Asset Securitization: A Supervisory Perspective

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Asset Securitization: A Supervisory Perspective In recent years the number of banks and bank holding companies (referred to here as banking organizations) that have issued securities backed by their assets and that have acquired asset-backed securities as investments has increased markedly. The reason for this increase is that securitization activities, if conducted in a prudent manner, can yield significant financial and operational benefits for banking organizations. At the same time, bank supervisors must carefully assess the effect of asset securitization activities on the financial condition, performance, and risk profiles of banking organizations.

This article examines asset securitization from a supervisory perspective. The first section describes the mechanics of the securitization process, the structures of asset-backed securities, and the involvement of banking organizations in this process. It also discusses the incentives for issuing and acquiring asset-backed securities.

The second section outlines the supervisory issues associated with ownership or issuance of asset-backed securities by banking organizations and the supervisory policies and procedures used by the Federal Reserve System in light of the growing involvement of banking organizations in asset securitization. It summarizes generally accepted accounting principles (GAAP) and bank regulatory reporting requirements as they pertain to sales treatment of asset securitization transactions. This section also examines the provisions of the risk-based capital guidelines that relate to the asset securitization process.

AN OVERVIEW OF ASSET SECURITIZATION

In its simplest form, asset securitization involves the selling of assets. The process first segregates generally illiquid assets into pools and transforms these pools into capital market instruments. The payment of principal and interest on these instruments depends on the cash flows from the assets in the pool that underlies the new securities. The new securities may differ from their underlying assets in terms of denominations, cash flows, and other features that make the securities more attractive to investors.

Asset securitization, as we know it, began when the federal government encouraged the securitization of residential mortgages. In 1970, the Government National Mortgage Association (GNMA) created the first publicly traded mortgage-backed security. Soon, the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC), both government-sponsored agencies, also developed mortgage-backed securities. The guarantees that these government or government-sponsored agencies provide, which assure investors of the payment of principal and interest, have greatly facilitated the securitization of mortgage assets.

Asset securitization has grown dramatically over the past few years. The outstanding amount of residential mortgage-backed, pass-through securities, which are the largest segment of the asset-backed securities market, has increased approximately 168 percent since year-end 1984 to $769 billion by year-end 1988 (table 1). In addition to rapid growth in residential mortgage-backed securities, recent years have witnessed an explosion in the issuance of securities backed by other assets: credit card receivables, automobile loans, boat loans, commercial real estate loans, home equity loans, student loans, nonperforming loans, and lease receivables. The annual issuance of securities backed by assets other than mortgages has increased from slightly more than $1 billion in 1985 to more than $16 billion by the end of 1988.

The Securitization Process

The asset securitization process begins, as depicted in the chart, with the segregation of loans or leases into pools that are relatively homogeneous with respect to type of credit, maturity, and interest rate risk. These pools of assets are then transferred to a trust or other entity known as an issuer because it issues the securities that are acquired by investors. …