What is Securitization of an Asset?


I do not understand it.

In: Economics

You take many assets with similar characteristics, for example mortgage loans held by a bank with similar rates and risk characteristics. Each of those assets have cash flows into the bank, basically the monthly payments made by the borrower. Then the bank will sell them to a securitization entity which will bundle up those assets and create new assets called securities which represent the cash flows on the assets which were securitized. These are them sold to various third party investors. What this does is it allows the banks to monetize these assets through selling them to the securitization entity. And the investors can purchase new assets based on their risk appetite and required return.

The other post kept it a little technical. Basically, what a company does is take a bunch of assets like mortgages, leases, accounts receivables, loans, anything that has a somewhat predictable stream of cash flow, and creates a new separate company to sell them to. That new company gets the money to buy the assets by issuing bonds. The interest on these bonds is paid by the cashflows from the assets. The assets also serve as collateral for the bonds too.

To the bank, a loan is an asset. It has value because of the monthly payments that come in. Any asset can be sold. So a bank can take 100 or 1000 loans and package them up and sort of make one really big asset out of it. That’s what securitizing means, turning loans into a bond. Then either insurance companies or investment companies or individuals can buy a part of the bond.