Securitization is the process of pooling income-producing assets together into a tradeable security. This can include debt, such as a mortgage, student and car loans. Securities backed by mortgage loans are commonly referred to as mortgage-backed securities, whereas other loan types back asset-backed securities. These combined assets, once packaged as securities, are then sold to investors, who receive regular payments from them. For example, if the security consists of loans, interest from those debts is typically paid to the investors.
Benefits of Securitization
Businesses, such as banks and corporations, create securities for a number of reasons: First, this practice allows them to establish new sources of cash flow because they are able to draw in investors who are more likely to buy into a pool of combined assets like securities, rather than invest in any one individual asset. Second, businesses can structure the cash flow generated by the assets in a way that maximizes maturity, credit or other aspect favored by investors. Third, securities are not included in a business's balance sheet or the calculation of its credit rating. Therefore, a business can purchase assets at a rate lower than what it would pay if it were relying on the strength of its balance sheet and credit rating alone.
- Creatas/Creatas/Getty Images