Asset Backed Securities

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  Investing in Fixed Income Securities

  Understanding the Bond Market

  • Gary Strumeyer(Author)
  • 2012(Publication Date)
  • Wiley

    (Publisher)

  Figure 15.1 .) ABS issuance first topped $100 billion in 1995, $200 billion in 2000, and $400 billion in 2003. In 2003, U.S. ABS issuance totaled more than $435 billion, according to Merrill Lynch ABS Research. In 2003, automobile ABS, credit card ABS, and home equity loan (HEL) ABS represented 84 percent of new issuance volume. According to Bloomberg, as of July 31, 2004, almost $3.5 trillion of ABS have been issued and there are currently $1.5 trillion of ABS outstanding—clearly the ABS market is a significant part of the investment landscape.

  Figure 15.1 ABS Issuance Volume

  Source: Merrill Lynch.

  ASSET-BACKED SECURITIES DEFINED

  Asset-backed securities are bonds that are backed by pools of self-liquidating financial assets. While mortgage-backed securities also are technically backed by financial assets, based on their prominence in the fixed income markets (over 32 percent of Merrill Lynch’s U.S. Broad Market Index) and the fact that they were introduced to Wall Street ahead of all other collateralized paper, they are normally dealt with separately from other instruments. Given their history and significance, MBS have been dealt with in the preceding chapter, leaving this chapter dedicated to all other forms of ABS.

  Asset-backed securities can paradoxically offer sponsors lower funding costs, while at the same time offering the investment community securities with a stable credit profile, liquidity, and attractive yields. With ABS, less liquid financial assets typically held in a portfolio are pooled and converted into liquid securities that may be traded freely in the capital markets. For example, a portfolio of relatively illiquid auto loans can be removed from a marginally rated financial institution’s balance sheet and transformed into a triple-A rated publicly traded debt security. By effectively selling these loans to investors, the financial institution can now recycle the cash, making it available to create new loans. The ABS transaction has thus improved economic efficiency, as well as creating liquidity and value. Has a process thus been created that can transform lead into gold? While this may be a bit of an overstatement, the fact remains that the creation of the ABS market has led to lower funding costs and greater balance sheet flexibility for issuers and sponsors. For the investment community’s insatiable appetite for high-quality, well-structured securities, ABS provides higher credit quality than corporate securities, and more predictable cash flows than its sister product, MBS.

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  Fixed Income Analysis

  • Barbara S. Petitt(Author)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  securitized assets. These assets are typically loans and receivables and include, among others, residential mortgage loans (mortgages), commercial mortgages, automobile (auto) loans, student loans, bank loans, accounts receivables, and credit card receivables. Advances and innovations in securitization have led to securities backed, or collateralized, by all kinds of income-yielding assets, including airport landing slots and toll roads.

  This chapter discusses the benefits of securitization, describes securitization, and explains the investment characteristics of different types of ABS. The terminology regarding ABS varies by jurisdiction.

  Mortgage-backed securities

  (MBS) are ABS backed by a pool of mortgages, and a distinction is sometimes made between MBS and ABS backed by non-mortgage assets. This distinction is common in the United States, for example, where typically the term “mortgage-backed securities” refers to securities backed by high-quality real estate mortgages and the term “asset-backed securities” refers to securities backed by other types of assets. Because the US ABS market is the largest in the world, much of the discussion and many examples in this chapter refer to the United States. Note, however, that many non-US investors hold US ABS, including MBS, in their portfolios.

  To underline the importance of securitization from a macroeconomic perspective, Section 2 discusses the benefits of securitization for economies and financial markets. In Section 3, the chapter describes securitization and identifies the parties involved in the process and their roles. Section 3 also discusses typical structures of securitizations, including credit tranching and time tranching. Sections 4–6 discuss securities backed by mortgages for real estate property. Many types of residential mortgage designs around the world are described in Section 4. Sections 5 and 6 focus on residential MBS and commercial MBS, respectively. Section 7 discusses ABS based on two types of non-mortgage loans that are typically securitized throughout the world: auto loans and credit card receivables. Collateralized debt obligations are covered in Section 8. Section 9 concludes the chapter with a summary.

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  The Capital Markets

  Evolution of the Financial Ecosystem

  • Gary Strumeyer(Author)
  • 2017(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER 18 Asset‐Backed Securities Daniel I. Castro, Jr.

  Starting in about 1985, non‐mortgage asset‐backed securities (ABSs) were created and offered to the public. One of the very first deals was a securitization that was backed by auto loans and equipment leases. Since that time, we have seen ABS collateralized by myriad financial assets, including auto loans, credit card receivables, home equity loans, and student loans. We have also seen the creation of ABS backed by off‐the‐run assets such as burglar alarm and cell tower receivables, mutual fund fees, tax liens, property and casualty insurance policies (catastrophe bonds), and loans for timeshare condos. The famed Bowie Bonds, collateralized by David Bowie's music royalties, received much outsized attention from the press. While the issuance of ABS collateralized by intellectual property (i.e., music and film royalties) comprises an insignificant part of the ABS market, it is worth mentioning as it hammers home the point that all sorts of financial assets can be securitized.1

  Since 1985, the ABS market showed consistent growth during its first decade, followed by explosive growth in the mid‐1990s through the mid‐2000s. Issuance peaked from 2005 through 2008 and then dropped dramatically following the financial crisis. ABS issuance first topped $100 billion in 1996, $200 billion in 2001, and topped out at almost $300 billion in 2007. The Fed's Term Asset‐Backed Securities Loan Facility (TALF) program helped restart the market in 2009, but still bottomed in 2010 before rebounding in 2012.2 (See Figure 18.1 .)

  Figure 18.1

  :

  U.S. ABS issuance

  According to SIFMA, as of December 31, 2015, $4.3 trillion of non‐mortgage ABS has been issued. SIFMA data also shows that ABS bonds outstanding peaked at almost $2 trillion in 2007 and have fallen to just under $1.4 trillion ABS outstanding at year‐end 2014. Clearly ABS is a major source of funding for issuers, a significant part of the fixed‐income market, and a major holding for many institutional investors. (See Figure 18.2

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  Capital Market Instruments

  Analysis and valuation

  • M. Choudhry, D. Joannas, R. Pereira, R. Pienaar(Authors)
  • 2004(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The Bond and Money Markets: Strategy, Trading, Analysis, Butterworth- Heinemann, 2001. Hayre, L. (ed.), The Salomon Smith Barney Guide to Mortgage-Backed and Asset-Backed Securities, Wiley, 2001. Martellini, L., Priaulet, P. and Priaulet, S. Fixed Income Securities, Wiley, 2003. Morris, D. Asset Securitisation: Principles and Practices, Executive Enterprise, 1990. Sundaresan, S. Fixed Income Markets and their Derivatives, South-Western Publishing, 1997, ch. 9. In Chapter 11 we introduced asset-backed bonds, debt instruments created from a package of loan assets on which interest is payable, usually on a floating basis. The asset-backed market was developed in the United States and is a large, diverse market containing a wide variety of instruments. The characteristics of asset- backed securities (ABS) present additional features in their analysis, which are investigated in this and the next two chapters. Financial engineering techniques employed by investment banks today enable an entity to create a bond structure from any type of cash flow; the typical forms are high volume loans such as resi- dential mortgages, car loans and credit card loans. The loans form assets on a bank or finance house balance sheet, which are packaged together and used as backing for an issue of bonds. The interest payments on the original loans form the cash flows used to service the new bond issue. In this chapter we consider mortgage-backed securities, the largest of the asset- backed bond markets. The remaining chapters deal with the other asset-backed instruments available. 1 INTRODUCTION A mortgage is a loan made for the purpose of purchasing property, which in turn is used as the security for the loan itself. It is defined as a debt instrument giving conditional ownership of an asset, and secured by the asset that is being financed.

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  Capital Market Instruments

  Analysis and Valuation

  • M. Choudhry, D. Joannas, G. Landuyt, R. Pereira, R. Pienaar(Authors)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The asset-backed market was developed in the United States and is a large, diverse market containing a wide range of instruments. Techniques employed by investment banks today enable an entity to create a bond structure from any type of cash flow; assets that have been securitised include loans such as residential mortgages, car loans and credit card loans. The loans form assets on a bank or finance house balance sheet, which are packaged together and used as backing for an issue of bonds. The interest payments on the original loans form the cash flows used to service the new bond issue. Traditionally mortgage-backed bonds are grouped in their own right as mortgage-backed securities (MBS) while all other securitisation issues are known as asset-backed bonds or ABS. Reasons for undertaking securitisation The driving force behind securitisation has been the need for banks to realise value from the assets on their balance sheet. Typically these assets are residential mort- gages, corporate loans, and retail loans such as credit card debt. Let us consider the factors that might lead a financial institution to securitise a part of its balance sheet. These might be for the following reasons: • If revenues received from assets remain roughly unchanged but the size of assets has decreased, this will lead to an increase in the return on equity ratio. • The level of capital required to support the balance sheet will be reduced, which again can lead to cost savings or allows the institution to allocate the capital to other, perhaps more profitable, business. • To obtain cheaper funding: frequently the interest payable on ABS securities is considerably below the level payable on the underlying loans. This creates a cash surplus for the originating entity. In other words a bank will securitise part of its balance sheet for one or all of the following main reasons: • funding the assets it owns • balance sheet capital management • risk management and credit risk transfer.

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  The Economics of Banking

  • Kent Matthews, John Thompson(Authors)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  The types of assets which are securitized are varied but the concept of securitization can be applied to any asset which has readily ascertainable future streams of income. A wide range of assets meet this criterion and, therefore, have been sold as ABS, particularly by banks but also by other financial institutions and private individuals. One example of this latter category was by David Bowie who raised $55m through the issue of bonds backed by future royalties on previously issued albums. The categories of assets more usually securitized include Collater- alized Debt Obligations (CDOs), which include Collateralized Loan Obligations (CLOs) and Collateralized Bond Obligations (CBOs); credit card obligations; auto loans; loans; and mortgages. (The split up between the European issues of these various categories for the year 2012 is shown in Table 9.2, from which it can be seen that by far the largest component is Mortgage Backed Securities (MBSs), 55% (of which roughly 96% consisted of residential mortgages). Residential mortgages are a particularly attractive type of asset to securitize given TABLE 9.1 Liability growth of UK financial institutions, 1987–2011 Percentage Growth Monetary financial institutions a ** 470 Pension funds* 370 Life assurance companies* 460 Unit trusts, OEICs b and investment trusts* 962 a Combined banks and building societies b Open-ended investment companies Source:* Office for National Statistics online database and ** the Bank of England interactive database. 146 THE ECONOMICS OF BANKING the large number of different borrowers contained in such an ABS. This spreads the risk if they are genuinely different. 4 In the case of issues of ABS by banks, their role in the process of intermediation is not eliminated but changed. In other words, some of the bundle of separate activities discussed above are sold separately while still retaining the overall function of intermediation.

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  Securitization

  Structuring and Investment Analysis

  • Andrew Davidson, Anthony Sanders, Lan-Ling Wolff, Anne Ching(Authors)
  • 2004(Publication Date)
  • Wiley

    (Publisher)

  Unlike other classes of ABS, there are no hard assets or physical property backing these securities, just indi- vidual promises to repay a financial obligation. This chapter focuses on the unique features of credit-card receivables and how they drive the securitiza- tion process. CREDIT-CARD ASSET-BACKED SECURITIES ISSUANCE Figure 20.1 shows credit-card ABS origination since 1995. With $79 billion originated in 2001, and a total of $433 billion originated between 1995 and the third quarter of 2002, the credit-card sector is one of the three largest sectors within the ABS market. The first credit-card deals were issued in 1987 by banks with the intent of diversifying their sources of funding. There are two primary types of credit-card accounts that make up credit-card ABS. General purpose credit cards are those issued by Visa, Mas- terCard, American Express, and Discover. Their respective shares of this market in 2000, for example, were 46 percent, 37 percent, 9 percent, and 8 percent. The other type is generally referred to as affinity cards—those used by members of a particular affinity group, such as American Airlines fre- quent flyers, or alumni of universities. MBNA and First USA are the two largest issuers of such cards. The primary originators of credit-card ABS are banks, specialty finance companies (such as MBNA, Providian), and retailers such as Sears, which may carry their own line of charge cards or co-brand with MasterCard/Visa. CHAPTER 20 Credit-Card Asset- Backed Securities Institutional features differentiating commercial banks from the specialty fi- nance companies (SFCs) include: SFCs do not borrow via checking/savings accounts (though a number do borrow retail using CDs). SFCs do not have branches; therefore there is much less overhead.

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  Act Companion to Treasury Management

  • Valerie Hawkes(Author)
  • 1999(Publication Date)
  • Woodhead Publishing

    (Publisher)

  Key issues in the ABS field include: valuation, clear title to the assets, the role of the trustee, liquidity for the securities and pricing. With mortgage-backed securities, investors usually have pro rata interests in a pool representing the whole of the mortgage portfolio used for the issue. Income is used to pay first interest and then principal. For the treasurer of a company issuing asset-backed securities, the key issues quoted above will be important, but first should be an exhaustive test of the ratio-nale for the transaction. If linked to a S W A P , the usual considerations about trans-action costs and C O U N T E R P A R T Y R I S K apply. Asset finance See L E A S I N G . Asset Stripping The segregation of a company's assets for realisation and distribution in cash is known as asset stripping. This is usually carried out by the owners of the com-pany when the market price of the company's share does not fairly reflect the value of the entire business on a going concern basis, or in other words, the value of the entire company is less than the value of the individual assets of the com-pany combined. Asset stripping normally takes place for a company with a nega-tive goodwill. Asset stripping can be the basis also for acquisitions, wherein the new owner buys a company for the purpose of asset stripping. Asset stripping need not necessarily involve liquidation of the company. Sometimes, individual assets in a company may not have been optimally utilised; hence, it is better to sell off these assets so as to provide additional cash for other opportunities and reinvestment by the company. Also, creative thinking on alter-native uses of the individual assets may throw up new business opportunities for the company which may add up to its bottom line. Asset stripping operations are, however, not looked upon favourably by the public when they involve the loss of jobs.

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  Synthetic and Structured Assets

  A Practical Guide to Investment and Risk

  • Erik Banks(Author)
  • 2006(Publication Date)
  • Wiley

    (Publisher)

  Nongovernment securitizations, lacking the same low-risk characteristics, may require up to 15 % subordination in order to support a AAA tranche. Default risk can affect investor payment streams when performance is not government guaranteed. Historical experience suggests that default risk peaks during the first three years of scheduled repayments, and declines steadily from that point on. Unlike other MBS and ABS structures, student loan securitizations are not sensitive to refinancing opportunities, as alternative financing sources are not readily available to most borrowers. Aircraft lease ABS Aircraft leases, which are a popular form of financing in the commercial aviation market, are repackaged periodically by intermediaries through aircraft lease ABS or equipment trust certificates. Aircraft lease ABS are backed by a pool of leases from various airlines, while equipment trust certificates are backed by leases from a single airline. Accordingly, the rating 98 Synthetic and Structured Assets of the aircraft lease ABS is based primarily on the cash flows from the pool, while the rating of the equipment trust certificates reflects primarily the credit quality of the single airline obligor (and/or any third party guarantor that may be involved). Investors appear to favor aircraft lease ABS as a result of their diversification. Though aircraft feature useful lives of 20 + years, most aircraft leases are operating leases covering 4–5 years. This means that the specialized aircraft leasing companies that are respon-sible for arranging and servicing the financing transactions must actively re-lease the aircraft. The related securities, however, make no assumptions about the re-leasing process, and are based solely on the terminal maturities of the operating lease contracts. Though the earliest deals in the market relied on aircraft sales to cover principal repayments, most are now based on lease revenue streams, meaning enhancement requirements have declined.

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  Risk Of Investment Products, The: From Product Innovation To Risk Compliance

  From Product Innovation to Risk Compliance

  • Michael Chak Sham Wong(Author)
  • 2011(Publication Date)
  • World Scientific

    (Publisher)

  8. CONCLUSION The recent financial crisis exposed systematic flaws that undermined the credit markets. Throughout the loan value chain, the ability to effectively measure and monitor key risk elements in the proper context is challenging, but critical to all stakeholders. In particular, loan securitization hinges on accurate risk classification and calibration to portray realistic investment risk and returns associated with ABSs. Connecting the underlying loan 158 M. Zhang and C. Abrahams performance with the valuation of any ABS should be a primary concern for both investors and rating agencies. Assurances provided to investors (e.g. credit enhancements, pool overcollateralization, portfolio insurance, etc.) have proven insufficient. The framework we have described in this chapter supports and connects the interests of all stakeholders through the use of a standardized and consistent view afforded by a unique loan-pooling process that captures the risk dynamic and more closely reflects the business realities. The key advantages of this framework are its comprehensive, forward-looking, transparent, and adaptive properties. If adopted, it will provide investors with the ability to validate both ABS rating and valuation and serve to restore their confidence in the ABS market. The net result will be greater ABS market liquidity, which will help spur a stronger and faster economic recovery. REFERENCES Abrahams, C. and Zhang, M. (2008). Fair Lending Compliance: Intelligence and Implications for Credit Risk Management . New Jersey: John Wiley & Sons, Inc. Abrahams, C. and Zhang, M. (2009). Credit Risk Assessment: The New Lending System for Borrowers, Lenders, and Investors . New Jersey: John Wiley & Sons, Inc. Agarwal, S., Cun, C. and De Nardi, M. (2010) “Rescuing Asset-Backed Securities Markets.” Chicago Fed Letter, Federal Reserve Bank of Chicago, January, Number 270. Association of Mortgage Investors (2010). “Reforming the Asset-Backed Securities Market.” March.

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