A Comprehensive Guide to Asset-Backed Security and Its Industry

Asset-backed security is a type of financial instrument that's backed by a pool of assets, such as credit card debt or mortgages. This allows investors to buy a claim on the cash flows generated by these assets.

The asset-backed security market has grown significantly over the years, with a total outstanding amount of over $12 trillion in the United States alone. This growth can be attributed to the increasing demand for alternative investments.

Asset-backed securities are typically issued by special purpose entities, which are set up to own and manage the underlying assets. These entities are usually structured as trusts or corporations.

Investors can buy asset-backed securities from a variety of sources, including banks, investment firms, and online platforms.

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An asset-backed security is a type of security that's backed by a pool of assets, which can be a single asset or a collection of similar assets.

Asset-backed securities can be used as an umbrella term for a variety of securities, including collateralized debt obligations (CDOs) and mortgage-backed securities (MBS), which are subsets of asset-backed securities.

In the context of investments, asset backing refers to a security with value deriving from a single asset or a pool of assets, which act as collateral for the security.

Asset-backed securities are pools of similar cash-flowing assets that are packaged together and sold to investors, providing access to either consumer or commercial credit.

These securities are often issued by a special purpose vehicle (SPV), which is an entity set up to acquire the assets, package them, and issue them as a single security.

The issuer then sells these securities to investors, who receive fixed- or floating-rate payments from a trustee account funded by the cash flows generated by the portfolio of assets.

Asset-backed securities can be divided into slices, called tranches, each bearing a different degree of risk, indicated by a different credit rating.

Asset-backed securities can be created from a wide range of income-generating assets, but certain types are more common.

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Securities collateralized by home equity loans are the largest asset class within the ABS market, accounting for the majority of issuance.

Among the most typical ABS types are collateralized debt obligations, which are backed by a portfolio of debt instruments, such as bank loans, mortgages, and credit card receivables.

Student loan ABSs can be collateralized by either government student loans or private student loans, with government-backed loans having a better repayment record.

Credit card receivables ABSs are a type of non-amortizing ABS, where new loans and changes can be added to the composition of the pool, making the cash flows unpredictable.

Securities backed by credit card receivables have been the benchmark for the ABS market since their introduction in 1987.

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Home Equity ABS are one of the largest ABS categories, made up of home equity loans that are often taken out by borrowers with less-than-stellar credit scores.

These loans are amortizing, meaning payments go toward satisfying a specific sum and consist of interest, principal, and prepayments. Home equity loans are not the same as mortgages, but rather a type of loan that allows homeowners to borrow against the equity in their property.

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Securities collateralized by home equity loans are the largest asset class within the ABS market, with first-lien loans now making up the majority of issuance.

Subprime mortgage borrowers have a less-than-perfect credit history and are required to pay interest rates higher than what would be available to a typical agency borrower. Home equity loans can also consist of high loan to value (LTV) loans, re-performing loans, or open-ended home equity lines of credit (HELOC).

Owner trusts are not typically used for home equity loans, but rather for auto loans, where investors receive interest and principal on a sequential basis.

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Consumer lending exposure is a significant aspect of asset-backed securities. ABS provides investors with access to the vast U.S. consumer lending market.

One of the most common types of consumer lending is auto loans, which make up the second-largest subsector in the ABS market. Auto loans are classified into three categories: prime, nonprime, and subprime.

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These categories are based on the credit quality of the borrowers. Prime auto ABS are collateralized by loans made to borrowers with strong credit histories, while nonprime and subprime auto ABS consist of loans made to lesser credit quality consumers.

Credit card receivables are another type of consumer lending that is commonly used in ABS. These receivables are non-amortizing, meaning they don't have a fixed payment amount and can be added to or changed over time.

The cash flows of credit card receivables include interest, principal payments, and annual fees. There is usually a lockup period for credit card receivables where no principal will be paid.

Here are the types of consumer lending exposure in ABS:

Home equity loans are also a significant type of consumer lending exposure in ABS. These loans are collateralized by the borrower's home and are often used by borrowers with less-than-stellar credit scores or few assets.

The cash flows of home equity loans include interest, principal, and prepayments. Home equity loans are amortizing, meaning payment goes toward satisfying a specific sum.

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Asset securitization begins when a lender or a firm with income-producing assets sells a batch of these assets to an investment bank or other financial institution. This institution pools the assets with comparable ones from other sellers and creates a special purpose vehicle (SPV) to acquire and package them.

A SPV is an entity set up specifically to issue the assets as a single security. The issuer then sells these securities to institutional investors such as hedge funds, mutual funds, and pension plans. These investors receive fixed- or floating-rate payments from a trustee account funded by the cash flows generated by the portfolio of assets.

The issuer may divide the original asset portfolio into slices called tranches, which are sold separately and bear a different degree of risk, indicated by a different credit rating. This allows investors to choose the level of risk they're willing to take on.

Securitization is a process that creates asset-backed securities by transferring assets from the issuing company to a bankruptcy remote entity. Credit enhancement is an integral component of this process, creating a security with a higher rating than the issuing company.

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The exposure of these refinanced loans to "bad credit" decisions is hedged against by the sellers of the same or the re-structurers of the same. This means that the risk is transferred to another party, often without the actual asset against which the loan is backed reaching an upswing in value.

Asset-backed securities allow their issuers to raise cash, which can be used for lending or other investment purposes. The underlying assets of an ABS are often illiquid and can't be sold on their own, making securitization a necessary process to make them marketable to investors.

ABS issuers can be creative in the types of assets they use, such as home equity loans, automobile loans, credit card receivables, student loans, or even cash flows from movie revenues or solar photovoltaics.

Asset-backed securities can offer several compelling reasons to invest in them.

They can provide diversification opportunities beyond traditional asset classes like stocks and bonds, giving you access to a diverse pool of underlying assets such as mortgages, auto loans, and credit card receivables.

ABS can also have somewhat predictable cash flows, as the underlying assets typically generate steady income streams such as monthly mortgage payments or loan repayments passed through to ABS holders.

However, ABS can also have some drawbacks. The ability to earn substantial fees from originating and securitizing loans can skew the incentives of originators in favor of loan volume rather than loan quality.

This can lead to a credit bubble, as seen in the mid-2000s, and can also increase the risk of a credit crisis.

Here are some key participants in the ABS market, each playing a small part in the issuance, trading, and management of ABS transactions:

These participants work together to create and manage ABS transactions, but the incentives of originators can sometimes lead to problems.

The U.S. ABS market is a massive industry, with a size of over $880 billion. This enormous market offers a wide range of investment opportunities in consumer and commercial cash-flowing assets.

Auto loans, credit cards, and student loans make up about 60% of the U.S. ABS market, providing a significant portion of the industry's revenue. The remaining 40% is comprised of smaller sectors, such as franchise fees, aircraft leases, cell towers, and timeshares.

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Issuers are at the forefront of the asset-backed securities market, originating or sponsoring the underlying assets that will be securitized. These can be financial institutions, banks, auto finance companies, credit card issuers, or mortgage lenders.

Some of the key Issuers in the market include banks and financial institutions. They play a crucial role in originating and sponsoring the underlying assets.

Investors in the market include institutional investors such as pension funds, insurance companies, hedge funds, and asset managers. They purchase ABS securities to earn returns from the cash flows generated by the underlying assets.

Underwriters facilitate the issuance of ABS securities by structuring the transaction, pricing the securities, and arranging their sale to investors. They play a key role in assessing market demand, determining appropriate pricing, and ensuring compliance with regulatory requirements.

Here is a breakdown of the key players in the market:

Servicers are responsible for managing and administering the underlying assets on behalf of ABS investors. They collect payments from borrowers, handle delinquencies and defaults, and distribute cash flows to ABS holders according to the terms of the securitization.

The U.S. ABS market is a massive one, valued at over $880 billion in size.

This enormous market allows for investment in a wide variety of consumer and commercial cash-flowing assets.

Auto loans, credit cards, and student loans make up about 60% of the U.S. ABS market.

The remaining 40% is comprised of smaller sectors, such as franchise fees, aircraft leases, cell towers, and timeshares.

Indices play a crucial role in the market, allowing investors to gain broad exposure to specific sectors without holding the actual assets.

ABS indices, for instance, allow investors to invest in the subprime market without holding the actual asset-backed securities.

These indices are created by companies like CDS Indexco and Markit, which launched ABX.HE, a synthetic asset-backed credit derivative index, on January 17, 2006.

Selling financial assets to the pools reduces their risk-weighted assets and frees up their capital, enabling them to originate more loans.

Asset-backed securities lower the risk of the originator, but in a worst-case scenario, the owner of ABS might pay the price of bankruptcy instead.

Here's a list of how ABS indices work:

Asset-backed securities can provide diversification opportunities beyond traditional asset classes like stocks and bonds, giving you exposure to a diverse pool of underlying assets such as mortgages, auto loans, and credit card receivables.

ABS can offer higher yields compared to other fixed-income investments with similar ratings, and the ability to opt into different tranches with varying risk appetites can appeal to investors with different risk tolerances.

Asset-backed securities are frequently backed by collateral that can provide a degree of credit enhancement, which helps mitigate credit risk to some extent.

Investing in ABS requires specialized skill and experience to analyze each asset's investment case and determine how it might perform under varying economic scenarios.

Janus Henderson is a leading provider of active fixed income ETFs, with nearly 60 years of combined experience in securitized investment management, and manages $57B in firmwide securitized assets.

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Active management is crucial when investing in Asset-Backed Securities (ABS). There is no one benchmark that is representative of the ABS investment universe.

Investors who want to invest in ABS should seek out experienced active managers with a proven track record of investing in securitized markets. This is because ABS cover a broad universe of subsectors that each have distinct fundamental and technical characteristics.

Investing in ABS requires specialized skill and experience to analyze each asset's investment case and determine how it might perform under varying economic scenarios. This is especially true given the different performance of each subsector through the market cycle.

Asset-backed securities offer a unique way to diversify your investment portfolio, and our ETFs provide a convenient way to access this market.

We offer an Asset-Backed Securities ETF that allows investors to tap into the potential for higher yields offered by investment grade asset-backed securities.

This ETF provides a way to invest in a broad range of asset-backed securities, giving you sector diversification and the potential for higher returns.

A collateralized debt obligation, or CDO, is an example of an asset-backed security that can be invested in through our ETFs.

Asset-backed securities have a rich history dating back to the 1970s, when the first mortgage-backed security was issued in the United States.

The first asset-backed security was a mortgage-backed security, which was created by the Government National Mortgage Association (GNMA) in 1970. This marked the beginning of the asset-backed security market.

The 1980s saw the introduction of auto loan-backed securities and credit card-backed securities, which expanded the range of assets that could be securitized. This expansion was driven by the growth of the consumer credit market.

The Securities and Exchange Commission (SEC) played a crucial role in regulating the asset-backed security market, issuing guidelines in 1981 to ensure that these securities were properly disclosed to investors.

Legal Factors Influencing Asset-Backed Securities are governed by comprehensive legal agreements that outline the rights and obligations of various parties involved, including issuers, investors, underwriters, servicers, and trustees.

These contracts specify terms such as payment schedules, credit enhancements, conditions for early amortization, and the responsibilities of each party throughout the life of the securities. This baseline information dictates what the rate of return may be given if the borrower meets their scheduled payments on time.

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Issuers are typically required to provide detailed disclosures about the underlying assets, the structure of the securitization, risks associated with the ABS, and other material information. Regulatory requirements often mandate specific disclosure standards to ensure investors have access to accurate and timely information.

ABS transactions often incorporate legal protections to safeguard investors' interests, including mechanisms such as credit enhancements, representations and warranties regarding the quality of the underlying assets, and provisions for the orderly resolution of disputes or defaults.

Here are the three main legal aspects of ABS to keep in mind:

The 2008 Global Financial Crisis was a culmination of factors rooted in the housing market bubble and financial market practices. Low interest rates and loose lending standards encouraged excessive borrowing and speculative investments in subprime mortgages.

Years of lax regulations and oversight allowed the situation to escalate, leading to a housing bubble that eventually burst. This triggered a crisis of confidence in the financial markets as the true extent of losses became apparent.

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The crisis escalated in 2007 with the collapse of two Bear Stearns hedge funds heavily invested in subprime loans, signaling broader market instability. The failures of major financial institutions like Lehman Brothers highlighted the systemic risks posed by interconnected global financial markets.

The government provided relief to the ABS industry through the Term Asset-Backed Securities Loan Facility (TALF) during the Great Recession of 2008.

Here are some key players involved in the crisis:

Asset-backed securities (ABS) are a type of investment that can be backed by various types of assets, including loans and receivables, as well as residential or commercial mortgages. A key principle of ABS structures is that their underlying cash flows can be reconfigured into various tranches, each with its own payment pattern to investors and associated risks.

A collateralized debt obligation (CDO) is an example of an ABS, backed by a portfolio of debt instruments such as bank loans, mortgages, and credit card receivables. This portfolio acts as collateral for the interest generated by the CDO, which is reaped by institutional investors who purchase it.

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ABS securitization provides several benefits, including risk transfer, flexibility to issuers and investors, and efficiency of capital allocation. By creating distinct senior and subordinated bond classes, credit tranching offers credit protection for the more senior bond classes in a securitization.

Here are some common types of ABS:

Each bond class created in a securitization is typically rated based on both the quality of the underlying collateral and the seniority of the class. This allows investors to choose the level of risk, expected maturity, and associated returns they prefer.

Asset-backed securities derive their value from a single asset or a pool of assets that serve as collateral.

Asset backing is a concept in investments where a security's value is tied to a specific asset or group of assets that act as collateral.

A security with asset backing is essentially a loan or investment that uses a tangible asset as collateral to secure the investment.

The asset backing a security can be a single asset, such as a car or a property, or a pool of assets, like a group of mortgages or loans.

Investors who buy asset-backed securities essentially become owners of a portion of the underlying asset or pool of assets.

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