Non-Mortgage Asset-Backed Securities | CFA Level I

In this lesson, we’ll explore the nuances of ABS backed by a variety of financial assets, highlighting the distinctive features and risks associated with each.

Understanding ABS Structures

Asset-backed securities come in two primary forms based on the underlying loans: amortising and non-amortising loans. Amortising loans include both principal and interest in their regular payments, whereas non-amortising loans require only interest payments with the principal due at maturity. This fundamental difference significantly influences the structure of ABS, exemplified by Solar ABS and credit card receivables.

Amortising Loan-Backed Securities: Solar ABS

• Solar ABS are funded by homeowner loans for solar energy system installations, echoing the structure of mortgage-backed securities.
• They often feature a pre-funding period, allowing for investment in solar loans post-ABS issuance, enhancing diversification and volume.
• Attractive for ESG-focused investors, these securities fund renewable energy initiatives, aligning investment with sustainability goals.
• Credit enhancements such as subordination and overcollateralisation are common, securing investor confidence through additional risk buffers.

Non-Amortising Loan-Backed Securities: Credit Card Receivables

• Credit card receivable ABS are backed by consumer credit card debt, offering a unique structure without scheduled principal repayments during the initial period.
• During the lockout period, principal repayments are reinvested in new receivables, maintaining the principal pool’s value.
• The amortisation period commences post-lockout, during which principal repayments are distributed to investors until full repayment.
• Early amortization provisions safeguard against deteriorating credit quality, triggering principal repayments ahead of schedule under specific conditions.

Risk Characteristics and Investor Considerations

While ABS structures offer innovative financing solutions, they come with distinct risk profiles. For instance:

• Amortising loans like Solar ABS may carry risks related to property value fluctuations and borrower default rates.
• Non-amortising loans, represented by credit card receivables, are sensitive to consumer credit behavior and economic conditions impacting repayment patterns.
• Investors must weigh the benefits of credit enhancements against the inherent risks of the underlying assets, adjusting their portfolios to align with risk tolerance and investment objectives.

In summary, non-mortgage ABS presents a spectrum of investment opportunities and challenges, with structural complexities and credit enhancements playing pivotal roles in shaping their appeal and risk profile. As we delve deeper into specific ABS types in subsequent lessons, we’ll uncover more about their unique market dynamics and investment potential.