2. Securitization of Islamic Assets - An Overview
2.1 Introduction
Securitization is the process of transformation of non-tradable assets
into tradable securities. It is a structured finance process that distributes
risk by aggregating debt instruments in a pool and issues new securities
backed by the pool.
When a bank or financial institution is in need of additional capital
to finance a new facility, to raise the fund, instead of selling the
assets, the financial institution decides to sell the portion of the
finance to a Trustee named as Special Purpose Vehicle (SPV) and collect
the fund up front and remove the finance asset from the balance sheet
of the institution. SPV holds the asset as collateral in balance sheet
and issues bonds to the investors. It uses the proceeds from those bond
sales to pay the originator for the assets.
The detailed securitization process with typical components has explained
with typical components in the diagram below:
The roles and
responsibilities of various components involved in the securitization
structure are explained below:
- Borrower – An Individual or organization which obtains finance
from financial institution / bank and pays the monthly payments.
- Islamic asset Broker - Acts as a facilitator between a borrower and
the lender. The Islamic asset broker receives fee income upon the finance's
closing.
- Issuer - A bankruptcy-remote Special Purpose Entity (SPE) formed
to facilitate a securitization and to issue securities to investors.
- Lender - An entity that underwrites and funds finances that are eventually
sold to the SPE for inclusion in the securitization. Lenders are compensated
by cash for the purchase of the finance and by fees. In some cases, the
lender might contract with Islamic asset brokers. Lenders can be banks
or non-banks.
- Servicer - The entity responsible for collecting finance payments
from borrowers and for remitting these payments to the issuer for distribution
to the investors. The servicer is typically compensated with fees based
on the volume of finances serviced. The servicer is generally obligated
to maximize the payments from the borrowers to the issuer, and is responsible
for handling delinquent finances and foreclosures
- Trustee - A third party appointed to represent the investors' profits
in a securitization. The trustee ensures that the securitization operates
as set forth in the securitization documents, which may include determinations
about the servicer's compliance with established servicing criteria.
- Securitization Documents - The documents create the securitization
and specify how it operates. One of the securitization documents is the
Pooling and Servicing Agreement (PSA), which is a contract that defines
how finances are combined in a securitization, the administration and
servicing of the finances, representations and warranties, and permissible
loss mitigation strategies that the servicer can perform in event of
finance default.
- Underwriter - Administers the issuance of the securities to investors.
- Credit Enhancement Provider - Securitization transactions may include
credit enhancement (designed to decrease the credit risk of the structure)
provided by an independent third party in the form of letters of credit
or guarantees.
Note
Not all securitizations are identical. For example,
the lender and the servicer are sometimes the same entity, or in
other arrangements brokers may not play a role.
Securitization takes the role of the lender and breaks it into separate
components. Unlike the more traditional relationship between a borrower
and a lender, securitization involves the sale of the finance by the
lender to a new owner--the issuer--who then sells securities to investors.
The investors are buying ‘bonds’ that entitle them to a share
of the cash paid by the borrowers on their Islamic assets. Once the lender
has sold the Islamic asset to the issuer, the lender no longer has the
power to restructure the finance or make other accommodations for its
borrower. That becomes the responsibility of a servicer, who collects
the Islamic asset payments, distributes them to the issuer for payment
to investors, and if the borrower cannot pay, action is taken to recover
cash for the investors. The servicer can only do what the securitization
documents allow it to do. These contracts may constrain the servicer's
flexibility to restructure the finances.