What are Asset-Backed Securities?
Asset-Backed Securities (ABS) are a type of bond, typically issued by banks or other lenders.
What makes ABS different to other parts of fixed income, such as government or corporate bonds, is that they are ‘secured’ against a specially designed pool of loans with similar characteristics.
This collateral pool will typically contain thousands of high-quality loans such as mortgages, and the repayments on those assets are directed straight to investors in the bonds.
This is where the phrase ‘securitisation’ comes from – investors’ coupons are secured by the cash flowing from the regular interest and principal paid on the assets included in the pool.
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Asset : Thousands of assets with regular repayments and similar characteristics, such as mortgages or car loans, are pooled together.
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Backed : The company issuing the ABS sets up a legally separated Special Purpose Vehicle (SPV), which purchases the asset pool. The bonds investors buy are backed by the interest and principal proceeds from the asset pool. This means bondholders’ exposure is to the assets themselves rather than the seller of those assets; in an RMBS, for example, investors have exposure to the mortgages but not the bank that made those loans to customers.
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Securities : The company sells bonds – or securities – via the SPV to investors, who are paid directly from the repayments on the assets in the pool.
At first glance, the ABS market can look like a confusing mix of acronyms (RMBS, CLOs, Auto ABS) but they simply identify the assets backing the bonds – residential mortgages, senior secured corporate loans, auto loans.
