This paragraph will illustrate two important aspects which characterize the activity of banks providing finance to real estate investments: fund raising, e.g. the systems by which the banks collect money on the market in order to reallocate it to the disbursement of real estate loans, and loan syndication, e.g. the procedure whereby the initial lending bank shares the loan with other banks, or assigns all of the amounts due through securitization. Whilst the collection of funds is a necessary part of a bank's operations (as a financial intermediary), syndication and securitization are optional activities which have favoured the consistent disbursement of real estate loans even by smaller banks.

1.5.1 Traditional Funding and Securitization

Within this context it is important to recall that according to the traditional system for granting real estate loans, once the bank has obtained the funds, it grants the borrower the loan and the relative receivable remains due to the bank for the full term of the loan. Consequently, the relationship between the bank and the borrower has the same duration as the loan and any default on the loan will only affect the lending bank, which therefore has a strong interest in processing the loan application properly and in adopting a medium to long-term view of the operation.

Under the traditional system, the value of loans granted was thus directly proportional to the banks' assets, which have to guarantee, amongst other things, the relative credit risk on loans granted. In contrast, under a system based on securitization,[1] the banks assign their loans (even immediately after the operation is concluded) to third parties (which are not necessarily banks) which, in a nutshell, issue stocks on the market in order to finance the operation. The lending bank need not have any interest in attending to the fund raising activity (it will raise short-term funds), nor necessarily in establishing a lasting relationship with the borrower. After the assignment, any default by the borrower will be of no consequence for the original lending bank, but only for the parties which bought the notes issued on the market as part of the securitization process. The amount loaned in circulation is potentially infinite because it is no longer associated with the rigid capital requirements applicable to the banks.

In general, the technique of securitization consists in the conversion of various forms of assets into securities which can be readily traded on the market. This technique makes it possible to discount to the transaction date the present value of future cash flows which will be generated by the securitized assets. The transaction therefore makes it possible to finance the cash flows which one party, defined as the originator of the transaction, will be entitled to receive in future as a result of the collection of receivables or the sale of assets.

The securitization starts with the sale of those assets and is subsequently completed with the issue of the notes on the financial market. The cash flows resulting from loans, mortgages, and other assets (such as immovable properties) provide the guarantee for the notes issued and the means of ensuring their repayment.

More precisely, the assets at issue in the transaction are transferred for consideration from the originator to the transferee, which acquires them in return for payment of a fee: this transaction is financed through the issue of notes which are placed on the retail market or with institutional investors.

The former transactions were first concluded on the US market in the second half of the 1970s in order to transform the receivables of financial institutions into cash. However it was only later that this instrument was applied on a large scale to mortgage loans within the real estate market and the mortgage loans market.

Securitization offers banks a way of securing financing by enabling them to assign the loans they have granted to investors, thereby freeing up capital for new credit transactions.

  • [1] For further references on securitization please see also Stone and Zissu (2012), Fabozzi et al. (2007), Sabarwal (2006) and Fabozzi and Dunlevy (2001).
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