What Is Securitization?

THE ROLE OF SECURITIZATION AND THE SECONDARY MARKET

The securitization industry is a vast and critically important market that provides an efficient funding mechanism for originators of consumer and business credit. The industry provides liquidity to nearly every sector of the economy – including the residential and commercial mortgage industry, the automobile industry, the consumer credit industry, the leasing industry and the insurance industry – as well as to the commercial loan and corporate bond market. Securitization, moreover, provides effective mechanisms for bank and non-bank financial institutions and other entities to manage credit and other risks associated with their business activities.

The securitization process starts with lenders who extend credit to new borrowers or existing borrowers who refinance credit products. With the vast majority of credit products, lenders undertake an underwriting process by which they review a borrower's creditworthiness and determine whether and, if so, precisely what formal credit offer to extend to the borrower.  To free up additional capital for lending, a group of loans may be securitized by pooling and selling them into the secondary market as securities to investors.

Before securitization became prevalent, banks funded extensions of credit through their customers' deposits, and credit availability was dictated, in part, by the volume of bank deposits. Today, banks and other lenders have the option of retaining loans or selling them into what is called the secondary market where loans often underlie asset-backed securities. Many lenders issue their own asset-backed securities backed by the loans they originate or purchase. Others do not lend directly, but purchase pools of loans from a wide-range of originators. These pools can be used to back an issue of bonds or can be retained as an investment. Regardless, the original lender obtains new capital it can use to make new loans to new borrowers. Purchasers of such securities include institutional investors, such as pension funds, mutual funds, banks and insurance companies. These investors supply the capital needed to make loans that otherwise might not be available. The ability of originators to sell loans into the secondary market, therefore, increases the credit available to lend and lowers borrowing costs.