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Securitization, Risk Management and Bank Capital. Ashish Dev Executive Vice President Group Head, Enterprise Risk Management KeyCorp Introduction. What is Securitization?

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Securitization, Risk Management and Bank Capital

Ashish Dev

Executive Vice President

Group Head, Enterprise Risk Management




  • What is Securitization?
    • An entity pools together identifiable cash flows over time and packages the pool of collaterals into notes, with explicit priority of payments and sells them to investors.
    • Thus securitization is, first and foremost, a financing mechanism for the issuer of the collaterals.
    • The tranche structure makes securitization interesting, in terms of risk.


  • Size and Growth of the Market
    • The total Securitization market in the world stands at about US $ 3.0 trillion.
    • The US market is by far the largest in volume.
    • High growth in European and Asian markets in recent years.
    • As capital markets develop in countries around the world, securitization market is likely to take off in the near future.

Types of Securitizations

  • Securitization types are defined based on the type of the underlying pool of assets
    • mortgage loans ==> MBS
    • consumer loans ==> ABS
    • corporate loans ==> CLO
    • corporate bonds ==> CBO
  • Mortgage backed securities (MBS) were the first ones and are still the most predominant type of securitization.
securitization tranches
Securitization Tranches
  • Securitization (of a pool of loans) allocates interest income and principal repayments from the underlying pool to a prioritized collection of securities notes called tranches.
  • Cash-flow waterfall: senior notes are paid before mezzanine, and mezzanine notes before first-loss (equity) position.
  • Waterfall defines loss on a given tranche from the loss in the underlying pool.
prepayment risk in securitizations
Prepayment Risk in Securitizations
  • Prepayment risk: potential loss due to full or partial prepayment of the outstanding balance by borrowers
    • Important for Mortgage backed securities.
    • Prepayments happen when interest rates are low.
    • MBS issued by government agencies, credit risk is negligible and prepayment risk is the predominant risk.
    • In case of Credit cards, issuer replaces prepaid balances by new set of credit card receivables.
credit risk in securitizations
Credit Risk in Securitizations
  • Credit risk: potential loss due to defaults by borrowers in the pool
    • Credit risk is driven mostly by
      • probabilities of default by individual borrowers
      • recoveries in the event of borrowers’ default
      • correlations in default behavior between different borrowers
      • Extent of over-collateralization
loans bonds vs securitizations
Loans/Bonds vs. Securitizations
  • Similarities
    • Similar principal and interest cash flows in the event of no loss
    • Both are rated by agencies
  • Differences
  • Generally, credit risk models designed for loan/bond portfolios are not applicable to securitization tranches
models of credit risk for securitizations
Models of Credit Risk for Securitizations
  • Economic capital for securitizations should be determined from a dedicated model that
    • treats tranche as part of the investor’s portfolio
    • derives tranche loss from the loss distribution of the underlying pool
  • Recent credit risk models for securitizations
    • Pykhtin & Dev (RISK, May 2002): granular pools
    • Pykhtin & Dev (RISK, January 2003): non-granular pools
    • Gordy & Jones (RISK, March 2003): granular and non-granular pools
basel ii and securitizations
Basel II and Securitizations
  • Capital charge is determined by Standardized or IRB approach
  • IRB approaches include
    • Ratings-based approach (RBA)
      • calibrated to Pykhtin-Dev model
      • applied whenever external rating available
    • Supervisory Formula approach (SFA)
      • based on Gordy-Jones model
      • applied when external rating is not available
    • Internal assessment approach (IAA)
      • applied to Asset Backed Commercial Paper conduits only
supervisory formula approach
Supervisory Formula Approach
  • Capital charge: area under the curve between tranche bounds
ratings and required capital
Ratings and Required Capital
  • Agency ratings are based on either expected loss (Moody’s) or probability of default (S&P)
  • Generally, economic capital for a tranche cannot be determined from the credit rating alone.
  • Other determinants of economic capital or regulatory minimum capital
    • Tranche thickness and seniority
    • Granularity of underlying pool (i.e., effective number of assets)
ratings based approach
Ratings Based Approach
  • Basel Committee has made an attempt to incorporate the effects of thickness, seniority and granularity into the RBA
comparison of models
Comparison of Models
  • SFA and RBA are calibrated to different models
    • but the models can be calibrated to yield similar capital charges
  • As capital markets develop in countries around the world, Securitization is likely to be one of the fast growing financial instruments.
  • For purposes of Credit Capital, Securitization Tranches should not be treated similar to loans and bonds -- they require a model based on the loss distribution of the underlying pool.
  • Economic or Regulatory Capital cannot be determined from rating alone.
  • Development of recent models and their adoption in Basel II have significantly enhanced understanding of risk in Securitizations.