What is a Private Conduit

A private conduit is a private, rather than public, entity that pools mortgages and other loans. The entity will then issue pass- or pay-through securities in its own name, as a private conduit to investors. Many private conduits are now backed by mortgages, credit card receivables and other credit or asset-backed loans.

Private conduit is a label often associated with specialized investment companies such as real estate investment trusts or Master Limited Partnerships.

BREAKING DOWN Private Conduit

Private conduits enable banks and thrifts to more easily sell their loans to investors in the secondary market. This is because smaller lenders are not restricted by the size of the pool or limitations on eligibility. GNMA and FHLMC offered the first private conduits.

Private conduits do not trade publicly, such as on an organized exchange. As such, these arrangements are often considered a sophisticated investment vehicle. Because they are often illiquid, lack transparency and require advanced legal and tax consideration; private conduits are often investments for accredited investors.

The essential element of conduits is their pass-through nature. By simply passing through or acting as a conduit for all capital gains, dividends and interest to shareholders, the investment company should not be taxed at the corporate level. In contrast, shareholders in public corporations are taxed twice: once at the corporate level when corporate income taxes are paid and again at the individual level for income tax on any dividends. If an investment company structured as a conduit adheres to certain regulations, shareholders in a conduit are taxed only once. These vehicles can prove as effective tax planning instruments for those in a high tax bracket.

As part of the asset securitization market, private conduits are the apex of financial engineering, tax planning and legal structure — culminating in the sales of advanced investment vehicles.