An Introduction to Bond Markets, Fourth Edition

Chapter 10

AN INTRODUCTION TO ASSET-BACKED SECURITIES²⁴

There is a large group of bond instruments that trade under the overall heading of asset-backed bonds. These are created by bundling together a set of non-marketable assets - such as bank loans, mortgages, credit-card loans or other assets - and issuing bonds that are backed by this pool of assets. This process is known as securitisation, when an institution’s loan (assets) are removed from its balance sheet and packaged together as one large loan, and then ‘sold’ on to an investor, or series of investors, who then receive the interest payments due on the assets until they are redeemed. The purchasers of the securitised assets often have no recourse to the original borrowers; in fact, the original borrowers are not usually involved in the transaction or any of its processes.

 

Securitisation was introduced in the US market, and this market remains the largest for asset-backed bonds. The earliest examples of such bonds were in the US mortgage market, where residential mortgage loans made by a thrift (building society) were packaged together and sold on to investors who received the interest and principal payments made by the borrowers of the original loans. The process benefited the original lender in a number of ways. One key benefit was that removing assets from the balance sheet reduced risk exposure for the bank and enhanced its liquidity position.

 

The effect of these benefits is increased with the maturity of the original ...