Asset-Backed Security

<body onLoad="MM_checkPlugin('Shockwave Flash','','http://www.riskglossary.com/default_nofl.htm',false);return document.MM_returnValue" stylesrc="../_private/template.htm" bgcolor="#FFFFFF" link="#669933" vlink="#000000" alink="#000000"> <div align="left"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table2"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table3"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table4"> <tr> <td width="100%" align="left" valign="top"> <p class="header_gold">Asset-Backed Security</td> <td width="45" align="right" valign="bottom"> <map name="FPMap6"> <area href="http://www.contingencyanalysis.com" shape="rect" coords="1, 0, 44, 11" target="_top"> </map> <img border="0" src="../images/home.gif" usemap="#FPMap6" width="45" height="12"></td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table5"> <tr> <td width="0%" align="left" valign="top"> <p class="header2_black">Explained:<br> <img border="0" src="../images/blank_1x100.gif" width="100" height="1"></td> <td width="95%" align="left" valign="top"><p class="word_list"> <a href="#asset-backed security">asset-backed security</a><br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" style="border-collapse: collapse" bordercolor="#111111" width="310" align="right" id="table6"> <tr> <td align="right" width="9" height="14"></td> <td width="300" height="14"> <font size="2"> </font><font size="4"> </font></td> </tr> <tr> <td align="right" width="9"> </td> <td width="300"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="body">An <b><a name="asset-backed security">asset-backed security</a></b> (ABS) is a <a href="../articles/securitization.htm">securitized</a> interest in a pool of assets. Conceptually, the structure is similar to a <a href="../articles/mortgage_backed_security.htm">mortgage-backed security</a> (MBS), so it is convenient to describe the structure according to its differences from MBS. </p> <p class="body">MBSs are backed by mortgages—fixed rate, floating rate, residential, commercial, single family, multi-family, etc. ABSs are backed by non-mortgage assets. This includes auto loans, credit card receivables, home equity loans, student loans, etc. Due to government guarantees, MBSs typically entail no credit risk. ABSs generally lack such guarantees, so they entail credit risk. Due to diversification of the underlying assets, as well as <a href="../articles/credit_enhancement.htm">credit enhancements</a>, that risk tends to be modest. ABSs can be subject to <a href="../articles/mortgage_backed_security.htm">prepayment risk</a>, but this is slight compared to that of MBSs. Consumers are more likely to refinance a home than an auto in response to a drop in interest rates.</p> <p class="body">ABSs are appealing to issuers because the structure allows them to get assets off their balance sheets, freeing up <a href="../articles/capital_allocation.htm">capital</a> for further receivables. Also, ABSs make it possible for issuers whose unsecured debt is below <a href="../articles/junk_bond.htm">investment grade</a> to sell investment grade—even AAA-<a href="../articles/credit_risk.htm">rated</a>—debt.</p> <p class="body">To create an ABS, a <a href="../articles/corporation.htm">corporation</a> creates a <a href="../articles/off_balance_sheet_finance.htm">special purpose vehicle</a> to which it sells the assets. While is is common to speak of the corporation as the issuer of the ABS, legally, it is the trust or special purpose vehicle that is the issuer. It sells securities to investors. To protect investors from possible bankruptcy of the corporation, there are three legal safeguards:</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="left" id="table7"> <tr> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> <td width="9"> </td> </tr> </table> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10">Transfer of assets from the corporation is a non-recourse, true sale.</p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10">Investors receive a <a href="../articles/legal_risk.htm">perfected interest</a> in the assets' cash flows.</p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10">A non-consolidation legal opinion is obtained certifying that assets of the trust or special purpose vehicle cannot be consolidated with the corporation's assets in the event of bankruptcy.</p> <p class="body">These same safeguards allow the corporation to remove the assets from its balance sheet. The corporation generally continues to service the assets—collecting interest and <a href="../articles/par_value.htm">principal</a> payments, pursuing delinquencies, etc. It is paid out of asset cash flows for providing these ongoing services.</p> <p class="body">For investors, ABSs are an alternative to highly-rated corporate debt. They generally offer similar or superior liquidity. Because the underlying assets are diversified, they are less subject to credit surprises.</p> <p class="body">ABSs can be structured into different classes or <a href="../articles/securitization.htm">tranches</a>, much like <a href="../articles/collateralized_mortgage_obligation.htm"> collateralized mortgage obligations</a> (CMOs). There may be senior or subordinated classes of debt, which have different credit ratings. Tranches may be structured with different average maturities. Choice of structure depends upon investor demand as well as the nature of the underlying assets.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table8"> <tr> <td height="30" valign="bottom"> <p class="header2_black">Related Internal Links</td> </tr> <tr> <td bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table9"> <tr> <td width="100%"> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/credit_enhancement.htm">credit enhancement</a> Any methodology that reduces the credit risk of a transaction with a counterparty.<p align="left" class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><strong style="font-weight: 400"><a href="../articles/credit_risk.htm">credit risk</a> Risk</strong> due to uncertainty in a counterparty's ability to meet its obligations.</p> <p class="explanatory_text" align="left"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/collateralized_debt_obligation.htm">collateralized debt obligation</a> A securitized interest in debt.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/collateralized_mortgage_obligation.htm">collateralized mortgage obligation</a> A type of MBS with cash flows segregated into bonds offering different maturity and risk characteristics.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/mortgage_backed_security.htm">mortgage-backed security</a> Securitized interest in a pool of mortgages. CMOs are a type of mortgage-backed security.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/off_balance_sheet_finance.htm">off-balance sheet financing</a> Financing that doesn't appear on a firm's balance sheet.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/securitization.htm">securitization</a> The process of pooling assets and selling interests in the pool to investors.</td> </tr> </table> </td> </tr> <tr> <td height="30" valign="bottom"> <p class="header2_black">Related Books</td> </tr> <tr> <td bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table10"> <tr> <td width="100%"> <p class="explanatory_text">Hayre (<a target="_blank" href="http://www.riskbook.com/link/hayre_l_(2001).htm">2001</a>) is an excellent, comprehensive books on MBS and ABS.</p> <table border="0" cellpadding="4" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table11"> <tr> <td width="100" align="left" valign="top"> <map name="FPMap435"> <area target="_blank" href="http://www.riskbook.com/link/hayre_l_(2001).htm" shape="rect" coords="0, 0, 82, 124"> </map> <img border="0" src="../images/book_salomon_125.gif" usemap="#FPMap435" width="83" height="125"></td> <td align="left" valign="top"> <table border="0" cellpadding="1" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table12"> <tr> <td width="90%" colspan="3"> <p class="title"> <a target="_blank" href="http://www.riskbook.com/link/hayre_l_(2001).htm"> Mortgage-Backed and Asset-Backed Securities</a></td> </tr> <tr> <td colspan="3"> <p class="author"><b>Lakhbir Hayre (Ed.)</b></td> </tr> <tr> <td width="10%"> <map name="FPMap434"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"></map> <img border="0" src="../images/star_6.gif" usemap="#FPMap434" width="90" height="16"></td> <td width="10%" class="author">quality</td> <td width="70%"> <p class="author"> </td> </tr> <tr> <td width="10%"><map name="FPMap39"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"> </map> <img border="0" src="../images/tech_2.gif" usemap="#FPMap39" width="90" height="16"></td> <td width="10%" class="author">technical</td> <td width="70%">  </td> </tr> <tr> <td width="10%"> <p class="author">2001</td> <td width="10%"> </td> <td width="70%"> <p align="center"><map name="FPMap37"> <area target="_blank" coords="0, 0, 145, 19" shape="rect" href="http://www.riskbook.com/link/hayre_l_(2001).htm"> </map> <img border="0" src="../images/pointer_review.gif" usemap="#FPMap37" width="146" height="20"></td> 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<td width="100%"> <p class="explanatory_text"> <img border="0" src="../images/bullet_bullhorn_narrow.gif" align="left" width="27" height="22"><a target="_top" href="http://www.contingencyanalysis.com/archive/link_thread/06-2/00000274.htm">Credit Risk Model for ABS</a> <i>24 Mar 2006</i><br> Modeling an auto-loan asset-backed security.</td> </tr> </table> </td> </tr> </table>  <p align="center"><map name="FPMap0_I1"> <area target="_top" href="http://www.riskglossary.com" shape="rect" coords="0, 0, 164, 102"> </map><img border="0" src="../images/logo.jpg" usemap="#FPMap0_I1" width="165" height="103"></p> <p align="center"><span class="verdana10"> <a href="http://www.riskglossary.com/main/disclaimer.htm">Disclaimer</a></span></p> <p align="center">website: <span class="verdana10"> <a target="_top" href="http://www.contingencyanalysis.com">http://www.contingencyanalysis.com</a></span><br> glossary direct link: <span class="verdana10"> <a target="_top" 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