Asset-backed securities

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Asset-backed securities (ABS) are created by buying and bundling loans – such as residential mortgage loans, commercial loans or student loans – and creating securities backed by those assets, which are then sold to investors. Often, a bundle of loans is divided into separate securities with different levels of risk and returns. Payments on the loans are distributed to the holders of the lower-risk, lower-interest securities first, and then to the holders of the higher-risk securities.[1]

Consumer-related ABS are generally perceived to be safe assets because their short-duration makes cash flows more predictable, keeps ratings stable and puts them in a class of alternatives to cash and Treasuries.[2] However, the 2008 credit crisis revealed that many investors were not fully aware of the risk in the underlying mortgages within the pools of securitized assets.

The Dodd-Frank Act, signed in 2010, imposed new requirements on ABS, including business conduct standards, credit risk retention and reporting.