The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

ASSET-BACKED SECURITIES

An asset-backed security (ABS) is a security backed by a pool of loans or receivables. A special category of ABSs are securities backed by real estate property, both residential and commercial, and we describe them later in this chapter. The largest types of ABS issued are backed by credit card receivables, auto loans, and student loans.

Although an ABS is not issued by a corporation, this vehicle is used by corporations to raise funds as an alternative to bond issuance. For an issuer that has an opportunity to issuer an ABS or a bond, the decision as to which to issue depends on what the cost is. All other factors constant, an issuer will select the funding source that is less expensive.

The key to structuring an ABS is a third-party entity known as the special purpose vehicle (SPV). It is this entity that legally buys the pool of loans or receivables from the company seeking to raise funds and then issues the securities. Unlike a corporate bond where the investors look to the issuer to generate sufficient funds to satisfy the debt obligation, with an ABS investors look to the cash flow from the pool of assets.

Features of ABS

The collateral for an ABS can be classified as either amortizing or nonamortizing assets. Amortizing assets are loans in which the borrower’s periodic payment consists of scheduled principal and interest payments over the life of the loan. The schedule for the repayment of the principal is called an amortization schedule. ...