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FRM Exam Part II · An Introduction to Securitisation

Securitisation Basics and the Originate-to-Distribute Model

Updated 11 October 2026 · Fact-checked

Securitisation pools loans or other receivables, sells them to a special purpose vehicle (SPV), and the SPV funds the purchase by issuing tranched securities backed by the pool's cash flows. In the originate-to-distribute model, a bank makes loans to sell them on, not to hold them. To solve questions, trace the assets, cash flows and risk.

Understand Securitisation Basics and the Originate-to-Distribute Model

Securitisation turns a pool of illiquid assets into tradable securities. The assets can be mortgages, auto loans, credit card receivables or corporate loans. The cash they produce (interest and principal) pays the investors who buy the securities.

Here is the usual path. The originator (often a bank) makes the loans. It pools them and sells them to a special purpose vehicle (SPV), a separate legal entity. In a true sale, the assets move off the originator's balance sheet and are legally isolated from its bankruptcy. This is called bankruptcy remoteness. The SPV pays for the assets by issuing securities to investors. A servicer collects payments from borrowers. Rating agencies rate the securities, and an arranger structures the deal.

In the originate-to-hold model, a bank keeps its loans and bears the credit risk, so it screens borrowers carefully. In the originate-to-distribute (OTD) model, the bank originates loans, securitises them and passes the risk on. The bank earns fees and recycles its funding and capital. The weakness is a weaker incentive to screen and monitor borrowers, because the originator no longer bears the losses. This was a recognised factor in the subprime crisis. Retention rules (the originator keeps some exposure, often called skin in the game) were introduced in response.

Banks use securitisation for funding diversification, liquidity, and capital relief, since assets that are truly sold and meet regulatory criteria can reduce risk-weighted assets. Investors use it to gain exposure to a chosen risk and return profile through tranches, which may be unavailable from direct lending.

A covered bond is different. The bank issues the bond itself, and investors have recourse to the bank (the issuer) and also a dedicated cover pool of assets. The assets usually stay on the issuer's balance sheet and are replaced if they deteriorate. In securitisation, investors rely on the pool only and the assets are typically removed from the originator's balance sheet.

Key formulas to remember

Securitisation flow
Originator → (true sale) → SPV → issues tranched securities → investors; borrower payments → servicer → SPV → investors
Cash flows pass through the SPV to investors by the priority of the waterfall.
Pool cash flow identity
Cash available to investors = interest collected + principal collected − servicing and other senior fees
The waterfall pays senior tranches first, then lower tranches, with equity last.
Securitisation vs covered bond
Securitisation: investor recourse to the pool only; Covered bond: recourse to the issuer and the cover pool (dual recourse)
Covered bond assets typically stay on the issuer's balance sheet.
OTD incentive rule
Less retained risk ⇒ weaker incentive to screen and monitor
This is a moral hazard problem. Risk retention requirements aim to reduce it.

How to solve Securitisation Basics and the Originate-to-Distribute Model questions

Use this method for any securitisation or originate-to-distribute question.

  1. 1Identify the roles: originator, SPV, servicer, arranger, rating agency and investors.
  2. 2Check the transfer: is it a true sale that gives bankruptcy remoteness, or does the bank keep the risk?
  3. 3Trace the cash flow from borrowers through the servicer and SPV to tranches.
  4. 4Decide whether the bank holds or distributes the loans, and who bears the credit risk.
  5. 5Link the structure to the motive: funding, liquidity, capital relief or risk transfer.
  6. 6Identify the risk: weaker screening incentives, asymmetric information, model or rating risk, or residual exposure.
  7. 7Compare the answer options against the precise definition and eliminate extreme wording.

Quickest way: Three-question shortcut

When to use it: Use it when a question asks you to define the structure or choose the correct statement.

  1. Who owns the assets after the deal: the bank or the SPV?
  2. Who bears losses if the pool underperforms: the issuer, or only the investors?
  3. Does the bank still have an incentive to screen the borrowers?
  4. If investors have recourse only to the pool, think securitisation. If they also have recourse to the bank, think covered bond.

Common mistakes in Securitisation Basics and the Originate-to-Distribute Model

  • Treating securitisation and covered bonds as the same thing.

    Both are bonds backed by loan pools.

    Fix: Remember the recourse: covered bonds have dual recourse to the issuer and a cover pool, which usually stays on the balance sheet.

  • Saying the SPV is owned and controlled by the originator for bankruptcy purposes.

    The SPV is set up by the originator.

    Fix: The point of a true sale is legal isolation (bankruptcy remoteness) of the assets from the originator.

  • Assuming OTD always means the bank takes no risk.

    The loans leave the balance sheet.

    Fix: Banks may keep retained tranches, give support, or hold warehoused loans before sale. Risk transfer can be partial.

  • Thinking the OTD problem is credit risk rising mechanically.

    Students mix up cause and effect.

    Fix: The issue is the incentive problem: weaker screening and monitoring when losses are passed on.

  • Believing securitisation always gives capital relief.

    Removal from the balance sheet sounds automatic.

    Fix: Relief depends on meeting regulatory criteria, including significant risk transfer. Say it can reduce capital, not that it always does.

Worked examples

Example 1

A bank originates auto loans, sells them to an SPV in a true sale, and the SPV issues notes to investors. Investors are repaid only from the loan pool. Is this a securitisation or a covered bond, and why?

Show the solution
  1. The bank sold the loans to a separate SPV, so the assets are legally isolated from the bank.
  2. The SPV funds the purchase by issuing notes backed by the pool.
  3. Investors have recourse only to the pool, not to the bank.
  4. Covered bonds would give investors a claim on the issuer as well as the cover pool.

Answer: It is a securitisation, because of the true sale to the SPV and the pool-only recourse.

Example 2

Explain why the originate-to-distribute model can weaken lending standards, and name one policy response.

Show the solution
  1. Under OTD the bank sells the loans soon after origination.
  2. So it bears little of the eventual default loss.
  3. Its incentive to screen and monitor borrowers falls, a moral hazard problem.
  4. Lower standards raise default rates in the pool, which investors may not detect given asymmetric information and reliance on ratings.
  5. A response is risk retention: the originator keeps a portion of the exposure so it shares the losses.

Answer: OTD weakens screening incentives because losses are passed to investors. Risk retention requirements realign the incentives.

Exam tips

  • Look for the keyword recourse. It separates securitisation from covered bonds.
  • Questions often link OTD to the subprime crisis. Answer with incentives and asymmetric information.
  • Watch for absolute words such as always or never. Capital relief and risk transfer depend on conditions.
  • Know each participant's role: originator, SPV, servicer, arranger, rating agency.

Practice questions from An Introduction to Securitisation

Securitisation Basics and the Originate-to-Distribute Model in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Securitisation Basics and the Originate-to-Distribute Model: frequently asked questions

What is securitisation in FRM Part II?

It is the pooling of loans or receivables and the sale of them to an SPV, which issues securities backed by the pool's cash flows. You must know the participants, the cash flow path and the risks.

What is the originate-to-distribute model?

It is a model where a bank originates loans to sell them, usually through securitisation, and not to hold them to maturity. It earns fees and frees funding and capital, but screening incentives can weaken.

How do securitisation and covered bonds differ?

Securitisation relies on the pool alone, and the assets move to an SPV. A covered bond is issued by the bank and gives investors recourse to both the bank and a cover pool that usually stays on its balance sheet.

Why do banks securitise loans?

They do so for funding diversification, liquidity, and possible capital relief, and to transfer risk. Capital relief depends on meeting regulatory conditions.