Non-Mortgage Asset-Backed Securities | CFA Level I Fixed Income
Welcome back, folks! Today, we’re diving into non-mortgage asset-backed securities (ABS), which are backed by various types of financial assets like small business loans, accounts receivable, automobile loans, and credit card receivables. Each type has different risk characteristics and structures, so let’s break them down into amortising and non-amortising loans.
Amortising vs. Non-Amortising Loans
As we’ve covered earlier, amortising loans require mandatory regular payments that include both interest and scheduled principal repayments. On the other hand, non-amortising loans require only interest payments, with principal repayment due at the end of the loan. This difference significantly influences the structure of ABS, and we’ll illustrate this with auto loans and credit card receivables.
Auto Loan-Backed Securities
Auto loan ABS are backed by loans for automobiles. Like mortgage-backed securities, these loans are pooled, securitised, and sold to investors. The cash flow components of auto loan-backed securities include scheduled principal payments, interest payments, and prepayments.
Most auto loan ABS incorporate some form of credit enhancement, such as a senior-subordinated structure or overcollateralisation. Another credit enhancement method is to create a reserve account, called an excess spread account, which provides an additional buffer against credit risk.
Credit Card Receivable-Backed Securities
Credit card receivable-backed securities are ABS backed by pools of credit card debt owed to various institutions. For a pool of credit card receivables, the cash flows consist of finance charges collected, fees, and principal repayments.
As credit card debt is non-amortising, credit card ABS are structured with a lockout period, during which only finance charges and fees are passed on to the ABS owners. If borrowers make principal repayments during this period, the cash is used to purchase additional credit card receivables. After the lockout period, principal payments are passed through to security holders until the ABS is retired.
Some provisions in credit card receivable ABS require early amortization of the principal if specific events occur, which are referred to as early amortization or rapid amortization provisions. These provisions safeguard the credit quality of the ABS.
That wraps up our lesson on non-mortgage ABS, where we focused on auto loan ABS and credit card ABS. In our next lesson, we’ll conclude this topic with a discussion on collateral debt obligations. See you then!