Backed Securities

 Backed securities are primarily serviced by cash flows arising from a set pool of receivables or other financial assets that may include loans, leases, credit card debt, receivables, royalties or mortgages. A major reason for offering backed securities is that they enable the loan originators to bring together a pool of assets that could not have traded otherwise in their original form.[br] 

 Backed securities are primarily serviced by cash flows arising from a set pool of receivables or other financial assets that may include loans, leases, credit card debt, receivables, royalties or mortgages. A major reason for offering backed securities is that they enable the loan originators to bring together a pool of assets that could not have traded otherwise in their original form.[br] 

Types of Assets used for Backed Securities

Any asset that has a revenue stream can be used as a backing for a security. Most securities are backed by loans and other financial assets. Home equity loans, auto loans, credit cards and student loans (both private and government) form the major types of assets used to collateralize securities in the US. However, in recent years, manufactured housing loans, equipment leases and loans, aircraft leases, trade receivables, dealer floor plan loans, royalty payments and intangibles have been used to back securities.

 

The process of issuing backed securities in the US is governed by the Securities Act 1933 and the Securities Exchange Act of 1934. Publicly issued asset backed securities need to satisfy the standard SEC registration and disclosure requirements.

 

Advantages and Disadvantages of Backed Securities

 

The issuance of asset backed securities enables improved liquidity for assets, which in the normal course, face difficulty in being sold. The process of pooling various assets into a financial instrument for sale to general investors is called securitization. For investors, investment in securities backed by a mix of assets means diversification of the risk involved in investing in a single type of asset.[br]

 

Several commercial banks have securitized their credit card receivables to free up a significant portion of their capital for investment in other avenues. In the absence of the securitization option, the capital of these banks would have remained tied up, thus limiting the option of further investments.

 

A major disadvantage for the investor lies in the fact the performance of an asset backed security is solely dependant on the cash flows pertaining to the concerned assets. For example, in case of mortgage backed securities, the value of the security is determined by the frequency and regularity of the payments by mortgage holders. The 2007 housing crisis in the US resulted in uncertainty surrounding securities backed by mortgage payments and led to an overall financial collapse.