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9.8 Credit analysis required for asset-backed securities

  • An asset-backed security (ABS) is a type of bond issued by a legal entity called a "special purpose vehicle" (SPV).
  • An SPV is formed to own a collection of assets, called its "collateral pool."
  • The collateral pool usually consists of a collection of loans of a particular type.
  • Unlike corporate debt, an asset-backed security does not default when an interest payment is missed.
  • A default in the collateral pool does not cause a default to either the SPV or a bond tranche.
  • For an ABS, the bond continues to trade until either its maturity date or all of its face value is eliminated because of the accumulated losses in the collateral pool or through early loan prepayments.
  • Because of the complexity of the cash flows to an ABS, they are better characterized as credit derivatives than simple bonds.

Lesson Wrap-Up

This lesson should leave you able to explain the credit analysis required for asset-backed securities in a fixed-income context and connect it to the decisions made by issuers, investors, or analysts.

Review Prompts

  1. Explain credit analysis required for asset-backed securities in your own words.
  2. State one exam-style risk, valuation, or market implication of the credit analysis required for asset-backed securities.