Economic Capital for Securitisations

Michael Pykhtin

Securitisation is pooling of financial assets and issuing claims on cashflows generated by those assets in the form of marketable securities. These securities are generally known as asset-backed securities (ABS). Assets in the pool are usually some form of debt, and, depending on the nature of the debt, there are different names for ABS:

• first mortgages: mortgage-backed securities (MBS) and collateralised mortgage obligations (CMO);

• consumer loans other than first mortgages: ABS; and

• bonds and commercial loans: collateralised debt obligations (CDO).

The financial institution that originally owns the assets is called originator. Typically, the originator does not issue ABS. Instead, it sells the pool of assets to a special-purpose vehicle (SPV) – a company set up specifically for the purpose of the transaction. The SPV, which is usually rated AAA, is needed to protect ABS from default of the originator. The SPV issues notes backed by the cashflows from the pool of assets (hence the name ABS), sells them to investors and uses the proceeds of the sale to pay the originator for the assets.

Since different investors have different risk preferences, the SPV issues