Asset Backed Securities

Table of Contents

Executive Summary

Table of Contents

List of Abbreviations

List of Figures

1 Introduction

2 Problem Definition

3 Objectives

4 Methodology

5 Main Part
5.1 Product Introduction and Market Functions of
Asset-Backed-Securities
5.1.1 Market Overview and Development
5.1.2 Product Definition and Types
5.1.3 Securitization Process of Asset-Backed-Securities
5.2 The Need for Asset-Backed-Securities
5.3 Risks of Asset-Backed-Securities
5.4 The Financial Crisis 2007: A Short Summary
5.5 The Connection between Asset-Backed-Securities and the Financial Crisis

6 Results and Conclusion

Bibliography i

List of Abbreviations

illustration not visible in this excerpt

List of Figures

Figure 1: Structure of the asset-backed securities market

Figure 2: Securitization process

Figure 3: Diversity of asset pools

Figure 4: Developing of the Global Financial Crisis 2007

Executive Summary

This paper occupies with asset-backed securities as a financing instrument for companies and as an investment for investors. It shows the advantages of this financing vehicle. Firms can get a quick access to the financial markets and clean up their balance sheet and creditworthiness by selling receivables out of their assets. Investors get a good return on their input and help organizations financing themselves. But heavy risks, like securitization risks, regulatory risks, counterpart risks, economical risks and wrong rating risks can endanger the financial transaction and lead into a financial default. The greed of investment banks, bad economical circumstances and at least a deficient risk management of companies helped ABS products becoming a main role during the financial crisis of 2007. During the financial crisis ABS products lost their natural status as financing instruments and became something like financial investments.

1 Introduction

In the past the financing opportunities of companies has dramatically changed. More and more financial instruments were established to enable nearly every organization the access to financial resources. The globalization and the technological development allow companies to get in connection with creditors all over the world. New types of securitization enlarged the global volume of loans and therewith related risks.^[1] A good financial instrument and alternative to the typical capital procurement are asset-backed securities (ABS). This financing instrument is thereby characterized that pecuniary claims out of securities are backed by a pool of assets which are transferred from companies to a special purpose vehicle (SPV). In fact, the credit receiver gives a promise to the creditor that he will pay the given loan back and the collateral pool of assets guarantees the payback.^[2] In this context securitization is a process of packaging financial promises into a bundle which can be transferred among a multitude of investors^[3]. As a result, these securities can be transferred all over the world. And here is the link to the last financial crisis started in 2007. The securitization of an asset pool is also a credit risk transfer where the organization transfers the risk of bad debts to the investor.^[4] If the company is exposed to a loss of receivables, it possibly cannot comply for its own financial promises out of the ABS. That was one task which led into the youngest financial crisis. On the one hand, ABS are innovative and common financial instruments but on the other hand there are many risks resulting out of these financial transactions.

2 Problem Definition

As mentioned, ABS are good financing instruments and companies can use this financial source regardless of its own financial situation. This financing form can be cheaper than a usual bank loan if the risk premium for the pool of assets is lower than the risk premium for the company. It is also a fast way to transfer assets into cash and therefore the balance sheet is also involved in this transfer. It is a typical accounting exchange on the asset side. Beside the good facts about ABS, this financial instrument has also risks emerge from the quality of the pool of assets which are liable for the return out of the securities.^[5] Often, these risks are not clear to the investors and investment firms or banks sell these securities to common people which do not even know about what they are investing in. The problem here is that the globalization, the technical development and the improvement of banks in the securitization of assets can make out of a simple financing instrument a complex product and sell it all over the world. The investment markets disguise the risks and the greed of investors ensures that the catastrophe is perfect. In the worst case this financing system can lead into a global financial crisis.

3 Objectives

The objective of this assignment is to discover the advantages of ABS as a financing instrument for companies and as a financial investment for investors. An exactly description of the risks occurring out of ABS products under consideration of the globalization and the dynamic financial markets should show the possible consequences established out of a wrong treatment.

4 Methodology

The methodology of this paper can be described as followed. The first chapter describes the product ABS with its different sub-types and application area. The securitization process will be explained and the different parties which are involved in this process are named. The second chapter informs about the needs of ABS products as financial instrument. In this part it will be defined why ABS are good alternatives for financing on the capital markets. Also the advantages of investors will be considered. The risks and the possible consequences of ABS transactions are characterized in the third chapter. Afterwards there will be given a short summary of the youngest financial crisis before connecting the ABS market with the causes of the crisis.

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^[1] Sommer (2009), pp. 41 – 44.

^[2] Rudolph & Hofmann et al. (2012), p. 48.

^[3] Davidson & Sanders et al. (2002), p. 3.

^[4] Rudolph & Hofmann et al. (2012), p. 41.

^[5] Rudolph & Hofmann et al. (2012), p. 62.