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1.5.2 How Securitization Works

While the practical details of the modern securitization process vary, it typically involves the pooling of mortgages under the common ownership of an entity whose sole purpose is to hold the loans. This process begins with the lender who originates the loans. In some cases another entity will buy up the loans (sometimes from multiple lenders) and aggregate them.

In private-label securitization, the loans are eventually assigned in bulk to an entity often called the “sponsor” or, confusingly, the “seller.” This transaction is usually governed by a mortgage loan purchase agreement that includes various representations and warranties regarding the loans.408 The sponsor then transfers the pool of loans to the “depositor,” sometimes also called the “issuer.” These transfers may be planned in advance, before the loans were made, or may be arranged afterward. The depositor transfers the loans to their ultimate owner—usually a trust—in return for securities that are sold to investors.

The GSEs securitize loans in a slightly different manner, often simply swapping securities for mortgages and then creating the trust themselves or insuring a trust created by a third party.409

Mortgage-backed securities are rated by bond-rating agencies.410 The lower the rating, the harder it will be to sell the securities. Some of the lowest tranches (representing the greatest risk) may be unsellable and retained by one of the parties to the securitization process. Mortgage securitizations are structured to minimize the risk of loss to the investors through insurance and recourse agreements between the trustee and lender. Credit enhancement is an aspect of structuring a securitization transaction to get the desired bond rating. Bond insurance is an example of “external” credit enhancement. Even more common are methods of “internal” credit enhancement. Dividing securities into tranches is one example of an internal credit enhancement.411


  • 408 {408} Fed. Hous. Fin. Agency v. Nomura Holding Am., Inc., 104 F. Supp. 3d 441, 463 (S.D.N.Y. 2015), aff’d, 873 F.3d 85 (2d Cir. 2017).

  • 409 {409} Barry G. Jacobs, HDR Handbook of Housing and Development Law § 9:177 (2013).

    Information about Fannie Mae’s single-family mortgage-backed securities is available from the Fannie Mae website,

  • 410 {410} The rating companies could be Moody’s, Standard & Poors, or Duff & Phelps Credit Rating Co.

  • 411 {411} See Fed. Hous. Fin. Agency v. Nomura Holding Am., Inc., 104 F. Supp. 3d 441, 464–465 (S.D.N.Y. 2015) (discussing subordination and overcollateralization as forms of credit enhancement), aff’d, 873 F.3d 85 (2d Cir. 2017).