Funding purposes of securitization

[Randy Moon]

This explanation seems at odds with the concept that Banks securitize to move these assets off their balance sheets. How do banks grow their loan books when they securitize, at the same time that this process removes these assets from their balance sheet? My embryonic understanding at this point would agree that they can increase volume through securitization, but because they are removing these items from their balance sheet, its not really growing their loan book. Thoughts?

 

[David Harper CFA FRM]

Hi @Randy Moon Good question. I checked and Choudhry (the source author) does say "grow loan books" although I do agree with you that this language choice presents as potentially confusing. "Loan books" connotes the banking book (e.g., loan assets carried with an intention to hold) as opposed to the trading book, a distinction introduced in the Basel regulations (P2.T7). First, to your point, although types of securitizations vary, the most classic ABS-type securitization monetizes credit-sensitive assets (e.g., credit card receivables) by selling them to the SPE: on the asset side of the balance sheet, this is "merely" a swap of illiquid loan assets for cash. Per se it does not shrink the balance sheet until (eg) the cash is used to reduce debt principal or buyback shares. To your point, this is "removal" of the asset off the balance sheet. (Of course Choudhry knows all of this and more, he's a world expert). There are plenty of valid scenarios where the motivation is to use securitization to shrink the balance sheet, which in my opinion, in nearer to your legitimate, apparent contradiction; e.g., such actions tend to improve ROE.

But, I think Choudhry is referring to "offensive" uses of securitization, rather than what I will call "defensive" motivations, and here the "loan book" seems to refer to the total set of loans being originated, which nowadays is a mix of sold and some retained. So, a bank can be using securitization, and moving much of the loans "off the balance sheet" to the SPE, yet simultaneously growing its balance sheet by using the securitization to ramp up the origination footprint. One of the companies I watch, but do not own, is Sofi (https://www.sofi.com/) and I was curious, because of course they securitize bigtime, so checked their last earnings call:

"Quickly switching to our balance sheet, which grew by approximately $600 million year-over-year to $9.2 billion in total primarily as a result of growth in originations that accelerated in the back half of the year. In addition, we exited the year with $1.6 billion drawn on our warehouse facilities, less than 25% of our overall $7 billion of capacity. That low reliance on warehouse capacity allowed us to significantly reduce our cost of funds, and we ended the year very well capitalized, having raised a total of $3.6 billion of new capital. Our total book value is $4.7 billion, and our capital and leverage ratios are extremely strong" https://www.bamsec.com/transcripts/15099356?hl_id=nynkcytzh

And 10K:

"Our lending business is primarily a gain-on-sale model, whereby we seek to originate loans and recognize a gain from these loans when we sell them into either our whole loan or securitization channels. We sell our whole loans primarily to large financial institutions, such as bank holding companies, typically at a premium to par, and in excess of our costs to originate the loans. Our loan premiums fluctuate from time to time based on benchmark rates and credit spreads, and we are not guaranteed a gain on all or any of our loan sales. When securitizing loans, we first isolate the underlying loans in a trust and then sell the beneficial interests in the trust to a bankruptcy-remote entity. In securitization transactions that do not qualify for sale accounting, the related assets remain on our consolidated balance sheet and cash proceeds received are reported as liabilities, with related interest expense recognized over the life of the related borrowing. In securitization transactions that qualify for sale accounting, we typically have insignificant continuing involvement as an investor.

Prior to selling our loans, we hold our loans on our consolidated balance sheet at fair value and primarily rely upon warehouse financing and our own capital to enable us to expand our origination capabilities. By securing our national bank charter, we believe we can lower our cost of funding by utilizing our members’ deposits held at SoFi Bank to fund our loans. Net interest income, which we define as the difference between the earned interest income and interest exnse to finance loans, is a key component of the profitability of our Lending segment." -- https://www.bamsec.com/filing/181887422000031/1?cik=1818874&hl=29187:30847&hl_id=nkyt9fkf3

So hopefully that's helpful realistic color! Thanks,

 

[Randy Moon]

Hi @Randy Moon Good question. I checked and Choudhry (the source author) does say "grow loan books" although I do agree with you that this language choice presents as potentially confusing. "Loan books" connotes the banking book (e.g., loan assets carried with an intention to hold) as opposed to the trading book, a distinction introduced in the Basel regulations (P2.T7). First, to your point, although types of securitizations vary, the most classic ABS-type securitization monetizes credit-sensitive assets (e.g., credit card receivables) by selling them to the SPE: on the asset side of the balance sheet, this is "merely" a swap of illiquid loan assets for cash. Per se it does not shrink the balance sheet until (eg) the cash is used to reduce debt principal or buyback shares. To your point, this is "removal" of the asset off the balance sheet. (Of course Choudhry knows all of this and more, he's a world expert). There are plenty of valid scenarios where the motivation is to use securitization to shrink the balance sheet, which in my opinion, in nearer to your legitimate, apparent contradiction; e.g., such actions tend to improve ROE.

But, I think Choudhry is referring to "offensive" uses of securitization, rather than what I will call "defensive" motivations, and here the "loan book" seems to refer to the total set of loans being originated, which nowadays is a mix of sold and some retained. So, a bank can be using securitization, and moving much of the loans "off the balance sheet" to the SPE, yet simultaneously growing its balance sheet by using the securitization to ramp up the origination footprint. One of the companies I watch, but do not own, is Sofi (https://www.sofi.com/) and I was curious, because of course they securitize bigtime, so checked their last earnings call:


And 10K:

So hopefully that's helpful realistic color! Thanks,

Very useful. Thank you for your very thorough response, and the time you invested in this.