Mock Securitization: Process & Principles

Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

Securitizing loans into packages and selling them to investors is a common practice in real estate and auto finance. However, newer asset types must try a mock or practice securitization to determine feasibility. We will look at an example.

What Is Securitization?

Many of you may be involved in a securitized transaction and not even know it! If you are buying a home, a car or even have a credit card, your lender may have included your debt in a securitized package.

Securitization is the process whereby the issuer (usually a lender) groups similar types of loans (assets) together and sells them to investors as securities. Think of securitization like a cake. Let's say a mortgage company wants to securitize five mortgage loans. The loans form the layers in a big cake, which is then cut into slices (called tranches) and sold to investors. The benefits of securitization accrue to the different parties:

  • The obvious appeal to the investor is diversification. It's less risky to own a piece of five different mortgages than to own just one mortgage.
  • The mortgage company benefits because they get their money back quickly from the investors, instead of waiting for the customers to pay. The assets (loans) come off of their balance sheet and lower capital requirements.
  • Consumers benefit because when lenders get their money back quickly, they can lend it out again and finance another new home or vehicle.

Mock Securitization

Mock securitization is when the participants in a securitized transaction prepare all of the documents and paperwork like it was a real transaction, only no money changes hands and no one loses any!

Mock securitization is useful when a new asset class is being considered for securitization. Doing the mock lets the developer of the assets know if it's even possible to securitize, and if so produces a wealth of feedback about what the rating agencies and investors want to see in a package. The most important feedback is whether the proposed securitization is attractive enough to get a high rating from the agencies. Getting an investment grade rating like an A or high B will assure that investors will look into them. That also assures a low rate can be offered.

Solar Energy Example

A new asset class that has emerged recently is solar energy. Residential customers buy or lease solar panels that will generate energy to power their homes. To help solar energy to take a bigger piece of the energy pie, solar developers decided a few years ago to look into securitization. It would inject new investor capital into the industry and speed up cash flows, allowing solar developers to build and install more panels.

Securitization will speed up growth in the solar industry.

In 2015, promoting solar energy was a priority of the federal government as well, so a division of the Department of Energy organized the Solar Access to Public Capital Mock Securitization Project. Let's take a closer look at this project.

Mock Securitization Project

The project drew a lot of interest, as over a dozen solar developers participated, along with five big-name rating agencies including Standard & Poor's and Moody's. The developers represented a fictional company called SolarCo, which would pitch the securitized leases to the rating agencies, who would then provide feedback and a rating for the securities. SolarCo would need to prepare a complete package for the agencies, just as if it were a real issue. In addition to all of the legal documents, granular data packages were prepared in these areas:

  • The pool of assets. This consisted of residential leases based on actual data provided by the developers. The 'cake' to be securitized consisted of 21,308 leases, 73% of which were in the leading solar state, California. The average credit score (FICO) of the customers was 765. The average energy savings of solar over conventional utilities for these customers was 16.81%, an important consideration because these savings give customers an incentive to keep paying on their leases.
  • Performance data on the leases. The agencies were concerned about a credit risk unique to solar: the transfer of the lease to a different homeowner when the customer moves, divorces, goes bankrupt or dies. The SolarCo group was able to show that leases may fall into arrears, but the money eventually gets recovered in these situations.

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