See Also:
Collateralized Debt Obligations
Secured Claim
Subordinated Debt
Mezzanine Debt Financing (Mezzanine Loans)
Asset Based Financing
Passthrough Securities Definition
A passthrough security is a debt obligation that represents the cash flows towards a certain asset or liability. There is often an intermediary between the cash flows and the investor who provides a lump sum many times to receive several cash payments in the future.
Passthrough Securities Explained
Passthrough securities are similar to asset-based financing; however, asset based financing involves using an asset like land for a loan. Whereas a passthrough security simply passes future cash flows onto an investor. Some of the most well known pass through securities were involved in the recent financial crisis. These are regularly known as mortgage backed securities (MBS) and asset backed securities (ABS). Furthermore, these securities simply take the future mortgage or asset payments toward a certain asset and sell them in the market for a lump sum. As a result, a company can see more cash or liquidity up front. Notice that the passthrough occurs between the person making the payment to the bank or financial institution, and the financial institution then providing this cash to the investor. In most situations, a bank will assume the role as a passthrough entity.
Passthrough Securities Example
For example, Money Bank specializes in the real estate market and provides financing to individuals buying houses. In order to stay liquid and keep providing loans Money Bank groups the mortgages it has obtained every quarter and sells them in the marketplace at a discount. Bob is a wealthy investor and wishes to invest in something that will provide him a meaningful return. Bob comes across the passthrough securities provided by Money Bank and decides to purchase some of the pass through securities. Both parties have benefited because Bob is earning a meaningful return while the Bank has received liquidity and can now provide more real estate loans.
