Financial Dictionary -> Loans -> Security

In the financial sector, a security is a blanket term referring to an instrument (usually just recorded as a piece of paper) that represents financial value, such as stock, bonds, debt securities, funds, options, futures contracts and other derivatives. Technically currency can also be regarded as a security, such as a paper note, although they are generally not seen that way.

A common form of security is asset backed or asset as collateral (ABS - Asset Backed Security). This simply means the value and income payments on the security are derived from a collection or pool of underlying assets, like a collection of mortgages. The pooling of these assets allows an instrument to be sold to investors based on the general performance of the pool as a whole, giving them a diversified security, rather than a riskier one off investment. This process of pooling assets to create an asset backed security is called securitization.

Usually asset as collateral securities are set up by separate financial institutions from the typical high street banks. They'll buy the underlying assets from the banks, such as credit card payments, vehicle loans, mortgages, leases, royalties etc and pool them in to a special purpose asset vehicle that is used to pay back the original banks when they sell it to investors based on specified requirements, such as the risk factor. Once paid the bank will then settle the debt, and the risk is now the financial responsibility of the newly created security, although repayments of the underlying assets still go through the bank that issued them.

Asset backed securities that deal specifically in mortgages are common, the largest companies to do this are the Federal National Mortgage Association, otherwise known as the Fannie Mae, and the Federal Home Loan Mortgage Corporation, otherwise known as the Freddie Mac.