A Primer on Asset Back Securities
Our financial system has evolved tremendously over the past decades. This system touches almost every aspect of our lives and provides us the tools to do a multitude of things. One of these tools is the Asset Backed Security. This is a financial instrument created in the 1980’s in order to provide extra liquidity and peace of mind to investors.
There are many different uses for this type of security and they are important in many industries including the automotive, motorsport, boating, and real estate fields. This tool is important because it provides lenders with liquidity, which allows them to continue to originate more loans. Which ultimately translates into more goods for willing and able buyers, who need help financing big purchases.
In its simplest version, an ABS (Asset Backed Security) is a derivative made up of a group of loans with underlying assets. Once these loans are pooled, they go through a layering process which splits the loans into different risk categories called tranches, in order to attract different buyers. One of the most fundamental rules in finance is that when there is higher risk, investors demand a higher return and vice versa. With that being said, each tranche will have a certain risk associated with it, which is tied to the quality of the underlying loans. A pool of prime loans will be lower risk which will in turn have a lower yield. While a pool of subprime loans will be higher risk, delivering a greater yield. It all comes down to the investors' risk preferences.
These different asset backed securities are very similar in nature whether it be the automotive, boating, or other market. First there needs to be an underlying asset that can be recovered if the loanee defaults. This asset usually is income generating. For example, monthly principal and interest payments on a vehicle, boat, property or plane.
Asset backed securities, whether that be for automotive, real estate, and or boating have been performing well, especially this year. Covid-19 is still causing huge supply chain problems which is driving the price of the underlying assets that make up these loans. This is good for investors because demand is at an all time high. We will have to see how this trend plays out over time, but there is no denying the opportunity in the present.
Where does Automatic fit into all this? Automatic allows lenders to buy individual or tailored portfolios of loans, that match their risk profile and yield appetite. We offer a wide range of loans across the credit spectrum, from super prime to deep subprime. As more deals flow into the platform, this gives greater opportunity for lenders to hand craft an investment that meets their risk parameters. These deals are auto approved based on the lender criteria and allow for a swift and efficient transaction.