Definition
The term securitization refers to the process of taking an income generating asset and turning it into a security. Perhaps the most common form of securitization is an asset-backed security, issued by financial institutions.
Explanation
Securitization allows credit originators (lenders) to remove some of the risk in their portfolio and move it to another party. The process takes place in two steps. In the first step, a company (originator) identifies an income-producing asset(s) they wish to remove from their balance sheet and places the asset(s) into a reference portfolio. The originator then sells the reference portfolio to an issuer, which is oftentimes a special purpose vehicle, or SPV. A financial institution will set up the SPV in order to purchase the asset and keep it off their balance sheet too.
In the next step in the process, the issuer will finance the purchase of the reference portfolio by issuing interest-bearing securities to investors. The interest payments received by investors is funded by the cash generated by the reference portfolio's assets. Typically, the originator is the party that provides the interest payment to investors since they continue to collect payment from the original borrowers.
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