

Answer 6

• can be complicated and expensive compared to traditional methods such as bank loans
• may restrict the business ability to raise money in future
• risk of loss of control of some assets, which reduces the business’ value
• there may be substantial costs to close the SPV and reclaim the assets.