In the past two years, the popular press, for good reason, has railed against the lack of regulation, systemic failures, and rampant conflicts of interest that led to the recent financial crisis. Securitized products, and derivatives of those products, have been featured prominently as analysts, academics, and legislators assign blame for the bank failures and the market turmoil of the past two years.

But to dismiss the financial technology of Securitization in its entirety would be to throw the baby out with the bathwater. Securitization has tremendous potential as a social finance tool. A tool that can be used to raise capital for a variety of endeavors, from microfinance to the construction of low-income housing, while providing impact investors with access to new investment products.

Arguably, Securitization might even be a more palatable tool in the social finance context than in the traditional business realm, since the social finance context avoids some of the issuer opportunism that has hurt investors in traditional securitized products. Wouldn’t it be the best sort of irony if a financial technology associated with corporate excess, questionable rating agency practices, and capital markets gone awry were used to solve meaningful problems and finance socially beneficial enterprises?

Below I try to provide a high level explanation of Securitization, point to some uses of Securitization in the social finance context, and discuss other potential uses of the technology.

What is Securitization?

Broadly speaking, Securitization is the financial technology behind the alphabet soup of "bond-like" assets investors hold, including RMBS (Residential Mortgage-Backed Securities), CMBS (Commercial Mortgage-Backed Securities), CLOs (Collateralized Loan Obligations), and CDOs (Collateralized Debt Obligations).

Securitization is used to transform a given set of assets into a packaged security that can be sold to investors. Here’s a very simple illustration in the mortgage context from a World Economic Forum publication entitled Blended Value Investing: Capital Opportunities for Social and Environmental Impact.

A bank will initiate a large number of home loans, lending the bank’s money to home buyers. The bank can then package the debt into new bonds, and the coupon and principal payments associated with these bonds are passed from the home owners through an intermediary and eventually to the purchasers of the security. Typically, banks will sell those bonds (and the homeowners’ associated cash flows) to third parties that can manage the various cash flows and can distribute or resell the bonds. Doing so effectively converts a bank’s loans receivable into cash immediately, and the bank can then loan that cash to new home buyers, starting the cycle anew.

Using Securitization in the Social Finance Context

Several international microfinance organizations, including the Grameen Foundation, have already completed securitization transactions in their domestic markets, packaging microfinance loans into securities offered to investors.

Many other possibilities exist to finance socially beneficial enterprises using securitization. In Canada for instance, regional organizations such as the Ottawa Community Loan Fund make loans to community businesses, co-ops and social enterprises. Loans to social enterprises made by loan funds across the country could be securitized to raise additional funds for social lending while creating an investment product that would allow SRI and impact investors the opportunity to participate in financing social enterprises across the country.

Securitization also offers benefits to government participants and grant-makers by allowing them to increase the impact of each dollar they put towards social enterprises. A large governmental or quasi-governmental organization can use its financial clout to guarantee a (portion of a) securitized pool of loans, which makes investors more comfortable with buying the securitized product. The guarantee allows governments and grant-makers help social enterprises raise capital without the need to deliver actual funds to the enterprises up-front. The International Finance Corporation (IFC), for example, uses a guarantee structure to participate in securitization transactions. The IFC has completed a number of guarantee-based securitzation transactions related to development projects, and has even used this approach to finance a Sharia-compliant mortgage-backed securitization to help finance middle-income housing for the Kingdom Installment Company.

Increasing Access to Private Capital for Social Enterprises

By creating securities that have different risk/return profiles, Securitization can be used to match social purpose businesses with funding from multiple sources, including purely commercial investors. For any given securitization in the social finance context, where the financial returns of the underlying businesses are potentially lower, commercial investors can participate in the "top" part of the capital structure, if it has a more acceptable risk profile. The simplified illustrations below speak to the use of securitization in financing social purpose businesses – and specifically to increasing private sector financing options. While government and blended-value investors will always be very important to social finance, commercial investors can serve as an increasingly important additional source of financing for this asset class, as they already do in the microfinance context.

Source:Shyam Shankar

A good fit for Social Finance

Securitization can be an important social finance tool in the years to come. A tool that in some ways might prove even more valuable in the social finance context than in the traditional corporate one. Social finance issuers of securitized products would not necessarily be driven by the accounting optics of higher ROAs or off-balance sheet treatments that corporations look to. Instead they would seek a straightforward way to raise capital as they carry out their social and commercial mandates. Since social finance organizations are motivated primarily by the social impact of their investees and loan recipients, many of the moral hazard issues related with risk-transference in the traditional business context are conspicuously absent. So while the traditional corporate securitization industry re-examines itself after recent dramatic market events, securitization can establish itself as an innovation that will help finance socially beneficial projects, has an attractive SRI and impact investing component, and can help maximize the reach of available government and grant-making dollars.

Additional Resources

There are a number of detailed securitization resources and primers available online. For starters, check out:

• A Securitization Primer by Scotia Capital
• International Finance Corporation on Securitization
• Blended Value Investing: Capital Opportunities for Social and Environmental Impact

Photo credit: http://www.flickr.com/photos/lovingshiva/1570839078/

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