Securitization: formula sheet

Key formulas

Originator's cash from sale

Sale price = Pool value (face) × Issue price % − upfront costs, if any

If securities are issued at a discount to the pool's principal, the difference is the originator's cost of the deal. Always read what the question treats as costs.

Excess spread (per year)

Excess spread = Interest collected on pool − Interest paid to investors − Servicing fee − Expected credit losses

Positive excess spread acts as first-level credit protection. Use the items the question gives.

Subordination (junior tranche) cover

Credit cover % = Junior tranche ÷ Total pool × 100

Losses are absorbed first by the junior tranche, then reach the senior tranche.

Pool pass-through cash flow

Cash to investors = Principal repaid + Interest collected − Servicing fee

The SPV passes collections to investors after fees. Use only the heads the question states.

Flow of the structure

Obligors → Servicer → SPV / Trustee → Investors

Cash flows upward from borrowers to investors. The sale flows the other way: Originator → SPV (pool), SPV → Investors (securities).

SPV purchase price

Price paid by SPV = Present value of pool cash flows at investors' required yield

Originator receives this in cash. It is also the amount the SPV raises from investors, less any issue expenses.

Pass through payout

Investor payment = Collections (interest + principal) − servicing fee, shared pro rata

Pass through payment depends on actual collections. If the pool pays slower or faster, investors receive accordingly.

Excess spread

Excess spread = Pool interest rate − (Investor coupon + Servicer fee)

A common first line of credit cushion. State it as a rate per year on the outstanding pool.

Pass-through payment to investors

Investor receipt = (Interest + Principal collected) − Servicing fee

Paid pro rata to certificate holders. Principal includes prepayments received.

Pro rata share

Holder's receipt = Holder's units ÷ Total units × Net collections

Use for every pass-through question. All units rank equally.

Tranche waterfall rule

Senior tranche is paid first; losses hit the equity/junior tranche first

Applies to pay-through, CDO and structured MBS. Principal is paid in order of seniority.

Prepayment effect on STRIPS

Higher prepayment → IO value falls, PO value rises

IO depends on outstanding principal. Prepayment shrinks that principal, so the interest stream ends early and IO falls in value. Prepayment also hurts holders who bought at a premium over par, because they lose the above-par coupon stream early. PO gains from early receipt of the fixed principal.

Over-collateralisation amount

Over-collateralisation = Pool value − Face value of securities issued

Express as a % of pool value or of securities issued. Say which base you use.

Credit enhancement as % of pool

Credit enhancement % = (Pool value − Senior securities) ÷ Pool value × 100

Everything junior to the senior tranche, including over-collateralisation, forms the cushion for it.

Loss absorption order

Pool loss is absorbed by: excess spread / reserve → junior tranche → mezzanine → senior

Exact order depends on the deal waterfall. State your assumption.

Excess spread

Excess spread = Interest collected on pool − (Coupon on securities + servicing and other costs)

Compute per year. It is the first line of defence in many deals.

Cover multiple

Cover multiple = Credit enhancement available ÷ Expected loss

A higher multiple supports a higher rating. Do not quote a fixed multiple for a rating unless the question gives it.

Security receipt holding by ARC

ARC's own investment = 15% × total SRs issued under the scheme

RBI norm for ARCs: they must hold at least 15% of SRs in each scheme, so their own money is at stake.

Minimum retention requirement (MRR)

Retained amount = MRR % × book value of loans securitized

RBI sets the % by loan type and original maturity (higher for longer loans). Use the % given in the question; do not quote from memory if not stated.

Amount raised by sale

Pool sold to SPV = Pool value − retained portion

Use this to find what investors fund after the originator keeps its MRR.

SARFAESI enforcement trigger

Account classified NPA → demand notice (60 days) → enforce security interest

The secured creditor may take possession or sell the secured asset without court order; the borrower can appeal to the Debt Recovery Tribunal.

Recovery to SR holders

Payout to SR holders = Recoveries − ARC fees and costs (as per scheme terms)

SR value rises and falls with actual recoveries; it is not a fixed-income claim.

Instalment on a level-payment pool

EMI = P × r ÷ [1 − (1 + r)^−n]

P is the pool principal, r the rate per period, n the number of periods. Use the annuity factor if the question gives one.

Interest and principal split

Interest = Opening balance × r; Principal = Instalment − Interest; Closing balance = Opening balance − Principal − Prepayment

Interest is always on the opening balance after the previous period's prepayment.

Net cash flow to investors

Net flow = Interest + Principal + Prepayment − Servicing fee

Deduct fees and any stated retained amounts. Do not deduct anything the question does not mention.

Value of the PTC / pool

Value = Σ [Net flow(t) ÷ (1 + y)^t]

y is the investors' required yield per period, not the pool's coupon.

Premium or discount

Premium (+) or Discount (−) = Value − Outstanding principal

Value above principal means investors accept a yield lower than the pool coupon.

Single monthly mortality (prepayment rate)

SMM = Prepayment ÷ (Opening balance − Scheduled principal)

Use only when the question gives a prepayment rate. It applies to the balance after the scheduled principal.

Periodic rate from annual rate

Monthly rate = Annual rate ÷ 12 (nominal); (1 + y)^(1/12) − 1 (effective)

Use the convention the question states. Default to the nominal rate ÷ 12 if unspecified.

Quick revision

• Securitization converts illiquid assets into tradable securities backed by pool cash flows.
• The originator sells the pool to an SPV, which issues the securities.
• True sale to the SPV is what takes assets off the originator's books and separates investor risk from the originator.
• The servicer collects payments from borrowers and passes them to the SPV or trustee.
• The trustee protects investor interests and oversees the structure.
• ABS is backed by receivables such as vehicle loans or credit card dues; MBS is backed by mortgage loans.
• In a pass-through certificate (PTC), collections pass to investors in proportion to their share, net of servicing costs.
• Credit enhancement can be internal (subordination, excess spread, overcollateralization) or external (guarantees, insurance).
• A rating reflects the credit quality of the pool and the enhancement, not just the originator.
• Prepayments shorten the life of the pool and change investor yield.
• Pool value is the present value of expected collections at the investors' required rate.
• Benefits to originator: liquidity, risk transfer and capital relief; main investor risks are credit, prepayment and interest rate risk.

Common mistakes

• Treating securitization as a simple loan taken by the originator. Fix: State that it is a sale of assets to the SPV. Investors look to the pool for repayment, not to the originator's general credit.
• Leaving out the true sale and bankruptcy-remote nature of the SPV. Fix: Always say the SPV is separate and that the sale isolates the pool from the originator's creditors.
• Calling the borrower the originator. Fix: The originator is the lender that sells the assets. The borrower is the obligor.
• Saying the SPV exists only to reduce tax. Fix: The core purpose is a true sale and bankruptcy remoteness, so investors depend on the pool and not the originator's solvency.
• Treating ABS and MBS as different structures. Fix: Remember that the difference is the collateral. Both can be pass-through or pay-through.
• Saying pass-through certificates are tranched. Fix: PTC holders share pro rata. Tranching belongs to pay-through, CDOs and structured deals.
• Treating over-collateralisation and tranching as the same thing. Fix: Over-collateralisation is extra pool value over securities. Tranching is a split of securities by seniority. Explain them separately.
• Taking the cushion as a percentage of the wrong base. Fix: Use pool value as the base unless the question says otherwise, and state it.
• Treating SARFAESI as the law for all securitization, including performing loans. Fix: Link SARFAESI mainly to ARCs, SRs and enforcement of security, and link standard-asset deals to RBI's securitization directions.
• Saying SRs give a fixed return like a bond. Fix: Remember SR holders are paid from recoveries on the acquired NPA, so returns depend on realization and can be lower than expected.

Exam tips

• Draw a small flow diagram in words and arrows: originator, SPV, investors. It scores clear marks in theory answers.
• Always name the parties: originator, SPV, investors, servicer, trustee, rating agency, and give each a one-line role.
• In MCQs, watch for the words true sale, bankruptcy-remote and homogeneous pool. They are common test points.
• For numerical questions, show each cash flow line separately. Marks go for method even if one figure is wrong.
• Write both benefits and limitations when asked to evaluate securitization.
• Draw a small flow diagram of the parties in descriptive answers. It scores fast and shows structure.
• Always say why the SPV is separate: true sale and bankruptcy remoteness. Examiners look for this phrase or its meaning.
• When asked to compare pass through and pay through, use two or three points: investor's claim, prepayment risk, and structure of payments.