What is a Conduit?
A conduit is a unique company or trust made to buy assets. The assets are for securitization or asset-backed commercial paper (ABCP).
Sometimes, a private company like a bank or securities firm makes the conduit. They are called the sponsor. Sometimes, the government makes the conduit, too.
The sponsor sells or gives assets to the conduit. The conduit keeps getting assets until it has enough. This group of assets is called a portfolio.
What Does a Conduit Do?
When the conduit has all the assets it needs in the portfolio, it does a few things:
Issuing Notes or ABCP
The conduit makes unique financial products called notes or asset-backed commercial paper (ABCP). It sells these to investors.
The notes and ABCP have to follow special rules called the terms of the securitization. The terms say what the conduit has to do with the money it gets.
Selling the Portfolio
Sometimes, the conduit doesn’t issue the notes or ABCP itself. Instead, it sells the whole portfolio of assets to another company. That company issues the notes or ABCP to investors.
Types of Conduits
There are different types of conduits depending on where they get assets from:
Single-Seller Conduits
Some conduits only take assets from one company. That company is the only seller.
Multi-Seller Conduits
Other conduits take assets from lots of different companies. They have many sellers.
Protecting Investors
Investors who buy notes or ABCP from conduits want to make sure they will get their money back. Conduits have some special ways to protect investors:
Guarantees
A third-party company makes a special promise called a guarantee. They agree to pay investors if the conduit can’t. This protects against credit risk – the chance that people who owe the conduit money won’t pay it back.
Letters of Credit
A company like a bank writes a special letter called a letter of credit. The letter says the bank will pay investors if the conduit doesn’t have enough cash. This protects against liquidity risk – the chance that the conduit won’t have enough money available to pay investors on time.
Conduits can have full or partial guarantees and letters of credit. Full ones cover all the money investors put in. Partial ones only cover some of it.
Why Use Conduits?
Companies and banks use conduits to do securitization and issue ABCP. Securitization is a way for them to get money now for assets that will earn money in the future.
The companies sell assets to the conduit. The conduit sells notes and ABCP to investors. The conduit uses the money from investors to pay the companies for the assets.
This way the original companies get money faster than waiting for the assets to earn it over time. The conduit and investors get the money when the assets finally earn it.
Banks and securities firms sponsor conduits because it earns them fees. They get paid for setting up and running the conduit. Conduits are a big business for them.
