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Asset-Backed Securities
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Learning Objectives
After reading this chapter, you will understand
how asset-backed securities are created the basic structure of a securitization the parties to a securitization
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the credit risks associated with asset-backed securities and how they are analyzed.
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall
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Creation of an ABS
A security created by pooling loans other than mortgage loans is referred to as an asset-backed security (ABS). To explain how an ABS is created and the parties to a securitization, the textbook uses the following illustration. Suppose that Exception Dental Equipment, Inc. has a bulk of its sales from installment contracts (wherein the buyer agrees to repay Exceptional Dental Equipment, Inc., over a specified period of time for the amount borrowed plus interest). The dental equipment purchased is the collateral for the loan. The credit department of Exceptional Dental Equipment, Inc., makes the decision as to whether or not to extend credit to a customer.
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall
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For the third-party guarantors, the rating agencies will perform a credit analysis of their ability to pay.
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall
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When early amortization occurs, the bond classes are retired sequentially (i.e., highest rated bond class first, then the second highest rated bond class, and so on).
This is accomplished by distributing the principal payments to the specified bond class instead of using those payments to acquire more receivables. The length of time until the return of principal is largely a function of the monthly payment rate.
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There are provisions in credit card receivable-backed securities that require early amortization of the principal if certain events occur.
Such a provision, which is referred to as either an early amortization provision or a rapid amortization provision, is included to safeguard the credit quality of the structure. The only way that the principal cash flows can be altered is by triggering the early amortization provision.
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall
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Performance of the Portfolio of Receivables The following concepts must be understood in order to assess the performance of the portfolio of receivables and the ability of the collateral to satisfy the interest obligation and repay principal as scheduled:
i. ii. iii. iv. v. gross portfolio yield charge-offs net portfolio yield delinquencies monthly payment rate
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall
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where M is the number of months after origination (i.e., loan age). Given the ABS, the SMM is obtained as follows:
SMM ABS 1 A B S M 1
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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.
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