Structures of Asset-Backed Securities

The way an asset-backed security (ABS) is structured often depends on the type of collateral it is based on. Different types of loans require different structures to manage how payments are received and distributed.

Installment Loan Asset-Backed Securities

Installment loan asset-backed securities are similar to mortgage-backed securities but are based on loans for things like cars, boats, or other vehicles.

Structure: These securities are backed by a specific pool of installment loans. Investors buy into a trust that holds these loans. The trust collects payments from the loans and distributes them to investors.

Payments: Investors receive regular payments from the trust. This includes interest and a portion of the principal from the loans each month. If loans are paid off early, investors still get a full month's interest on these early repayments. The total amount of principal payments depends on how quickly the loans are paid off.

Impact of Prepayments: Faster prepayments (when borrowers pay off their loans early) can shorten the life of the security because the principal is returned to investors more quickly.

Revolving Asset Transactions

Revolving asset-backed securities are used for loans like credit card balances or home equity lines. These loans don’t have a fixed repayment schedule and can be borrowed and repaid repeatedly.

Structure: Due to the short duration of these revolving loans, the securities are structured differently to handle cash flows efficiently. Instead of paying out principal and interest immediately, the security goes through two phases: a revolving phase and an amortization phase.

Revolving Phase: During this phase, only interest payments are made to investors. The principal payments are used to buy more receivables, like new credit card charges or home equity draws. This phase continues as long as new loans are added to the pool.

Amortization Phase: After the revolving phase ends, the amortization phase begins. During this phase, both principal and interest payments are made to investors. The length of the security's life is influenced by the duration of the revolving phase.