Meyer International believes that fixed income instruments are a key part of any portfolio. But before any investment choice, it is vital to have at least a general understanding as to how it works. To further understand asset-backed securities (ABS), we are going to take a look at the various components and steps involved in creating ABS. Here we’ll look at securitisation.
“Having an understanding of how an investment instrument works is key to making smart investment decisions,” explains Richard Cayne of Meyer International.
Turning debt into a security
Securitisation is the process of turning financial assets into a security that can be bought and sold. While it is true that a lender can sell single loan to another lender, this is very rare – most potential buyers would not want to purchase a loan so that the liabilities goes on their balance sheets. By bundling them together, default risk is spread across the group of loans.
With securitisation, the lender, or originator, selects a group of assets, such as loans, and sells them to a special purpose vehicle (SPV) it created. The originator structures the SPV solely for bundling these assets and issue bonds based on them, creating asset-backed securities.
What does this mean?
This creates a barrier between the assets and the originator, which creates benefits for both investor and originator.
For the originator, this provides another way of raising money, other than getting a loan themselves, which is often not ideal for them. There are also tax and risk mitigation benefits as these assets are moved from their balance sheets.
For investors, this provides a fixed income investment opportunity. Depending on the quality of the underlying loans, based on the borrower, collateral, repayment terms, etc., you could find yourself a steadier flow of income than with other instruments.
“The 2008 credit crisis gave securitisation and ABS a bad name,” says Richard. “It is actually a sound method for creating fixed income that would benefit many investment portfolios.”
If you’re interested in added fixed income to your portfolio with some ABS, contact Richard at Meyer International.