Financial engineering : Question 3
What are the advantages and drawbacks of securitisation and defeasance, in terms of risk and valuation?

The securitisation of assets provides a financial institution or a company with ready cash, and, if applicable, enables it to remove it from its balance sheet. Accordingly, securitisation enables a company to reduce the total balance sheet and improve the weighted debt / equity ratio, one of the ratios that banks keep a very close eye on. This said, the cost of these arrangements is higher than that of straight debt, especially for a high-quality borrower.

Defeasance is an extension of the concept of securitisation – the borrower simultaneously sells debt and a portfolio of assets to a special-purpose vehicle (SPV). The portfolio of assets is designed to meet the interest payments and repay the principal of the debt. The goal of this technique is to enable the company to make a clean sweep of the past. It brings forward the cost of the debt, and thereafter, the total debt on the balance sheet corresponds to the company’s real debt obligations. It only enables the company either to spread out losses over time, which entails a cost, or to separate the wheat from the chaff, allowing the rest of the company’s assets to flourish, “unfettered” by the legacy of a heavy debt burden.

For more information, see chapter 48 of the Vernimmen.