While Mortgage-backed Securities (MBS) and Collateralized Mortgage Obligations (CMO) securities are a form asset backed securities (and technically the largest class of ABS), the acronym “ABS” is commonly used to refer to those securities whose underlying assets are not mortgage loans.
ABS collateral includes: auto loans, credit card receivables, student loans, home equity loans, manufactured housing loans, Small Business Administration loans, and collateralized bond obligations.
Securitization Process for an ABS
- The loan originator (commonly a bank) makes a loan, such as a home equity loan where the borrower is borrowing against the equity (home value in excess of remaining mortgage balance) in his or her house.
- The bank then pools similar loans and sells these loans to a special purpose vehicle (SPV).
- The SPV holds the loans as assets and issues ABS bonds backed by the loan pool.
- Proceeds from the ABS issuance allow the SPV to fund the purchase of the loans from the bank.
- The SPV employs a third part (the third part can actually be the loan originator) as the servicer to collect monthly payments.
- The servicer then delivers the payments to the SPV’s trustee.
- The SPV’s trustee forwards payments on to the ABS bondholders and files financial reports for the collateral.
From a legal perspective, a non-mortgage ABS is very similar to an MBS, but non-mortgage ABS may have significantly lower credit quality collateral and the non-mortgage ABS collateral may be amortizing or non-amortizing.
The payment structure to an ABS investor is commonly driven by whether or not the underlying collateral is amortizing or non-amortizing.
- ABS with Amortizing Collateral: Prepayment is commonly passed through to ABS investors.
- ABS with Non-amortizing Collateral: Principal repayments from borrowers during a “lock-out period” are used by the trustee to purchase additional collateral.
- Revolving Structure: The ABS investors will not receive any principal repayments until the lock out period ends. After the lock out period ends, no new collateral will be acquired and principal payments will then be passed through to investors. This is called a revolving structure.