What are Asset Backed Securities?

Okay, so firstly, let's answer the question, what are asset-backed securities? Asset-backed securities also known as ABS are bonds or notes backed by financial assets.

The asset pool is usually a group of small and illiquid assets that would be difficult to sell on individually.

Pooling these assets into financial instruments allows them to be sold to investors such as other banks, hedge funds, insurance companies and pension funds.

The pool of potential underlying assets is extensive.

It can include credit card receivables, mortgage loans, student loans, auto loans, trade receivables, aircraft and other equipment leases, royalty payments and even things like movie revenues.

When creating an asset-backed security, the originating bank usually sets up a separate company called a special purpose vehicle to handle the securitization.

This separate company creates and sells the asset-backed securities and uses the proceeds to pay back the bank that originated the underlying assets.

This is done to keep the asset-backed security at arm's length from the issuing bank.

such that if there are failures of the securities over time they remain separate from the performance and credit results of the bank that initially created them.

On screen right now you can see an image showing how an SPV works.

This may look confusing at first but it's just a diagram showing a corporate structure.

Everything starts with the finance company on the left of the screen.

Let's imagine they're a large company who has made lots of sales on credit and they have a large pool of receivables.

Their customers who owe the money are highlighted in green.

The company raises money from investors shown on the right side of the slide.

who want to invest in these receivables that money is put into a new company the SPV which in this example is called special purpose company it's at the center of the slide they buy the assets from the company and as those receivables are collected the money will be passed back to the investors there may be a ratings agency which assesses the quality of the assets for investors There may be a trustee who manages the SPV and makes sure everyone is being treated fairly.

There may even be a financial guarantee provider.

But as you can see, the main purpose of this company is to hold the assets and to keep them separate from the originating company.

such that investors can invest in these specific assets without investing in the originating company.

That's all an SPV is.

So anyhow, now that we know what an SPV is, the pools of assets are packaged into a tradable instrument whose value depends on the performance and cash flows of the underlying pool of individual assets.

Once the assets have been packaged and transferred to the SPV, the originating bank can remove the assets from its own balance sheet, receiving cash in return.

The asset-backed securities are sold on to other financial institutions or investors.

This transaction often improves the credit rating of the originating bank, as well as reduces the amount of regulatory capital that they are required to hold against their other business activities.

Okay, so firstly, let's answer the question, what are asset-backed securities? Asset-backed securities also known as ABS are bonds or notes backed by financial assets.

The asset pool is usually a group of small and illiquid assets that would be difficult to sell on individually.

Pooling these assets into financial instruments allows them to be sold to investors such as other banks, hedge funds, insurance companies and pension funds.

The pool of potential underlying assets is extensive.

It can include credit card receivables, mortgage loans, student loans, auto loans, trade receivables, aircraft and other equipment leases, royalty payments and even things like movie revenues.

When creating an asset-backed security, the originating bank usually sets up a separate company called a special purpose vehicle to handle the securitization.

This separate company creates and sells the asset-backed securities and uses the proceeds to pay back the bank that originated the underlying assets.

This is done to keep the asset-backed security at arm's length from the issuing bank.

such that if there are failures of the securities over time they remain separate from the performance and credit results of the bank that initially created them.

On screen right now you can see an image showing how an SPV works.

This may look confusing at first but it's just a diagram showing a corporate structure.

Everything starts with the finance company on the left of the screen.

Let's imagine they're a large company who has made lots of sales on credit and they have a large pool of receivables.

Their customers who owe the money are highlighted in green.

The company raises money from investors shown on the right side of the slide.

who want to invest in these receivables that money is put into a new company the SPV which in this example is called special purpose company it's at the center of the slide they buy the assets from the company and as those receivables are collected the money will be passed back to the investors there may be a ratings agency which assesses the quality of the assets for investors There may be a trustee who manages the SPV and makes sure everyone is being treated fairly.

There may even be a financial guarantee provider.

But as you can see, the main purpose of this company is to hold the assets and to keep them separate from the originating company.

such that investors can invest in these specific assets without investing in the originating company.

That's all an SPV is.

So anyhow, now that we know what an SPV is, the pools of assets are packaged into a tradable instrument whose value depends on the performance and cash flows of the underlying pool of individual assets.

Once the assets have been packaged and transferred to the SPV, the originating bank can remove the assets from its own balance sheet, receiving cash in return.

The asset-backed securities are sold on to other financial institutions or investors.

This transaction often improves the credit rating of the originating bank, as well as reduces the amount of regulatory capital that they are required to hold against their other business activities.