1. Asset Backed Finance
Presented By:
Chudamani Chapagain
Roll No-07
MBA 3rd Semester
2. Asset backed Finance
• Asset – backed financing uses assets as direct security.
• ABS are bonds or notes backed by financial assets , usually consists of
receivables other than mortgage loans.
• An asset-backed security is a security whose income payments and hence
value is derived from and collateralized by a specified pool of
underlying assets
• The pool of assets is typically a group of small and illiquid assets which are
unable to be sold individually and include common payments from credit
cards, auto loans, and mortgage loans, royalty payments.
3. • Pooling the assets into financial instruments allows them to be sold to
general investors, a process called securitization, and allows the risk of
investing in the underlying assets to be diversified because each security will
represent a fraction of the total value of the diverse pool of underlying
assets.
• ABS derive their cash flows from a pool of underlying assets
MBS = mortgage backed securities
CARS = certificates for automobile receivables
CARDS = certificates for amortizing revolving debts
HELS = home equity loan securities
4. Asset-Backed Securities
• The underlying assets generate cash flows of principal
and interest which can be repackaged and sold to
investors.
Principal
Interest
Asset-backed
securities
Fixed income
assets
5. Securitization
• In ABS, the underlying assets are collected into a pool .
• Financial institutions sell the pool of assets to special-purpose
vehicle (SPV).
• SPV buy such assets in order to securitize them, again
sells them to a trust.
• The trust repackages the loans as interest-bearing
securities and issues them.
6. Benefits of Investing in ABS
Attractive yields
High credit quality
Diversity and investment diversification
Predictable cash flow
Reduced Event Risk
7. Types of Assets that back ABS
However the assets are classified into four types ,the ways to
classify the securitized assets are classified into two types:
• Amortizing
• Nonamortizing
1. Home –equity loans(HELs):
Largest sector of ABS market.
Backed by closed-end home-equity loans(HELs) and open-end
loans, which are called (HELOCs)-home equity lines of credit.
8. 2.Auto Loans
• Second largest and oldest asset class in ABS market.
• 16.1% of issuance .
• Most auto ABS are supported by prime loans.
• Some auto ABS are collaterized by loans to subprime (B, C and
D borrowers).
• Loans to individual car buyers are amortizing assets.
9. 3. Credit cards
• Oldest segments of ABS market.
• 14.3% of ABS issuance .
• Holders of credit card borrow funds, generally on
unsecured basis up to an specified limit and pay the
principal and interest as they wish, as long as they make
a required minimum payment on a regular basis.
• Credit card debt has no actual maturity, so credit
cardholders do not have to pay off the principal on a
schedule date.
10. 4.Student Loans
• 8.1%of ABS issuance .
• Student loans have relatively high default rates.
• Neutralized by government guarantee programs.
• Lenders bear the risks directly.
• Student loans are amortizing loans where principal
and interest are paid off on schedule or
predetermined schedule.
11. 5. Equipment Leases
• Small portion of ABS market(1.5% of issuance ).
• Securitization of leases for computers ,telephone
systems and other kinds of business equipment .
• Leases takes in two forms- closed end and open end.
• Equipment leasees are usually corporations rather
than individuals ,that have good credit profiles.
12. Interest Rates and Yields on ABS
• Yield on ABS depends on:
Purchase price in relation to interest rate(fixed or
floating)
Length of time the principal is outstanding.
• Prepayment assumptions must also be taken while
determining the yield.
• New ABS yield> T.S and corporate bonds
13. • In secondary market , spread between ABS and Treasury
securities or comparable corporate bonds widen or narrow
depending on:
Market conditions
Direction of interest rates in economy
No. of issues coming to market.
Average life:
• Time weighted average maturity of stream of principal
cashflows.It can be estimated for a security that pays
principal in a single payment.
14. Structure of ABS
1. Fully Amortizing:
• Reflect the full repayment of underlying loans through
scheduled interest and principal payments.
• Typically backed by HELs,auto loans, manufactured-housing
contracts and other fully amortized assets.
• Prepayment risk is key consideration however the rate
of prepayment varies as per the types of underlying
assets.
15. 2. Controlled Amortization:
• Revolving debt like credit card receivables,HELOCs,trade
receivables and some leases are securitized using this
structure.
• Provides investors with relatively predictable repayment
schedule ,eventhough underlying assets are nonamortizing
• During a revolving period, only interest payment is made,
after that principal payments made to investors in a series
of defined periodic payments, over less than a year.
• Risk inherent in this structure –early amortization event.
16. 3.Soft /Hard Bullet
• ‘Bullet' structure which are used with revolving assets are
designed to return principal to investors in a single
payment.
• ABS feature two cash flow management periods :
1. Revolving period
2. Accumulation period
soft bullet
• Bullet payment is not guaranteed on the expected
maturity date.
• Shortfall exists in accumulation period.
17. Hard Bullet:
• This bullet structure ensures that principal payment is
made on the expected maturity date with a longer
accumulation period, a third party guarantee or both.
• Rating agencies evaluate the timeliness of principal
payments.
• Hard bullet are rare because investors are satisfied or
comfortable with soft bullet and are unwilling to pay
extra for a guarantee.
18. Floaters:
• Due to floating interest rate ,a no. of issues raises behind amortizing
and nonamortizing assets.
• Rate are adjusted periodically(LIBOR +Fixed margin)
• When the underlying collateral is itself made up of floating –rate
loans-credit card index to prime rate – a floating rate coupon on ABS
can help avoid a cashflow mismatch between borrowers and
investors.
Sequential pay
• ABS are issued as an sequential pay securities.
• First tranche(one with shortest avg. life) receives all available
principal payments until it is retired; only then second tranche begin
to receive principal and so on.
