Loading the player...

What is 'Securitization'

Securitization is the process through which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors. This process can encompass any type of financial asset and promotes liquidity in the marketplace.

Mortgage-backed securities are a perfect example of securitization. By combining mortgages into one large pool, the issuer can divide the large pool into smaller pieces based on each individual mortgage's inherent risk of default and then sell those smaller pieces to investors.

BREAKING DOWN 'Securitization'

The process of securitization creates liquidity by enabling smaller investors to purchase shares in a larger asset pool. It can involve the pooling of contractual debts such as auto loans and credit card debt obligations, or any assets that generate receivables. Using the mortgage-backed security example, individual retail investors are able to purchase portions of a mortgage as a type of bond. Without the securitization of mortgages, retail investors may not be able to afford to buy into a large pool of mortgages.

In securitization, the company holding the loans, also known as the originator, gathers the data on the assets it would like to remove from its associated balance sheets. These assets are then grouped together by factors, such as the time remaining on a loan, the level of risk, the amount of remaining principle and others. This gathered group of assets, now considered a reference portfolio, is then sold to an issuer. The issuer creates tradable securities representing a stake in the assets associated with the portfolio, selling them to interested investors with a rate of return.

Benefits of Securitization to Creditors and Investors

Securitization provides creditors with a mechanism to lower their associated risk through the division of ownership of the debt obligations. The investors effectively take the position of lender by buying into the security. This allows a creditor to remove the associated assets from their balance sheets.

The investors earn a rate of return based on the associated principle and interest payments being made by the included debtors on their obligation. Unlike some other investment vehicles, these are backed by tangible goods. Should a debtor cease payments on his asset, it can be seized and liquidated to compensate those holding an interest in the debt. Like other investments, the higher the risk, the higher potential rate of return. This correlates with the higher interest rates less qualified borrowers are generally charged. Even though the securities are back by tangible assets, there is no guarantee that the assets will maintain their value should a debtor cease payment.

  1. Securitize

    Securitize is the process of combining debt contracts into a ...
  2. Net Interest Margin Securities ...

    A security that allows holders to access excess cash flows from ...
  3. Mark To Model

    The pricing of a specific investment position or portfolio based ...
  4. Temporary Lender

    A mortgage lender that sells the loans it originates into the ...
  5. Excess Spread

    Excess spread is the remaining net interest payments from the ...
  6. Credit Market

    1. The broad market for companies looking to raise funds through ...
Related Articles
  1. Investing

    Investing In Securitized Products

    Securitized assets are customizable pools of financial assets that come with a wide range of yields. Learn what makes them an attractive asset class.
  2. Investing

    Financial Institutions: Stretched Too Thin?

    Find out how to evaluate a firm's loan portfolio to determine its financial health.
  3. Personal Finance

    Behind the Scenes of Your Mortgage

    Four major players slice and dice your mortgage in the secondary market.
  4. Personal Finance

    Understanding the Mortgage Payment Structure

    We explain the calculation and payment process as well as the amortization schedule of home loans.
  5. Insights

    The Fuel That Fed The Subprime Meltdown

    Take a look at the factors that caused this market to flare up and burn out.
  6. Personal Finance

    Reduce Interest With An All-In-One Mortgage

    "Offset" mortgages combine a checking account, home-equity loan and mortgage into one account.
  7. Tech

    How to Choose a Cryptocurrency Mining Pool

    Here are some selection criteria cryptocurrency miners should consider before joining a crypto mining pool.
  8. Personal Finance

    Ways to Be Mortgage-Free Faster

    Getting rid of this debt faster has bigger benefits than you might think.
  1. What are some of the arguments in favor of debt securitization?

    Find out how debt securitization creates benefits for loan originators, borrowers, investors and capital markets by diversifying ... Read Answer >>
  2. Why do banks securitize some debts, and how do they sell them to investors?

    Learn how and why banks securitize debt, how the securitized debt is sold to other investors, and how different the different ... Read Answer >>
  3. What is securitization?

    Securitization involves taking an illiquid asset, or group of assets, and transforming it into a security. A typical example: ... Read Answer >>
  4. Why do MBS (mortgage-backed securities) still exist if they created so much trouble ...

    Read several different arguments in favor of allowing the trade of mortgage-backed securities, even after the financial crisis ... Read Answer >>
Hot Definitions
  1. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  2. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  3. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  4. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  5. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  6. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
Trading Center