What is an asset-backed security?

If a financial company takes over an illiquid asset (a loan or mortgage) and designs it into an easily marketable form such as a stock or security, the process is called securitization.

A typical example is mortgage-backed securities. Let's take a closer look.

In this example, Omega Investments purchased a large number of mortgage projects in the Beta bank loan register. The quality of these mortgage loans varies from large loans to high-net-worth borrowers to small loans to high-risk borrowers.

Omega Investments divides these mortgage projects into parts based on loan quality, and then further splits each part into shares that can be sold to investors, these investors receive regular payments (proceeds) from the borrower's repayment of the loan.

These split parts are rated by rating agencies. For the portion of the loan that is of good quality and has a priority guarantee, the return will be lower than the unsecured portion. This reduces the risk of a borrower defaulting on a mortgage.

Mortgage-backed securities can be divided into two types: individual mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS). Other types of loans can be securitized in a similar manner, the most common of which are loan-backed securities (CLO).

The minimum investment for these securities is approximately US $10,000, so retail investors can participate in the market through the relevant funds.

Who is the winner?

Most securities are risky, and asset-backed securities are no exception. Don't forget that bad mortgage-backed securities were the culprits that triggered the last global financial crisis (2006 - 2008).

In a stable housing market, mortgage originators (I. E., the originator of the original loan) can make a profit by reselling the loan, thereby mitigating the risk to its own balance sheet.

People who securitize loans can also make a profit in some cases. They have provided a certain amount of liquidity to the market through loan securitization, thereby bringing more funds to the housing market.

Investors can profit from regular payments when they hold mortgage-backed securities, and of course they can buy and sell these securities at any time. However, the selling price of these securities can vary widely, depending on the market conditions at the time of sale.

Also keep in mind that unexpected fluctuations in interest rates, PBOC statements or political events can have an impact on mortgage-backed securities anywhere, the specialized nature of these securities also increases their risk of price volatility.