Securitization transforms illiquid assets into more liquid assets and allows lenders and originators to obtain more capital for lending. Keep reading to learn the basics of this vital and important process and why it matters to you.
What is securitization?
In short, “securitization” is a process that occurs when a group of similar financial assets are pooled together as collateral for securities. On their own, the individual financial assets — which can be things like mortgages and credit card receivables — are not easy to trade. Securitization makes these assets easier to trade by placing them in a trust and issuing a “security” that represents an interest in the assets (e.g., loans) of the trust. Securitization increases the amount of capital available for lending because loans do not sit on balance sheets until they are repaid. Instead, their value can be realized up front. In other words, money for lending is recycled more quickly through securitization.
What types of assets are securitized?
Technically, any asset that has a steady cash flow can be securitized.
When securitization emerged in the 1970s, the U.S. government used it to pool together large batches of home mortgages. Since the 1980s, the types of assets that have been packaged into securities has widened considerably. Most securitization is of common financial assets, such as mortgages, auto loans or credit card receivables. However, more esoteric assets like toll road revenues, intellectual property rights, taxicab medallions and rights to natural gas production have been securitized.
How does securitization affect investors?
Investors benefit from securitization, as it provides a larger range of tradable securities, which allows for portfolio diversification. Institutional investors cannot easily invest in assets such as individual mortgages, but through securitization they can invest in securities collateralized by mortgages and other assets such as credit cards and auto loan receivables. Securitizations allow investors to better manage the type and amount of risk they want to take on when it comes to their portfolio.
What does the process enable for the general public?
Let’s say you are looking to purchase a new car. You probably will need to take out a loan to do that. If you do, your loan may be bundled with a number of other loans and securitized. Securities collateralized by these loans can then be sold to investors in the financial markets. By selling these loans, the lender receives cash, which can then be used to make more loans instead of waiting for all of the borrowers to repay their loans. For you, this means the lender has the resources it needs to lend you the money so you can purchase your car — for the country, this expanded access to credit means more people are able to buy cars.