Securitizations

Securitization is the financial process by which illiquid assets, such as loans or receivables, are pooled and sold to investors in the form of securities. The assets are transferred to a special purpose vehicle (SPV) that is designed to be bankruptcy-remote and to issue notes backed by the pool’s cash flows. The SPV isolates the assets from the originator’s balance sheet, which can help transfer credit risk and free up capital.

Key participants include the originator or sponsor, the SPV, a servicer who collects payments, a trustee, rating agencies, and investors. Cash flows from the underlying assets are allocated through a payment waterfall, with senior notes receiving priority and junior tranches absorbing losses. Credit enhancements such as overcollateralization, reserve accounts, subordinated securities, and third-party guarantees help improve the credit quality of the senior tranches.

Assets commonly securitized include residential and commercial mortgages (RMBS and CMBS), auto loans, credit card receivables, student loans, and other financial assets. Securitization can lower funding costs, increase liquidity, and diversify funding sources for originators, while transferring credit risk to investors.

Risks include credit and default risk, prepayment and extension risk, liquidity risk, and structural or legal risk due to complex structures. Ratings depend on model assumptions and the effectiveness of credit enhancements. Regulation in some jurisdictions requires originators to retain a portion of securitized risk to align incentives.

Related concepts include asset-backed securities (ABS) generally and synthetic securitizations; structured vehicles like CDOs provide broader or alternative forms of risk transfer. Securitization has been a major feature of global finance since the mid-20th century, with RMBS and CMBS among the largest segments.