The process begins with the pooling of the assets and the creation of the SPV.
The next step is the appointment of parties necessary to bring the transaction to the market. These usually comprise:
- Issuer – i.e. the SPV
- Lead manager to manage the transaction
- One or more rating agencies – e.g. Fitch
- Lawyers
- Auditors
These include:
- Trustees
- Paying agents
- Third party servicer (if outsourced)
This is followed by the rating agencies’ assessment which uses sophisticated financial modelling to simulate the performance of the mortgages, create cash flow projections and make assumptions about arrears, losses and other risks. The bonds are then rated.
The bonds are usually issued in a range of denominations from AAA notes (the highest rating offering the lowest return but also the lowest risk) through to BB and C notes (the lowest rating offering higher levels of risk and return).
The returns are usually long-term in nature reflecting the way in which borrowers repay their mortgages. However, investors in A-rated notes receive their payments before those investing in the higher risk B and C notes.
Prior to the selling of the bonds to investors, the auditors perform file audits to prove the quality of the assets and that of the underlying underwriting process.
The bond sale involves the lead manager presenting potential investors with information about the assets in the SPV and the lender’s business strategy and processes.
This frequently happens through investor ‘roadshows’ that may not necessarily be restricted to the UK. The investors usually comprise institutional investors.
The extent of investor interest and demand determines the final size of the offering. The launch date is then set along with the final price of the bonds. On completion, the lender receives its cash and the process starts all over.
Future prospects
While some commentators have been concerned for a while that securitisation was untested in a recessionary environment, none had foreseen the current scenario.
The position is only likely to improve once the banks crystallise their write-offs and regain their nerve for investing in fundamentally sound markets. It will also be driven by investors who do not like sitting on under-employed cash for long, particularly when high yielding, but high quality opportunities beckon.
This will take time. But securitisation is too valuable to disappear altogether. When it returns it will be more robust, more transparent and better regulated.
While painful now, we may therefore look back upon current events as necessary and inevitable in a market where front-end innovation was allowed to outstrip our ability to manage the risks.
