Asset Backed Securities

What are Asset Backed Securities (ABS)?

Similar to the way mortgage backed securities are structured, asset backed securities are also collateralized by assets and have been structured as pass through securities which can have multiple classes, or tranches

The key difference is probably obvious; MBS are backed by mortgages while ABS are backed by other forms of collateral, such as credit card receivables, manufactured homes, auto loans, or HELOC's (home equity line of credit).

Issuing Asset Backed Securities

In order to sell asset backed securities and protect themselves from the inherent risk of the security; corporations will create special purpose vehicles, or SPV's, in order to funnel the securities through.  This is a separate legal entity and absolves the issuer of any liabilities. 

ABS vs. MBS

An asset backed security is subject to prepayment risk; however, not nearly as much as MBS.  People are more likely to pay off mortgages by refinancing than they are to pay off credit card debt or auto loans.  Another key difference between the two types of securities is the guarantees offered by both.  Remember, Fannie Mae and Freddie Mac MBS are backed by the government and therefore have virtually no credit risk, similar to treasury securities.  An asset backed security, on the other hand, will entail a credit risk, albeit a small one due to the diversification of assets included in the security. 

Just like the mortgage industry where banks will sell mortgages to Fannie Mae and Freddie Mac to get them off their balance sheets; ABS issuers will do the same in order to issue more and more debt. 

ABS vs. Corporate Debt

Asset backed securities are extremely liquid and for this reason provide to be a great alternative to illiquid corporate debt.  In addition to the added benefit of liquidity; the asset backed security carries less event driven risk in comparison to corporate debt and therefore has gained quite a bit of popularity since their first issue in 1985.

Tim Ord
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