Securitization is the process used to create asset-backed securities (ABS). It takes the illiquid assets of a financing company (the leases, loans, mortgages and credit card debts of its customers), pools them and transforms them into highly liquid securities that are sold to investors.
The process benefits both the financing companies and the investors.
For the financing companies, new capital is raised at more affordable rates than they could get through their commercial banks. Better yet, they do that by freeing up cash from assets sitting on their balance sheets. They also grow their loan books by lending the capital back out to new borrowers.
Investors not only benefit from the income that flows from the assets that “back” the securities, but also from the liquidity of the securities themselves—the ability to sell them to another buyer at any time.
More about securitization
Securities are categorized according to the type of assets used to back them. Examples include:
- Securities backed by long-term loans with high interest rates
- Securities backed by short-term loans with low interest rates
- Securities backed by accounts receivable (money a business is owed by its customers)
- Securities backed by royalty payments from contracts
This grouping helps investors select the asset-backed securities that best fits their investment profile.
One specific sub-category of asset-backed securities is backed by real estate. These are called mortgage-backed securities (MBS).