Asset securitization is a structured finance stemming from assets that have been collateralized by a pool of loans such as home loans, auto loans, student loans, Mortgage Backed securities (MBS) and Asset Backed Securities (ABS), whose cash flows are used to pay cash flows on the securities. More precisely, it is the process of transforming an illiquid asset of an institution into tradable securities backed by these assets.
Asset securitization requires complex structures and experts who understand their complexities and legal framework in order to operationalise its processes. In my view, one asset that can be securitized is student loans issued by HELB!. You see HELB are struggling with the collection of student loans but an independent institution called a Special Purpose Vehicle (SPV) can be formed so as to issue out securities backed by the loans issued to college or university students.

We very well know that loans are assets to the issuing company and with this structure, what appear as “assets” i.e. debtors (student loans) can generate more money for the issuing company- in this case HELB! The SPV will in turn get commissions for the services offered to HELB and the collections will be professionally managed by the SPV that should be regulated by the Government.

Let’s use an illustration to describe a structured finance transaction. We will use as an example, Higher Education Loans Board (HELB). This institution issues out loans to students to finance their studies and fund the institution back once a person begins to earn a stable income. For simplicity we will assume that the loans are typically for four years. The collateral for the loan is the pin code that HELB gives its borrowers in order to track them as soon as the students begin to get a stable income. The loan specifies an interest rate that the students pay over the four year period. The credit department of HELB makes the decision as to whether or not to extend credit to a student. That is, the Credit department will receive a credit application from a student and, based on criteria established by the firm, will decide on whether to extend a loan and the amount. The criteria for extending credit or a Loan is referred to as underwriting standards. Because HELB is extending the loan, it is referred to as the originator of the loan.

Moreover, HELB may have a department that is responsible for servicing the loan. Servicing involves collecting payments from borrowers, notifying borrowers who may be delinquent, and, when necessary, recovering and disposing of the collateral if the borrower does not make loan repayments by a specified time. While the servicer of the loans need not be the originator of the loans, in our illustration we are assuming that HELB is the servicer.

We will assume that HELB has more than Sh200 million of installment loans issued to students. This amount is shown on the institutions balance sheet as an asset. We will further assume that HELB wants to raise sH200 million. Rather than issuing corporate bonds for Sh200 million, the treasurer of the institution decides to raise the funds via a structured financing.
To do so, HELB will set up a legal entity referred to as a special purpose vehicle (SPV). In our illustration,the SPV that is set up is called REAL ASSET TRUST (RAT). HELB will then sell to RAT Sh200 million of the loans. HELB will receive from RAT Sh200 million in cash, the amount it wanted to raise. But where does RAT get sh200 million? It obtains those funds by selling securities that are backed by theSh200 million of loans. The securities are the asset-backed securities we referred to earlier. These asset-backed securities issued in a structured finance transaction are also referred to as bond classes or tranches.

This structured finance is practiced in Europe, the USA, Australia and South Africa but as demonstrated it can also work in kenya!!. This can be a very good way Real insurance can generate additional income by charging commissions and fees to HELB from the process of securitization.RAT will be an independent institution bankruptcy remote and have separate management, BOD and legal structure separate from Real insurance BUT will act as its subsidiary.
A simple transaction can involve the sale of just one bond class with a par value of sh200 million. We will call this Bond Class A. Suppose that 200,000 certificates (when issuing shares to investors shown above) are issued for Bond Class A with a par value of sh1, 000 per certificate. Then, each certificate holder would be entitled to1/200,000 of the payment from the collateral. Each payment made by the students (i.e., the repairs’ of loans) consists of principal repayment and interest.
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REASONS FOR USING A STRUCTURED FINANCE TRANSACTION IN KENYA
1. The Potential for Reducing Funding Costs

To understand the potential for reducing funding costs by issuing an asset-backed security rather than a corporate bond , suppose that HELB has a triple B credit rating. If it wants to raise funds
equal to sh200 million and it issues a corporate bond, its funding cost would be whatever the benchmark Treasury yield is plus a yield spread for triple B issuers. Suppose, instead, HELB uses
sh200 million of its installment sales contracts (i.e., the loans it has made to additional students) as collateral for a bond issue. What will be its funding cost? It probably will be the same as if it issued a corporate bond. The reason is that if HELB defaults on any of its outstanding debt, the creditors will go after all of its assets, including the loans to students.

However, suppose that HELB can create another legal entity and sell the loans to that entity. That entity is the special purpose vehicle that we described earlier in our hypothetical structured finance transaction. In our illustration, it is Real Asset Trust (RAT). If the sale of the loans HELB Corporation to RAT is done properly—that is, the sale is at the fair market value of the loans—RAT then legally owns the receivables, not HELB.
This means that if HELB is forced into bankruptcy, its creditors cannot try to recover the loans (sold to RAT) because they are legally owned by RAT.

2. Diversifying Funding Sources

An issuer seeking to raise funds via a structured financing must establish itself as an issuer in the asset-backed securities market. Once an issuer establishes itself in the market, it can look at both the corporate bond market and the asset-backed securities market to determine the better funding source. That is, it will compare the all-in-cost of funds in the corporate bond market and the asset-backed securities market and select the one with the lower cost.

3. Accelerating Earnings for Financial Reporting Purposes

Generally accepted accounting principles permit a corporation to use a portfolio of its receivables or assets to accelerate earnings for shareholder reporting. This reason is best described by means of an illustration.
Consider again HELB, the issuer of student loans. Suppose that this firm has sh200 million in installment sales contracts (loans to students). For financial reporting purposes, the installment sales contracts are not realized as revenue until the installment payments are received (in accounting, this concept is Accrual concept). Suppose that the agreement with the Loan taker (student) is required to pay 8% interest per annum. Suppose further that the treasurer of HELB approaches RAT’S Investment banker and is told that it can sell an asset-backed security backed by the installment Loan contracts at a cost of 5%. This means that HELB is receiving from the installment sales of the loan contracts 8% and would pay investors in the asset-backed securities 5% . The difference between what HELB is receiving and paying is 3%. Part of that difference represents a cost to HELB for “servicing” the installment sales (loans)

In conclusion, the assets that can be securitized in Kenya are;

•Car loans because they usually have sequential interest payments

•Boat loans, wealthy individuals can decide to purchase a boat at the coast

•Credit card receivable since one pays sequentially over a period of time.




Emlyn Ngwiri

Zzzzzzzzzzzzzzzzz!!!!!!

from the above , people can come up with special purpose vehicles SPVS to grade or rank tranches based in the risk return ratio requred by the investor.

the question is,is kenya capable of this form of structured finance?

in my view yes it is, if the legal framework permits it since it involves complex legal consultations and approvals,it will give kenyans an interesting way to spread risk profiles of individuals.

Interesting article. I am currently working on a bond to finance university infrastructure and the main challenge is the future inflows as well as the fact that the university in mind can not get a rating. There is a gap in the arrears and looks like the government which is not allowed to borrow due to its HIPC status shall have to provide subvention to support this. Any ideas on how to overcome this?

@Mpenzi, While the legal framework may be a hindrance, the main challenge is how to make the bond attractive given that the source of revenue will end up being the government for all intents and purposes as the public university relies largely on government subsidies for its existence. My take is that this will be treated as infrastructure bond guaranteed by the government. However, the government is reluctant to guarantee due to HIPC considerations. I have approached other institutions to guarantee but there is no appetite. The investors would like to be assured of their investment and though a university bond is welcome, there are serious reservations harbored by investors.

Mmmhhh.

Interesting academic discussion.

First of all, I won't want to hear anything about CDS9they've caused more advanced economies to grind to a halt).
Securitisation is actually done better without credit ratings as they give you a false sense of security.
In Kenya the most obvious underlying instruments are loans and mortgages.

@ Emily
I like your thinking but... i also think that what you are describing is backing debt with debt.... and in the end a catastrophe is eminent.

See what I mean on "money as debt" by Paul Grignon http://www.moneyasdebt.net/

A good example is the collapse of the housing mkt in US recently and ensuing troubles. Just because Europe and the US are using it doesnt mean it is fault proof. Im not offering a tweak to your theory that would make it work, that would be presumptious, all im saying is maybe we can also learn from the mistakes made in the West.

my two cents

@ Emily - yeah pole, we seem to have deviated from your initial trail of thought. Pole, but Im happy to have bumped into like minded people :) Cheers!

@Scubidu - The local banks are known to put most of their attention towards gvt bonds as opposed to risky lending to common mwananchi but this trend i think has reduced over the last few years thanks to CBK. Previously you had to proove to the bank that you can afford to do wthout a loan to actually get one, and now there's a lady who stalks my collegues and I to take up a loan, even if i dont need one at the moment. of course when there is no money available to the common mwananchi, the economy will take a hit, so intervention by CBK is great, and welcome.

I saw your comments on fractional reserve banking. Yeah, the system creatss credit whenever someone takes up a new loan, but this is debt backed by debt, in my opinion there must be an elastic limit. We already knee deep in the mess, but i can't think of an alternative at the moment. The money creation process is flawed, and our taking on things that are practised in the west will be our undoing. So far our monetary system is quite conservative, but i think soon we'll scale up in the game.

What did you think of the documentary film - money as debt? More importantly, how do you think we can escape the trap, as individuals yaani?

Secondly have u seen this, and what are your thoughts on it? http://www.theeastafrica.../-/cghfxcz/-/index.html

Personally i think infrstructure bonds are great, coz the infrastructure will stimulate growth in existing sectors, along with job creation during developments, so in a way even though we're taking on a lot of debt, its self sustaining - at least i hope so.

Ur turn...

@ Scubidu - i've checked, i couldnt trace ur comments at Kenya Debt watch... Im new to Wazua site, hope u dont mind showing a girl around. Can u give a link to it? ama send to goldendelight@mail.com.
Thanks