How Securitization Works

An increasing number of financial institutions offer securitization, which is a process that allows companies to sell bonds according to the funds they will earn in the future from assets. It is considered to be more affordable to raise money through securitization. The benefit of securitization is that there is a decrease in risk and other vulnerabilities.

The Securitization Process

The process of securitization involves two steps. In the first step, a company with income-producing assets will pool together certain assets to an issuer who will then purchase this bundle. When repackaged, these assets will then become interest-bearing securities, in which an issuer will sell to capital market investors. What securitization does is that it provides an alternative source of finance that is based on the transfer of credit risk.

Securitization offers financial institutions an alternative method of finding sources for funding. In the past, this has helped institutions reduce borrowing costs. Many companies do not have the required credit rating or financial capabilities to take out a loan or sell bonds. Instead, the company could pool together assets in order to raise cash by selling the package to an issuer, which then converts the pool into tradable security. The assets are also removed for the company's balance sheet, which makes the process more affordable. Moreover, securitization does not increase the company's liabilities.

Nowadays, securitization can be done with various types of assets and not just the traditional ones such as mortgages, bank loans, or self-liquidating assets. Today, the assets can include home equity loans, lease receivables and even small business loans. This has allowed securitization to be highly common alternative in newer markets.