ABS Flashcards
What is an asset backed security?
An asset-backed security (ABS) is a financial security collateralized by a pool of assets such as loans, leases, credit card debt, royalties or receivables. For investors, asset-backed securities are an alternative to investing in corporate debt. An ABS is similar to a mortgage-backed security, except that the underlying securities are not mortgage-based.
Here is an example of an asset backed security:
Assume that Company X is in the business of making automobile loans. If a person wants to borrow money to buy a car, Company X gives that person the cash, and the person is obligated to repay the loan with a certain amount of interest. Perhaps Company X makes so many loans that it runs out of cash to continue making more loans. Company X can then package its current loans and sell them to Investment Firm X, thus receiving cash that it can use to make more loans.
Investment Firm X will then sort the purchased loans into different groups called tranches. These tranches are groups of loans with similar characteristics, such as maturity, interest rate and expected delinquency rate. Next, Investment Firm X will issue securities that are similar to typical bonds on each tranche it creates.
Individual investors then purchase these securities and receive the cash-flows from the underlying pool of auto loans, minus an administrative fee that Investment Firm X keeps for itself.
How many tranches will an ABS typoically have?
Usually an ABS will have three tranches: class A, B and C. The senior tranche, A, is almost always the largest tranche and is structured to have an investment-grade rating to make it attractive to investors.
The B tranche has lower credit quality and thus has a higher yield than the senior tranche. The C tranche has a lower credit rating than the B tranche and might have such poor credit quality that it can’t be sold to investors. In this case, the issuer would keep the C tranche and absorb the losses.
What are the assets in ABS’s usually like?
An asset-backed security (ABS) is a security whose income payments and hence value are derived from and collateralized (or “backed”) by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets which are unable to be sold individually.
Pooling the assets into financial instruments allows them to be sold to general investors, what is this process called?
a process called securitization
What are tzpical underlying assets?
The pools of underlying assets can include common payments from credit cards, auto loans, and mortgage loans, to esoteric cash flows from aircraft leases, royalty payments and movie revenues.
What is ofetn created to handle ABS’s
Often a separate institution, called a special purpose vehicle, is created to handle the securitization of asset backed securities
What does the special purpose vehicle do?
The special purpose vehicle, which creates and sells the securities, uses the proceeds of the sale to pay back the bank that created, or originated, the underlying assets.
What does thge bank do with the assets?
As long as the credit risk of the underlying assets is transferred to another institution, the originating bank removes the value of the underlying assets from its balance sheet and receives cash in return as the asset backed securities are sold, a transaction which can improve its credit rating and reduce the amount of capital that it needs.
What ios the incentive of banks for asset backed securities?
Thus, one incentive for banks to create securitized assets is to remove risky assets from their balance sheet by having another institution assume the credit risk, so that they (the banks) receive cash in return. This allows banks to invest more of their capital in new loans or other assets and possibly have a lower capital requirement.
What relationhips do CDO’s and MBS have to ABS?
In the first case, collateralized debt obligations (cdo, securities backed by debt obligations – often other asset-backed securities) and mortgage-backed securities (mbs, where the assets are mortgages), are subsets, different kinds of asset-backed securities.
As a rule odf thumb diostinguish MBS, CDO and ABS
“As a rule of thumb, securitization issues backed by mortgages are called MBS, and securitization issues backed by debt obligations are called CDO …. Securitization issues backed by consumer-backed products – car loans, consumer loans and credit cards, among others – are called ABS
What are home equity loans?
A home equity loan is a type of loan in which the borrower uses the equity of his or her home as collateral. The loan amount is determined by the value of the property, and the value of the property is determined by an appraiser from the lending institution.[1] Home equity loans are often used to finance major expenses such as home repairs, medical bills, or college education. A home equity loan creates a lien against the borrower’s house and reduces actual home equity.
Of what type are most Home equity loans?
Investors typically refer to HELs as any nonagency loans that do not fit into either the jumbo or alt-A loan categories. While early HELs were mostly second lien subprime mortgages, first-lien loans now make up the majority of issuance.
What is the second major type of ABS?
Auto loans
