Asset Backed Finance

Presented By:

Chudamani Chapagain

Roll No-07

MBA 3rd Semester

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.

• 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

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

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.

Benefits of Investing in ABS

Attractive yields

High credit quality

Diversity and investment diversification

Predictable cash flow

Reduced Event Risk

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.

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.

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.

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.

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.

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

• 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.

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.

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.

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.

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.

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.

Prepayments Models

• Constant Prepayment Rate (CPR)

• Monthly Payment Rate(MPR)

• Absolute Prepayment Speed(APS)

• Prospectus Prepayment Curve(PPC)

• Manufactured –Housing Prepayment Curve(MHP)

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