A collateralized mortgage obligation (CMO) is a type of financial debt vehicle that was first created in 1983 by the investment banks Salomon Brothers and First Boston for U.S
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said debt as bonds, pass-through securities, or Collateralized mortgage obligation (CMOs), to various investors. The principal and interest on the debt, underlying the security, is paid back to the various investors regularly. Securities backed by mortgage receivables are called mortgage-backed securities, while those backed by other types of receivables are asset-backed securities. The so-called lower risk of securitised instruments attracts a greater number of investors seeking to benefit in the process of taking many individual assets and repackaging them as Collateralized debt obligation.
Confusion between on and off balance sheet
Traditionally, banks lend to borrowers under tight lending standards, keep loans on their balance sheets and retain credit risk -- the risk that borrowers will default (be unable to repay interest and principal as specified in the loan contract). In contrast, securitization enables banks to remove loans from balance sheets and transfer the credit risk associated with those loans. Therefore, two types of items are of interest: on-balance sheet and off-balance sheet. The former is represented by traditional loans, since banks indicate loans on the asset side of their balance sheets. However, securitized are represented off the balance sheet, because securitization involves selling the loans to a third party (the loan originator and the borrower being the first two parties). Banks disclose details of securitized assets only in notes to their financial statements.
The Banking Example
A bank may have substantial sums in off-balance sheet accounts, and the distinction between these accounts may not seem obvious. For example, when a bank has a customer who deposits $1 million in a regular bank deposit account, the bank has a $1 million liability. If the customer chooses to transfer the deposit to a money market mutual fund account sponsored by the same bank, the $1 million would not be a liability of the bank, but an amount held in trust for the client (formally as shares or units in a form of collective fund). If the funds are used to purchase stock, the stock is similarly not owned by the bank, and do not appear as an asset or liability of the bank. If the client subsequently sells the stock and deposits the proceeds in a regular bank account, these would now again appear as a liability of the bank.
As an example UBS has CHF 60,316 Million Undrawn irrevocable credit facilities off its balance sheet in 2008 (USD 60.37 Billion.)
Citibank has USD $960 Billion in off-balance sheet assets in 2010, which amounts to 6% of the GDP of the United States.
