FIXED-INCOME SECURITIES
Chapter 18
Asset-Backed Securities
Outline • Definition • ABS Credit Ratings • Credit Enhancement • Prices and Quotes
Issuers of Bonds Definition • ABS are securities exclusively collateralized by the cash-flows of a package of financial assets • There exist two categories of collateral – –
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Consumer financial assets: automobile loans, recreational vehicle loans, boat loans, home equity loans, student loans and credit card receivables, etc. Commercial financial assets: computer leases, manufactured housing loans, small business administration loans, agricultural machinery loans and trade receivables, etc. Main collateral types are automobile loans, home equity loans and credit card receivables
• ABSs have the highest priority claim on a pool of specific assets, isolated by the issuer from the whole assets of the company • This gives ABSs their secured status
Issuers of Bonds ABS Credit Ratings • Typically, a trust issues ABSs with different credit ratings • These credit ratings correspond to priority ranks in receiving cash-flow payments from the trust in case of default • The ranks are referred to as seniority classes • An ABS may have two or more such classes • For instance, it may be structured in three classes – A senior class, rated AAA – A middle or ''mezzanine'' class, rated A – A subordinated class, rated BBB or BB
Issuers of Bonds Credit Enhancement • The credit quality of ABSs is improved in comparison to that of the underlying loans or receivables • This is known as the credit enhancement mechanism • Credit enhancement can take several forms – – – – – – –
Excess spread protection Subordination Early amortization Letter of credit Cash reserve account Insurance Overcollateralization
Issuers of Bonds Prices and Quotes • ABSs are traded in a highly active secondary market • Like MBSs, they are quoted in yield spread over the Treasury bond yield curve or the swap yield curve, using the weighted average life measure (WAL) • The bid/ask spread generally varies between 2 and 15 basis points • The liquidity of ABSs is considered as good as that of investment-grade corporate bonds • The valuation of ABSs is very similar to that of MBSs, except that they are far less exposed to prepayment risk than MBSs