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Unformatted text preview: CHAPTER 15 ASSET-BACKED SECURITIES CHAPTER SUMMARY A security created by pooling loans other than residential prime mortgage loans and commercial mortgage loans is referred to as an asset-backed security (ABS). The market classifies securities backed by subprime mortgage loans as mortgage-related ABS. The two types of assets that can used as collateral for an asset-backed securitization are existing assets/existing receivables or assets/receivables to arise in the future. Securitizations with existing collateral are referred to as existing asset securitizations. Securitizations of assets/receivables to arise in the future are referred to as future flow securitizations. The types of assets that have been securitized fall into the following two general categories: (1) consumer asset-backed securities and subprime residential mortgage-backed securities (MBS) and (2) commercial asset-backed securities. The broad-based bond market indexes include an ABS sector. The five largest subsectors within this sector are: (1) credit card receivable ABS, (2) auto ABS, (3) home equity ABS, (4) rate reduction bonds (also called stranded cost ABS), and (5) manufactured housing ABS. CREATION OF AN ABS A security created by pooling loans other than mortgage loans is referred to as an asset-backed security (ABS). The textbook uses the following illustration to explain how an ABS is created and the parties to a securitization. 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. The criteria for granting a loan are referred to as underwriting standards . Because Exceptional Dental Equipment, Inc., is granting the loan, the company is referred to as the originator of the loan. Moreover, Exceptional Dental Equipment, Inc., (EDE) may have a department that is responsible for servicing the loan. As explained in previous chapters, servicing involves collecting payments from borrowers, notifying borrowers who may be delinquent, and, when necessary, recovering and disposing of the collateral (i.e., the dental equipment in our illustration) if the borrower fails to make the contractual loan payments. While the servicer of the loans need not be the originator of the loans, in our illustration we are assuming that the originator (EDE) is also the servicer. Suppose EDE has more than $300 million of installment sales contracts and wants to raise this amount. Rather than issuing corporate bonds for $300 million, the EDEs treasurer decides to raise the funds via a securitization. To do this, EDE sets up a legal entity called a special purpose vehicle (SPV) that is called DE Asset Trust (DEAT). EDE will then sell to DEAT $300 (SPV) that is called DE Asset Trust (DEAT)....
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